The Interpretation of the Earnings and Price Correlated F.A.S.T. Graphs™ Made Simple
At their core, F.A.S.T. Graphs™ are easy to interpret and understand. When you are clear on what the lines and shaded areas on a F.A.S.T. Graphs™ represent, you will experience an instantaneous and comprehensive understanding of the business behind the stock, and how the market has, and is, pricing it.
The Orange Line and Dark Green Shaded Area
First, F.A.S.T. Graphs™ plots the earnings of the company and calculates its growth rate for the time period being graphed. Then presented as a theoretical calculation or metaphor for intrinsic value, an orange line with white triangles is generated based on applying widely-accepted formulas for valuing a business. The orange line represents the same P/E ratio on every point on the graph and is also reported in the orange rectangle in the FAST FACTS box to the right. The dark green shaded area is simply a mountain chart of the company’s earnings each year.
For companies growing earnings at a rate of 15% or better, the classic formula P/E equals growth rate, commonly referred to as PEG, and made famous by Peter Lynch is applied. Therefore, when a company’s earnings growth is 15% or greater, the orange line will have a P/E ratio that is equal to its growth rate. When this formula is used, it is designated with the letters “P/E=G” in the orange rectangular box on the FAST FACTS to the right. The following F.A.S.T. Graphs™ on Visa Inc (V) is an example of a fast-growing company utilizing the P/E=G formula.
For the timeframe graphed below, Visa achieved an operating earnings growth rate of 22%, which is listed in the green rectangular FAST FACTS box to the right. Then notice that the P/E ratio of Visa’s orange line is also 22, which is equal to its earnings growth rate. The designation P/E=G in the orange rectangle designates what formula the F.A.S.T. Graphs™ has used to calculate fair value.
Our second example is Southern Company (SO), a slow-growing utility stock whose operating earnings growth rate has only averaged 3% during the 11-calendar year timeframe graphed. Here we see the operating earnings growth rate of 3% shown in the green rectangle on the FAST FACTS to the right. However, in this case the P/E ratio of the orange line is 15, and was calculated using the famous formula authored by Ben Graham. The designation GDF, which stands for Graham Dodd Formula, is included in the orange rectangle in the FAST FACTS to alert the reviewer to the formula used, and to the growth rate the company has achieved.
Across the entire span of the graph, the P/E ratio in this low growth example is 15. Additionally, the slope of the orange line in this example is 3%, or the earnings growth rate of Southern Company in this example. Once again, the dark green shaded area represents a mountain chart of Southern Company’s earnings.
Our third example is V.F. Corporation (VFC), which has a moderate rate of operating earnings growth that has averaged 10.4% per annum over this 11 calendar year timeframe. When earnings growth is above 5% but below 15%, the P/E ratio is calculated utilizing an extrapolation of the two previous formulas (P/E=G and GDF) with the connotation GDF…P/E=G – Formula (note that the dots between them are utilized to indicate that the extrapolated formula is being used).
Once again, the fair value P/E ratio that applies to the orange line is listed in the orange rectangle under the FAST FACTS to the right of the graph. In the V.F. Corporation example, the P/E ratio of the orange line is 15 across the entire span of the orange line on the graph. However, the slope of the line is equal to the company’s 10.4% growth rate, which is listed in the green rectangle in the FAST FACTS to the right.
To summarize, the orange line and dark green shaded area depict the company’s operating earnings during the timeframe graphed. The intrinsic value, or P/E ratio, is calculated and listed in the orange rectangle in the FAST FACTS. The earnings growth rate, which is also the slope of the orange line, is listed in the green rectangle in the FAST FACTS to the right of the graph. Finally, the dark green shaded area represents a mountain chart of the company’s earnings.
More simply stated, the orange line and dark green shaded area give you a graphic portrayal and instant look at the business behind the stock. This is the most distinguishing and salient feature of the F.A.S.T. Graphs™ (Fundamentals Analyzer Software Tool) stock research tool. Most other stock graphing tools plot price only. As you will soon see, F.A.S.T. Graphs™ in contrast reveals the earnings and price relationship of the stock and the business behind the stock.
Dividends are Expressed in Two Important Ways
First, dividends are expressed on the F.A.S.T. Graphs™ reflecting that they have been paid out by the light green shaded area sitting on top of the orange earnings justified valuation line. Later when price is included on the F.A.S.T. Graphs™, you will see how the market prices earnings, representing capital appreciation, and how the dividend represents the second component of total return – dividend income. This is the primary reason why the light green shaded area representing dividends is included and depicted outside the dark green shaded area, which depict earnings.
Another advantage of expressing the dividends paid out in this manner is that the reviewer of the F.A.S.T. Graphs™ can instantly see whether or not a company pays a dividend, and for companies that have just started paying a dividend, they can also see when the dividend had first been initiated.
In addition to expressing dividends after they have been paid out by the light green shaded area on top of the orange earnings justified valuation line, dividends are also expressed by a light honeydew green line within the dark green shaded earnings area. This serves two important purposes. First, it allows the reviewer to instantly see whether dividends have grown consistently, or have been cut at any time during the timeframe graphed. The light honeydew green line is simply a plotting of the company’s dividends each year utilizing the same multiplier that applies to the orange valuation reference line on the graph.
When expressed this way, the second purpose of the light honeydew green line is to graphically illustrate the dividend payout ratio of the company. The entire area below the light honeydew green line represents the portion of the earnings (the dark green shaded area) that are paid out and simultaneously expressed by the light green shaded area on top of the orange earnings justified valuation line. In the case of our V.F. Corporation example below, the honeydew green line also alerts the reviewer to any changes in the company’s payout ratio (Notice how V.F. Corporation’s payout ratio increased dramatically in 2006). To understand this better, think of the area below the light honeydew green line of the dark green shaded area as a blank spot in a puzzle, and the light green shaded area as the puzzle piece that would fit there.
This would still be true for a company with very cyclical earnings, however, the light green shaded area could give the illusion that dividends were being cut because they are stacked on a rising and falling orange earnings valuation reference line. This is an additional benefit of the light honeydew green dividend line, it will instantly reveal whether the dividend has been cut, raised, or lowered over the timeframe graphed.
In the United Technologies Corporation (NYSE: UTX) example shown below, by observing the light honeydew green line we see that their dividend increased even during the time following the Great Recession (the gray shaded area) when earnings dropped. Because dividends paid are stacked on top of the orange line, the light green shaded area would give the false illusion that dividends fell when in actuality they increased.
Introducing Monthly Closing Stock Prices
The black line on a F.A.S.T. Graphs™ plots monthly closing stock prices for the timeframe being graphed. When added to the earnings and dividend graph, the correlation between how well the business has done and how stock price has reacted and correlated is vividly revealed. On graph after graph where earnings go the price is sure to follow. To illustrate the correlation between price and earnings we turn to Ross Stores Inc (ROST) that represents a quintessential example of the earnings and price relationship.
Notice how the stock price (the black line) closely follows earnings (the orange line) over the long run. Further notice that when the stock price falls below the orange valuation reference line undervaluation is indicated, when the price is above the orange valuation reference line overvaluation is indicated and when the price is touching the orange valuation reference line this represents a time when price is at intrinsic value levels.
The Blue Normal P/E Ratio Line
Moreover, and as an oversimplification, when the black line is above the orange valuation reference line, overvaluation is indicated. When the black line is touching the orange valuation reference line, fair value is indicated. When the black line is below the orange valuation reference line, undervaluation is indicated. However, the real world does not always cooperate as planned. There are certain companies that the market typically overvalues or undervalues, and the F.A.S.T. Graphs™ research tool reveals these situations when they occur by adding an additional valuation reference line to the graph called the normal P/E ratio line (the dark blue line).
F.A.S.T. Graphs™ automatically calculates the P/E ratio that the market has most commonly applied to a given stock over any timeframe that is graphed (Note: The orange rectangles at the top of the graph allow users to instantly change time frames by just clicking on the rectangle). This adds a second metaphor of valuation to the F.A.S.T. Graphs™. The normal P/E ratio is dynamic and can and will change when different time frames are drawn.
It’s important to state here that F.A.S.T. Graphs™ were not designed to dictate fair value. Instead, they were designed to reveal it. In other words, it is up to the user to decide whether or not the blue normal P/E ratio valuation reference line on the graph, or the orange earnings justified valuation reference line on the graph, is the right one to base valuation decisions on. The essence of FAST Graphs™ is that they are “a tool to think with.”
Therefore, with the Coca-Cola Company (KO) example below, there are two expressions or references of valuation included. The blue line representing the normal P/E ratio, and the orange earnings justified valuation line. The key to evaluating either of these metaphors of valuation is simply to look closely at the graph and ask yourself which line most appropriately represents a reasonable valuation for the company over the timeframe being graphed. It is also important to notice how the black monthly closing stock price line trends and correlates with both lines. In other words, where earnings go, price is sure to follow.
Understanding the Associated Performance Results
As a great convenience and benefit to the subscriber, F.A.S.T. Graphs™ automatically calculates the performance of the company over the timeframe graphed. The performance results table is easy to interpret and understand. Just under the company’s name and symbol is the performance table. The top of the table shows the amount invested, the beginning shares purchased, and the split-adjusted price for the date in which the graph begins. At the top right corner we see the closing values and closing prices through the previous day’s close.
Next we have the dividend cash flow table. Here you see the fiscal year-end, the dividends per share, the dividend growth rate, earnings per share payout ratio in percentages year-by-year and averaged for the timeframe, the end of period shares, dividends paid, and finally, yield on cost. Tallies are given at the bottom of the table for the appropriate columns.
Finally, the performance report shows total cumulative dividends paid, the amount of capital appreciation and the annual return it represents, followed by total return information that includes dividends in the total. For added perspective, the box at the bottom right-hand corner compares the company’s results with the S&P 500 over the same timeframe. In the example below, dividends are not reinvested, but F.A.S.T. Graphs™ are given the option to calculate the same performance with dividends reinvested by simply checking a box in the navigation bar and redrawing the graph.
The Estimated Earnings and Return Calculators – A Set of 5 Forecasting Graph Options
Finally, in addition to the basic Earnings and Price Correlated F.A.S.T. Graphs™ research tool includes a set of 5 forecasting graphs. Before we explain the components of these simple graphs, the reader’s attention is drawn to the word “calculator” in the description.
The first calculator, which is automatically utilized as the default setting for F.A.S.T. Graphs™ is the “Estimates” calculator based on reporting the near-term consensus estimates of leading analysts reporting to S&P Capital IQ for the next 1 to 3 years forward. The number of analysts providing estimates for each year is listed in the table at the bottom of the graph.
The second calculator is the “Normal PE” calculator which utilizes the company’s historical normal P/E ratio as the valuation reference line in order to provide a 2nd valuation reference for forward earnings. However, this calculator utilizes the same near-term consensus analyst estimates as the “Estimates” calculator.
The third calculator is the “3 to 5Y Growth” calculator which is based on a second set of long-term (3 to 5 year) consensus earnings estimates also collected and provided by S&P Capital IQ. The number of analysts providing estimates for the long-term earnings growth rate (the estimated three to five-year earnings growth rate) is listed in the green rectangular box in the FAST FACTS to the right of the “3 -5Y Growth” Estimated Earnings and Return Calculator graph.
The forth calculator is the “Historical CAGR” calculator which allows the user to replace consensus analyst earnings estimates with historical compound annual growth rate achievements. There is a drop-down at the bottom of the graph that allows the subscriber to select the historical growth rate that they consider most applicable or potentially achievable by the company. (Note: The growth rate in the “Historical CAGR” calculator may be different than the growth rate on the historical graphs above because the historical graphs include one or 2 years of forecasting and the calculators are utilizing historical completed years only.)
Finally, subscribers are given the option to input their own estimates into the “Custom Calculator”. This includes inputting your own estimates for earnings, dividends the company’s growth rate and a preferred P/E ratio. This final calculator allows subscribers to create forecasting graphs based on as many “what if” scenarios they desire.
Additionally, there are several other important pieces of information on each of the 5 respective Forecasting Calculators.
Each Earnings and Return Calculator provides a specific dollar amount for the current fiscal year earnings estimate per share and is found directly below the graph, and marked with a capital “E” for estimate.
Just below the earnings per share figure is a column depicting each year’s calculated change per year (Chg/Yr) thereby enabling the subscriber to compare the current fiscal year forecasts against the company’s historical norms. Just under this column are the number of analysts (#Analysts) comprised in the forecast. The next estimate is also a specific earnings per share number forecast for the next fiscal year, and again, the number of analysts making this forecast is indicated. Beyond these numbers there will be one or two additional years of specific estimates. However, it should be noted that the number of analysts providing these forecasts tend to drop off significantly. Following the final specific forecasts the graph simply extrapolates the long-term estimated earnings and growth rate.
As a general rule, it is suggested that more credence be given to near forecasts. It is only logical to assume that the closest forecasts could be expected to be more accurate than for years farther out. Furthermore, there are typically more analysts comprising the consensus for the closest years.
Summary and Conclusions
F.A.S.T. Graphs™ are easy to interpret and utilize when you know what you are reviewing. The orange valuation reference line on the graph shows earnings per share and reflects the growth rate of the company’s operating history. The black line represents monthly closing stock prices and how they track those earnings. The light green shaded area shows dividends, and an additional dividend expression is given by the light honeydew green line in the dark green shaded earnings area. The dark blue line on the graph calculates the price earnings ratio (Normal P/E) that the company has historically traded at during the timeframe being graphed.
Now you know why we state that F.A.S.T. Graphs™ provide essential fundamentals at a glance. In an instant you can see how well the business behind the stock you are reviewing has done, how the market has historically priced it, how the market is currently pricing it, what type of performance this has generated for shareholders, and finally, how the stock is currently being valued by the marketplace.