would probably be many years in the future. In the meantime, the restaurant’s earnings growth could be stymied. And with the asking price for the restaurant seemingly based on continuing growth (the owner would not reduce the price when he was confronted with the zoning board information), the purchase no longer seemed like a good investment. In this case, the investigation of the KPIV of population growth, which seemed to account for much of the past growth, indicated that future growth of restaurant customers could be slow.
Sure, someone who wanted to bet on expanding the restaurant’s menu or up- grading the facilities might be able to grow the restaurant’s profits despite the area’s lack of population growth, but my friend and I agreed that this made the restaurant investment too risky, especially given the price.
Readers should have gleaned several things from this example. First, some simple analysis of data helped us make an investment decision. Second, check- ing for correlations hinted that population growth had been a primary driver in past restaurant profit growth, and that drove us to find that future population growth was not expected, at least not soon. And third, the price of the restau- rant was an important part of the investment decision. At a lower price, the restaurant may have been a good investment even without the population growth, but it was not a good buy at the current price. Few investors give their stock investment picks even the rudimentary overview that we gave the pizza restaurant purchase, especially related to price!
Key Point
First, some simple analysis of data helped us make an investment decision. Second, checking for correlations hinted that population growth had been a primary driver in past restaurant profit growth, and that drove us to discover that future population growth was not expected, at least not in the immediate future. And third, the price of the restaurant was an important part of the investment decision.
First, in Figure 2.4, I show a graph of the proportional change of the S&P 500 Index every six months. I used values that include adjustments for divi- dends (assumes that dividends are reinvested) and splits.
Then, in Figure 2.5, I graphed the proportional change of GE every six months. I again used values that include adjustments for dividends and splits.
Comparing Figures 2.4 and 2.5, it isn’t easy to see much except that GE seems to be generally higher and very uniform in the six-month change average in the later part of the 1990s. So I generated another chart, Figure 2.6, showing the GE change rate minus the S&P 500 change rate to try to see more that’s of interest.
Again, it is difficult to see much. But on the right- hand side of the graph, near the end of the 1990s, there are seven points in a row (with the highest point on the chart right in the middle of the seven points) that are mostly positive, which seems to be unique for the graph time period.
Going back to the raw data used to build the graph, I found that those are the periods between July 1998 and June 2001. So, let’s see if we can get more information from this data by looking at the average differences
−0.3000
−0.2000
−0.1000 0.0000
Proportional Change
0.1000 0.2000 0.3000 0.4000 0.5000
Six-Month Intervals
Jun-71 Jun-73 Jun-75 Jun-77 Jun-79 Jun-81 Jun-83 Jun-85 Jun-87 Jun-89 Jun-91 Jun-93 Jun-95 Jun-97 Jun-99 Jun-01 Jun-03 Jun-05
FIGURE 2.4 Proportional Change in S&P 500 Index (Adjusted for Splits and Dividends), Six-Month Intervals
Source:Data from http://finance.yahoo.com/
Splits A company increases the number of its shares, and the price then adjusts down- ward in the same propor- tion; the net equity of each shareholder after a stock split generally stays the same
−0.4000
−0.3000
−0.2000
−0.1000 0.0000
Proportional Change 0.1000
0.2000 0.3000 0.4000 0.7000 0.6000 0.5000
Six-Month Intervals
Jun-71 Jun-73 Jun-75 Jun-77 Jun-79 Jun-81 Jun-83 Jun-85 Jun-87 Jun-89 Jun-91 Jun-93 Jun-95 Jun-97 Jun-99 Jun-01 Jun-03 Jun-05
0.3500 0.3000 0.2500 0.2000 0.1500 0.1000
Proportional Net Difference
0.0500 0.0000
−0.0500
−0.1000
−0.1500
Six Month Intervals
Jun-71 Jun-73 Jun-75 Jun-77 Jun-79 Jun-81 Jun-83 Jun-85 Jun-87 Jun-89 Jun-91 Jun-93 Jun-95 Jun-97 Jun-99 Jun-01 Jun-03 Jun-05
FIGURE 2.5 Proportional Change in GE Price (Adjusted for Splits and Dividends), Six-Month Intervals
Source:Data from http://finance.yahoo.com/
FIGURE 2.6 Net Change in Difference: GE Minus S&P 500, Six-Month Intervals Source:Data from http://finance.yahoo.com/
between GE and the S&P 500 for the period between July 1998 and June 2001 versus the time intervals before and after those dates. I illustrate this in Figure 2.7.
With this graph, it becomes evident. In the period before June 1998, the GE stock price gain, including dividends, averaged 2.1 percent per six-month in- terval (4.2 percent annually) higher than the S&P 500, including dividends.
That is a good performance! However, starting July 1998, GE really took off, with its stock, including dividends, performing at an unbelievable 7.5 percent av- erage increase per six-month interval (15.6 percent annually) in excess of the average performance of the S&P 500. And since the S&P 500 was going up an average of 4.5 percent per six-month interval (9.2 percent annually) during that period, the average gain for the GE stock price between July 1998 and June 2001 was almost 25 percent per year!
However, following this remarkable period, the average GE price change plus dividend results have been almost 4.1 percent per six-month period less than the S&P 500 average including dividends. Since the S&P 500 was going up approximately 4.0 percent per six-month period during this most recent time interval, that means that GE was basically flat and actually losing real value every year since June 2001 when inflation is included!
When we revisit the data used to generate Figure 2.7, statistical tests on the raw data can determine whether the three different levels shown visually on the graph are statistically different or just random events.
FIGURE 2.7 Six-Month Interval Average Differences: GE Minus S&P 500, June 1971–June 1998, July 1998–June 2001, July 2001–December 2006 Source:Data from http://finance.yahoo.com/
−0.06
−0.04
−0.02 0 0.02
Average Proportional Differences
0.04 0.06 0.08 0.1
Six-Month Values
Jun-71 Jun-73 Jun-75 Jun-77 Jun-79 Jun-81 Jun-83 Jun-85 Jun-87 Jun-89 Jun-91 Jun-93 Jun-95 Jun-97 Jun-99 Jun-01 Jun-03 Jun-05