BI > DECEMBER 2003

Shortcomings Of Breadcrumbs

Visualizing Representative Track Records

Hansel turned and looked back to check his track record. He smiled at the line of bread crumbs extending to the horizon, clearly marking the path that he and Gretel would need to find their way home. The trouble with NAIC Stock Selection Guide (SSG) bread crumbs is that the acquisition and divestiture "birds" tend to wreak havoc with the trail-marking croutons. Under these conditions, SSGs can be vulnerable to confusion and misdirection.

The effectiveness of a stock study using the SSG depends on whether the historical picture is representative of the outlook going forward. The key concept to embrace has to do with the notion of continuing operations.

What if the historical track record fails to reflect the company that you own or are considering for purchase?

Lines In The Sand

Much of the historical data available to investors fails to completely account for mergers and spinoffs. Rather than restate historical data to reflect sales (and profits) from continuing operations, most analysts draw vertical lines, add a footnote and maintain the data "going forward." Value Line delineates Pfizer's additions of Warner-Lambert (2000) and Pharmacia (2003) in this manner. Footnotes (E) and (F) tell us that the acquisitions are accounted for in the data starting in 2000's first quarter and 2003's second quarter.

It is important to note that the historical data for Warner-Lambert (before 2000) and Pharmacia (before 2003) is not included in the Value Line data array for Pfizer. Analysts rarely adjust historical data for mergers and acquisitions.

Click to enlarge.

Figure 1. The historical sales growth for Pfizer (1994-2003) is estimated at 20.9 percent -- if we fail to account for the additions of Warner-Lambert (2000) and Pharmacia (2003.) Source: Value Line Investment Survey.

Figure No. 1 provides the sales portion of an SSG, based on the sales track record found in Value Line. The S&P data would be very comparable. Without accounting for the missing historical contribution of Warner-Lambert and Pharmacia, we find that the sales track record for Pfizer leads to a computer-generated calculation of 20.9 percent for historical sales growth.

Click to enlarge.

Figure 2. A more representative look at the historical sales track record of Pfizer's continuing operations including Warner-Lambert. The historical sales growth rate for 1997-2002 is 10.0 percent. Source: Pfizer Annual Report.

Figure No. 2 is compiled using data from Pfizer's annual report for 2002. The financial summary has been reconfigured to reflect Pfizer's business as it was at the time of the report. The historical data has been adjusted to reflect the combined sales history, including Warner-Lambert. Pfizer analysts have itemized (and removed) intercompany sales and discontinued segments of the overall business.

Growth Expectations

The difference between 10 and 20.9 percent is enough to derail any stock study. Hansel and Gretel would be the first to suggest that having the right trail markers is a step in the right direction.

Mark Robertson is director of online resources and senior contributing editor for BetterInvesting. He serves as a member of BetterInvesting Magazine's Editorial Advisory & Securities Review Committee. Mark can be reached at Robertson_Mark@comcast.net.