Phil Town
Phil Town

New homework: David's applying technical indicators to HANS. Read on. [His original letter is dated March 9.]

Hello Phil Town,

I think I am getting the hang of this (Steve's post was great).

The red line is the "flag" and crossing it is the indication.

If I am correct, today is the day that all 3 red flags are up for HANS and it would be a good time to sell.  After trading shows a bit of a bounce.

Oh, I went back and did the same analysis on another stock I owned (WDC) and sold for a loss yesterday (and after having a gain for a while).  The lines told me to have sold on the 6th and kept my profit.

Am I on the right track here?  I am using one month for the timeframe.  Should I tighten that up a bit?

Preordered and waiting for your book.  Thanks for teaching us.


My response:

Hansen's Natural Sodas has been smoking the rest of the soft drink industry.

Hopefully you got in at a great price.  Before we even talk about the signals, do you like the Moat and the Management?  (I assume you love their colas.)

Assuming you've done your homework and want to own this business, let's talk about the price.  What's this thing worth today? 

Well, we have to see if it's a predictable business, right?  Or we can't even price it. And after looking at the sales, earnings, equity and cash flow, I'd say it's fairly consistent over the last ten years.  It has some flat spots and cash gets bumpy, but overall not terrible.  I can see this thing continuing to make headway in the cola wars.  But at what speed? 

I'm going with equity growth since it's most consistent over the years and the best predictor.  It's growing at about 20%.  Now I look at the analysts projections and the one person covering this stock is estimating 20% as well.  So let's use that.

Now we look at historical PE.  VERY interesting.  The range for Hanson is from 4 to 21.  And that's in one year!  Crazy!  While I'd like to put a Rule #1 PE on this (2 times the growth rate of 20 is a 40 PE), with those historical PE's I just can't.  Obviously the buyers out there are discounting the future.  Probably because it's up against Coke and Pepsi.  Crossing those moats can be hazardous.

So what number to use to know the price?  Let's use 20 and expect that if things go well, we'll see the PE rise over time.

And the TTM EPS is $2.14,  So we're going to double it 3 times in ten years (Rule of 72).  So 2 to 4, 4 to 8 and 8 to 16.  Then apply the 20 multiple and we get $320 for a price in ten years.

So if I know I can sell in ten years at $320, how much should I pay today?  If I want a 15% return I should pay one quarter of $320.  That's $80.  And that is the Sticker Price.

The Margin of Safety Price for a new entry into this business is half of that or so.  About $40.

And it's selling for $110.  Hmmmm.  If we buy today and things work out as planned and we sell for $320, our return on our investment is going to be kind of anemic.  About 11%.  And that's if all goes well.

So, David, either you have to have a very strong opinion that the analyst is wrong about the growth rate or you have to believe that the historical PE is going to move up quite a bit -- which, by the way, could easily happen in this case as the business makes the big guys believers. 

I think in this case the growth rate is quite good.  20% is nothing to sneeze at. And if it sticks the growth rate, the PE will rise at least into the 30's.

If we go back and play with that number we get a future price of $480 and a Sticker of $120 with an MOS of $60.

Dang it.  Seems like this business is already priced up to retail, doesn't it?

Okay, now we can talk about the "flags".  In this case, you are outta there my friend.  Just put Hansen on the watch list and wait patiently for the inevitable return to a big MOS -- and then step in and buy it when the big guys are moving back in.  Which does bring us to the "flags" at last.

I'm looking at MSN charts for HANS about 3 days ago, right?  Here's what I see:  The Stochastic went red.  During the trading day the MA went red but by the end of the day it was back above the 10 day MA line.  And the MACD dipped but never actually crossed the red line. (One of the reasons I prefer to watch these signals when the market is closed!)

I have a 50 day MA up on my MSN screen to go along with the 10 day because what I really want to use is the 30 day but MSN won't give it to me.  So I kind of interpret between the two.  Especially in a stock that is trending up like this one, I want to get out slower and get in faster so I tend to give it some room to recover from a dip by watching the 30 or 50 if that's all you have.  So in this case I would have stayed in.

And that is assuming that I rode this up from a great MOS, which means I'm playing with house money and can afford to be a bit slack.  I'd be basically waiting for the stock to hit my Sticker Price (somewhere right around here best case) and then I'll stay with it as far as it wants to run -- then get out on the flags and stay out until I get at least another 20% MOS.  Then I can pop it again.  Meanwhile, I'm looking over my watch list to see if there is something going green that has a big MOS.

And that's how you use the "flags".

Now go play!