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The BMW Method
My Comprehensive Approach to DD

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By TwinDeltaTandem
July 12, 2006

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Just like many of you, I've been trying to wrap my mind around what, exactly, the BMW method does: how does this seemingly technical tool function organically, within an actively fundamental approach to picking successful stocks? Here's what I've come up with: subscribe to Morningstar and read their analysis. (Ouch...I can hear your disdain already!)

Now, I have a few other hoops that I like to jump through, and will continue jumping through them (e.g., running a Piotroski analysis; considering Graham's acid test items; when possible, doing a little Peter Lynch-style fuzzy analysis (I recently visited most of the Home Depot stores in San Antonio to determine the consistency of merchandising, and to ask employees what they thought of Nardelli (which was "very, very little"); floating my thesis on The Fool and reading through any Fool boards dedicated to the company; etc.). But the foundation of my DD has become Morningstar. Here's why...

1. At $135 per year, Morningstar isn't free; but it's still pretty darn cheap. I've used most of the free services on the 'net, but just don't like any of them.

(MSN's free site is pretty good in terms of its data content, but the analysis is, to me, too much of a mongrel conglomeration of various investment styles--momentum, tech and value aspects are all thrown together to determine an overall rating. Also, it's all completely computer-generated with no human interaction. Oftentimes, the results are absurd.)

2. They're better than I am. I've studied and sometimes practice doing my own fundamental valuation analysis from the ground up, using Penman's techniques, or free on the web at the McGraw-Hill website--you can even download Excel spreadsheets with all the basic inputs for a complete company valuation. If you've never done this, it's an invaluable experience; however, there will always be assumptions made when doing a third-party valuation. And the process is absolutely painstaking--at the end of the day, the Morningstar valuations seem to be both relatively accurate and predictive. Unfortunately, we don't see the work behind the Morningstar valuation number. However, we do know the factors that drive it, and the analysts are very transparent in what they see as the drivers.

3. Morningstar is current. In addition to posting their thesis along with the leading bull and bear arguments, the analyst assigned to each company posts what amount to blog entries on a regular basis. For example, here's the latest entry for MMM:

Analyst Note 07-07-2006

On Friday, 3M MMM warned that it expected second-quarter earnings, excluding special items, to come in lower than it had forecast. The culprit appears to be the company's LCD television-related business. Manufacturers' overestimation of flat-screen TV demand stemming from the World Cup has resulted in an inventory overhang in the supply chain and concurrent decrease in TV production. Also affecting results are startup costs related to expanding 3M's optical film production capacity. The company has maintained that, with special items, it is still on target to achieve its earnings target for 2006. We have come to expect some lumpiness in this segment as flat-screen TV consumers have seemingly become as fickle as the weather. As with any inventory overhang, we believe this one will work itself out. Although it may cause 3M some short-term pain, we see no reason to alter our long-term projections and are maintaining our fair value estimate of $93 per share


4. Morningstar takes a value approach, and so do we. As MKlein and many others on this board have so compelling stated, it's critical to be consistent within your chosen approach to investing. TA, mechanical, momentum--these might all be fine ways to make money; but in my opinion, BMW is primarily concerned with identifying value. Morningstar is compatible with BMW in that it helps me to identify whether a company is undervalued or merely collapsing.

5. Morningstar offers quite a few very nice graphical presentations of fundamentals versus share price over time, which really help me to see the relationships between, e.g., EPS and share price for a given company. For example, it's easy to see that MMM's price per share very closely mirrors EPS, perhaps lagging EPS somewhat. But in time, EPS clearly drives the stock.

We can also see that Morningstar's fair value price has been steady and predictive over at least the past 5 years (you'll need to register for a free trial to see this one.)

So, the Morningstar analysts have their historical work open for review.

How does this all fit together with BMW?

Here's where I'm at. To me, BMW is a first-cut method to determine which stocks are candidates for further analysis. For this first cut, I like MKlein's website. So here's the sequence:

1. Hit MKlein's site and look for interesting opportunities, preferably companies within industries that are understandable (i.e., I'm a bit overwhelmed by banking and drugs).

2. Go to Morningstar and read through every page dealing with the company, beginning with the analyst's report. (However, if the company has less than 4 stars, or if it's already trading near or above its fair market value, I probably wouldn't dig much deeper than that). I really want to understand the bear argument.

3. If I'm still interested, I'll run Piotroski's F_Score and see whether the company looks good under Graham's microscope. Neither of these are deal killers; however, I can't imagine why I'd want a company with a 3 F_Score, or one that didn't meet at least a majority of Graham's criteria.

(Of course, I'm reading through recent filings in order to check the numbers used in this step. Also, if possible, I'll visit the stores, talk to my wife about their products, all that stuff.)

4. Read the company's BBS at the Fool, and float my own thoughts on this, or some other MF board.

That's it. How stupid is that?

John


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