PEND is derived from information in a 1988 article from Forbes Magazine, written by Laura R. Walbert.
Walbert reported a stock-screening method used by New York investment firm Garrison, Keogh & Co. PEND is virtually identical to Garrison’s method. In addition to the analysis we call PEND, Garrison used complex, time-consuming fundamental analysis methods to enhance his stock selections. It’s likely most investors will find it more fruitful to use PEND in combination with risk-reducing TREND rather than complex fundamental analysis.
The formula reported in Forbes was:
- 1. Find the earnings yield. This is earnings-per-share divided by the share price. Earnings yield is the reciprocal of the familiar price/earnings ratio.
- 2. Find the reinvestment rate. This is the amount of earnings not paid out in dividends divided by book value. The Value Line Investment Survey reports this ratio as “Percent retained to common equity”.
- 3. Find the dividend yield – the annual payout divided by the stock price.
- 4. Add the results from items 1, 2 and 3.
If the percentages totaled more than 25, Garrison would look at the company more closely. The first thing he would do is recalculate the score using his estimate of the company’s future earnings. The score should then go up.
Garrison used the method to screen all available stocks. Stocks that made it through the screen would then be researched more thoroughly using traditional fundamental analysis methods. Garrison commented, “The hard work begins after you have done the screen”.
Traditionally, many investors have determined the value of a stock using the price/earnings ratio, often written p/e or pe.
Price/earnings ratio is calculated by dividing a stock’s current share price by its earnings per share. Hence, a pe ratio of 10 means it costs you $10 to buy $1’s worth of annual company profit.
One of the drawbacks of the PE ratio, however, is that it says nothing about two crucial aspects of business performance, specifically:
- How efficiently managers have been employing the business’s capital.
- Whether managers are reinvesting a satisfactory proportion of profits into growing the business.
A stock-screening method outlined in Forbes magazine in 1988 addresses this issue by adding two numbers to the traditional pe analysis.
The PEND method, as we have named it, uses simple arithmetic to discover shares likely to outperform the market.
The PEND method is powerful, yet straightforward. It needs just four numbers to analyze a stock. The numbers are available in the financial sections of newspapers or from stock market websites.
They are; Share Price, Earnings, NTA and Dividend.
Note: Some investors may be unfamiliar with NTA. NTA is a company’s Net Tangible Assets per share, also called Book Value by some. NTA is the total value of a company’s assets, excluding intangibles such as goodwill and trademarks. Its inclusion is crucial to PEND because it provides us with a way of assessing how well a company is using its assets – something a simple PE ratio cannot do.
From the four numbers above, PEND calculates three figures that instantly tell us whether a stock is attractive compared with run-of-the-mill stocks. The first number we call Performance, the second we call Reinvestment and the third, Sum, is found by adding the Performance and Reinvestment numbers.
Performance tells us whether the company is earning enough money (compared with its share price) to interest us.
Reinvestment tells us whether the company is earning a good enough return on its assets and whether enough of that return is being plowed back into the business. This is essential for growth. The stock market is heavily biased towards rewarding growth companies.
Sum tells us whether a company’s overall finances are better than normal.