The BMW Method of Picking Undervalued Stocks

I bet you never thought that a BMW would be a way to value stocks? Well, you are correct – it isn’t. The BMW Method is a specific type of analysis done on a stock that I read about by reading the discussion forums over at The Motley Fool and has nothing to do with the cars. There is one particular board that was started by a member named BuildMWell.

The primary premise around the strategy is something similar to a reversion to the mean philosophy. Over time, things have a mean value to them and their natural propensity is to always return to that mean value, even if they strayed from the mean for a period of time. Think about it like losing weight – many people who lose weight quickly typically gain most of it back over time and end up around the same weight they were before. It focuses around a stocks compound annual growth rate (CAGR). Here is how BMW describes the process at his site:

The BMW Method is a rather simple concept even though it has never been offered by any of the investing gurus that I have read. In fact, every book on investing that I read seems to talk all around the BMW Method without getting to the guts of the matter. To me, the Compound Annual Growth Rate (CAGR) is at the heart of all investing, but no one seems to want us to understand it. My main goal is to change that.

I place little stock in P/E ratios or the PEG. I trust the CAGR. That is the compound average growth rate. I look back 30 years to get a base number to work from and I then calculate the range of CAGR’s that encompass the full range of stock prices over that 30 year period. The curves are extended into the future by 5 to 10 years and I have a complete picture of what has been and what can be if the business just rolls on along. I buy stocks when they are priced significantly below the lowest historical 30 year CAGR. It happens often. If I cannot find a business that is significantly below the low CAGR, I will settle for some that are on their 30 year lows or just below that level. These do not enthuse me nearly as much, but they will rebound also. The history proves it. This is a definite buy low, sell high concept…except it works. In fact, I want anyone to explain in detail how it cannot work.

Here is what a CAGR chart looks like, from Mike Klein at his site. You can see that the current share price for Wal-Mart is significantly below the average CAGR line (thick red), suggesting that the stock is underpriced from a historical perspective.

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Reading through the sites that are linked throughout this post, it is clear that the process is black and white. Just because the share price is below the CAGR line, does not mean that it is a buy. CAGR lines can change over time and the new share price is factored into the average. In addition, most of the materials suggest that the process does not select stocks for people to simply buy with no further analysis. If I were to use it, I would assure that dividends have gone up for at least 10 years. It does however seem to provide investors with a list of stocks that can then be further evaluated through fundamental analysis.

I like the approach as intuitively it make sense and I could see application with a dividend investing strategy. If you are familiar with the BMW Method, I would love to hear your experience with it and how you have found success (or not) using it. I would also love to hear how you integrate it into your investing approach. As I am sure I have missed important aspects of the method in this post, please use the comments to let me know.

(Photo Credit: tom zeitler)