The BMW Method

Jim Schout believes he's uncovered a trick to finding long-term winning stocks that have temporarily stumbled -- and he needs the potential for 25% annual returns before he becomes interested in a stock.

Granted, the investing industry abounds with prophets touting "winning systems" -- for a price -- but what grabbed my attention at a recent conference was that Jim doesn't charge a penny for his system. He's happy to exploit it for his own gain. We'll get to several stocks Jim likes -- and doesn't like -- shortly.

From its beginnings 13 years ago, Jim's "BMW" method has steadily gained adherents, blossoming into a self-propelled mini-industry of message boards (the BMW Method board is a staple of the Fool community), websites, conference calls, annual meetings, and T-shirts. Not to mention what seem to be great investing returns.

Invited to the 2007 BMW method conference to both speak and listen, I came away intrigued -- and armed with an interview from Jim Schout, the man who scoffs at 24% returns. (Note: This interview was first published Dec. 14, 2007.)

James Early: In a nutshell, what is the BMW method?

Jim Schout: The BMW method is about exploiting something in plain view, yet something the market seldom looks at: the really big picture. In the short run, the market may be very irrational, but the market is always correct in the long term. Like a band in formation, or sports fans collectively spelling out enormous words at a stadium, investors often don't see the big picture -- but with a bird's-eye view, it's easy to spot.

I achieve this by applying lines of constant growth to a stock's long-term price data. Let's say a company's stock price has average growth of 12% annually over the past two or three decades. I might apply lines representing 10%, 11%, 12%, 13%, and 14% growth to the chart. What often jumps into view is [that] the share price continually rises after reaching the 10% CAGR line. The price tends [to] "bounce" up from that low growth line over and over again. That is the BMW method in a nutshell. It is quite simple to spot underpriced equities this way.

If a stock is presently priced at its historically low CAGR, what's wrong? I'll dig deeper here with due diligence to determine if I think the problem is temporary. It's essential to see if there has been a fundamental shift in the company's ability to add value. Maybe a law changed, or a technology became obsolete. More often, Wall Street has decided to act irrationally and undervalue the shares. I love it when that happens.

At the end of the day, if I believe that the underperformance is temporary, or it exists for reasons that make the downturn irrational from an investing sense, then I will buy that stock.