Paraphrasing Gary Simms’ second question from his earlier comment:

Our methodology provides that we realize gains when we sell our shares because the  companies in which we invest steadily increase their earnings while we hold their stock. Assuming we paid a reasonable multiple of earnings (PE) when we bought it, by later selling it at a similar multiple, the sale price will reflect that increase in earnings.

As an example: if we pay 20 times earnings for the shares of a company earning $1 per share, and, five years later, the company is earning $2 per share. Selling it at a PE of 20 would produce a sale price of $40. Thus we’ve doubled our investment. 

His question is simply, "What if the earnings growth is right on schedule, but the PE isn’t near what it was when we’re ready to sell?"

The answer is a corollary to the answer to the first question. The PE is the price divided by the earnings. Therefore, if the earnings have grown as expected, the PE is low only because the current market price is low. The herd was simply not paying a reasonable price for the shares because of some fantasy; i.e. a story, rumor, or other event or opinion that drives the market prices down. You should, therefore, be patient and wait for it to come back up. It will.

The very same rule applies here: "If the price of a stock has declined for any reason other than a decline in the fundamentals; i.e., growth of sales, profits, or earnings, then it will return to where it was. What goes down must come up and vice versa."

It’s probably a good time for a refresher. Read “What’s a PE and What’s It to Me?

s How to Invest, NAIC Veterans' Lounge, Successful Investing fundamental analysis, fundamentals, Patience, PE ratio, the herd

Gary Simms, a “frequent flyer” on this blog, recently posed two excellent questions, each of which merits a separate post. This is the first.

To paraphrase: “If the fundamentals—sales, profit, or earnings growth—are what drive the price of stock, why does a decline in a stock’s price so often come before the fundamentals decline?” Great question!

Stock prices decline for only one of two reasons: fantasy or fact.

By “fantasy,” I mean shareholders have jumped to a negative conclusion from some event,  rumor, story, or combination of those. Acting on their hunch, the herd is simply guessing what might happen and getting out before it does. (Institutional investors are not immune from this behavior. Their colleagues, like lemmings, are often afraid not to jump when they do, for fear they might have missed something they shouldn’t have.)

More often than not, the "event" is not even related to the company, or even the industry it’s in. It could be merely the opinion of some talking head on Bloomberg or the like; and conjecture about how those imagined consequences might affect the company are sometimes pretty far fetched.

Read more…

s Fundamental Investment Views, Investment Concepts, NAIC Veterans' Lounge, Successful Investing declining prices, fundamental analysis, fundamentals, investing fantasy and fact, stock market, the herd, when not to sell, when to sell

As I said in my last post, each quarter you should analyze growth from last year to the current year and do it in the same order the items appear on the income statement. I submit that the best bet is to compare the sum of the data for the last four quarters with the similar period the year before. That way, it will take a down trend or a significant decline—more than just a single quarter—to get your attention. Read more…

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While we advocate expending the least amount of effort necessary for investment success, one urgent requirement is monitoring your portfolio to catch the poor performers before they do too much damage.

Our “rule of five,”—a convenient, statistical pigeonhole into which we can cram every failure—suggests that fully four out of five companies we select will do just fine, one even doing better than we had expected. The nice thing about that is, if we’ve selected carefully, the eighty percent of those we’ve selected will perform well enough to keep our portfolio’s performance from being too badly damaged. Read more…

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Yesterday (May 19th), the Dow Jones Index (the sum of the market prices of one share of 30 mostly venerable blue-chip companies, adjusted daily for splits and stock dividends) spurted more than $235. Our local newspaper, beneath the header, “India’s Market Soars,” spent its allocated two-paragraphs discussing the unprecedented surge in India’s stock market the day before. However, the banner headline on the front page of the financial section screamed “Stocks Jump on renewed optimism for housing, banks.” And the lead reported, “Reassuring news about housing and banking on Monday convinced investors to return to the stock market.”

Hello! This morning, reporting a $29.35 decline in the Dow, the header over the explanatory two paragraphs read, “Housing fall drags stocks.” And, the leading explanation was “…the surprise drop in construction and a cautious outlook from retailer Home Depot pared gains in energy and utility stocks.”

A typical chronicle of two exciting days of the herd’s decision-making!

Read more…

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Today’s stock market has caused a lot of usually sensible people to shake their heads and say, “This is different. This is unprecedented. It’s never been like this! We need a new set of rules to handle it.”

Do we?

Here’s a list of ten do’s and don’ts that may seem “different” than those you’re accustomed to, but they have stood the test of time and are especially important in today’s world. Read more…

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Lively chatter on the NAIC I-Club recently dealt with the topic of expectations. Our methodology calls for shooting for doubling our money every five years. This means that the value of our portfolios is expected to increase, on the average, just under 15% every year.

You and I both know that, for the same reason you can’t effectively time the market, you can’t reasonably expect the market value of your holdings to increase inexorably at that rate. That skittish “herd,” that has just spent months wallowing in its “irrational despair,” will never prove to be a reliable, much less predictable, appraiser of the value of your common stocks. Read more…

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