TAG | Equity securities
2
Why Ignorance Is Bliss In the Stock Market
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Why Ignorance Is Bliss In the Stock Market
by Alexander Green, Investment U’s Chief Investment Strategist
Monday, May 2, 2011: Issue #1503
The other day I was speaking with a friend who’s too nervous to invest in the market.
“I just can’t pull the trigger,” he said. “How can you buy stocks when the Fed is priming the pump, real estate is in a tailspin, the dollar is in the tank, the Euro zone is teetering, the Middle East is a powder keg and Congress – as always – is spending money the way my wife does in Vegas?”
I know just how he feels. After all, like most investment analysts I spend my days marinating in the news cycle. I see all these terrible headlines, often several times a day. It’s hard to turn a blind eye.
But if you want to be a successful investor, you may need to do just that. Let me explain …
The national news backdrop is always unsettling. Americans experienced plenty of good times over the last 80 years, but they were punctuated by recession, depression, inflation, war (including two big ones) and almost limitless scary scenarios.
But, through it all, there’s always been plenty of money made owning the fastest-growing, most-profitable companies in the nation. Everyone knows that the best way to get rich is to own a business making money hand over fist.
Yet if you strike out on your own, you’ll find there are more than a few hurdles. For starters, you need a significant amount of capital to start a business. You have to have a lot of entrepreneurial skill, a talent for dealing with customers, employees, suppliers and regulators. And if you meet these first two requirements, strap yourself in. Because it’s a well-known fact that 85 percent of new businesses fail in the first five years.
Fortunately, you don’t have to have this kind of money or take these kinds of risks to get rich in business. You only need to own shares of companies that are – in the words of my 25-year-old nephew – “killing it.”
I’m talking about companies experiencing double-digit sales growth, sharply higher earnings and fat returns on equity. These companies tend to be innovators, continually launching hot new products and services. (Apple is a prime example.) You’ll find that institutions are taking big positions in these stocks. The companies themselves are often buying back their own shares. And the chart – which shows technical factors like price and volume – generally gets an A+.
It’s called momentum investing. And it works. Just a few weeks ago, for instance, we bought shares of internet security company Fortinet (Nasdaq: FTNT). Last week the company reported a blockbuster quarter. Sales jumped 34 percent. Operating income more than doubled. And the CEO Ken Xie pointed out that the pipeline is full and the company is achieving “significant momentum.”
Our shares jumped over 14 percent in one day. And I see plenty more upside ahead.
Of course, we never would have bought this stock if – instead of looking at the fundamentals of the business – we spent our days worrying about the state of the world.
I’ll let you in on a little secret. As an investor, it’s not your job to envision solutions for the political arena, the world economy, or the financial markets. And that’s a good thing. Because the world is way too big and complicated to figure out anyway.
And it’s not necessary. If you want to make money in the market, forget about the “macro” picture. And focus instead on identifying businesses that are likely to post huge earnings surprises in the weeks and months ahead.
That’s how all the great investors – from Buffett to Templeton to Lynch – did it. And that’s how you can do it, too.
Good investing,
Alexander Green
7
Investing in Stocks: Ignore the Negatives, Embrace Your Contrarian Side and Buy Stocks Now
0 Comments | Posted by Alexander Green in Alexander Green
Investing in Stocks: Ignore the Negatives, Embrace Your Contrarian Side and Buy Stocks Now
by Alexander Green, Investment U’s Chief Investment Strategist
Tuesday, September 7, 2010: Issue #1338
When the Dow bottomed near 6,500 in the thick of last year’s financial crisis, few investors thought it was a good time to buy stocks. Sentiment was overwhelmingly bearish.
So when the market bounced higher, the consensus was that it was a “dead-cat bounce,” a bear-market trap. But it wasn’t.
As the rally gained speed, investors began to think that perhaps the worst of the financial crisis was indeed over and they would buy some stocks on a retracement or when the market tested its lows.
But that didn’t happen either. In fact, the Dow didn’t tire until it crossed 11,000 in May. By then, the market was up over 70% in just 14 months.
That was pretty depressing to investors sitting on the sidelines, earning microscopic yields on their cash. Many were so busy licking their wounds from the sell-off that they made little or no new investments during the rebound.
So what should you do now?
Investing in Stocks: Follow the Earnings
Since the market high four months ago, the Dow has lurched back and forth. But the primary direction has been down. No surprise here. After a rally of this magnitude, a correction is not unusual.
But don’t be like last year’s investors and miss the next rally. Now is a good time to put money to work in high-quality stocks.
In fact, the market is almost as cheap today as it was during the depths of despair in March 2009.
How is that possible when the Dow is more than 3,500 points higher?
Because a stock or index price doesn’t tell you anything about valuation. What matters are earnings and the multiple that the market puts on them.
Three Reasons Why You Should Buy Stocks Today
When measured by profits, the market is almost as cheap today – at 14.9 times trailing earnings and 12.2 times prospective earnings – as it was in March last year.
That’s because earnings are up. Way up. Second quarter profits at U.S. companies hit an all-time record.
A year and a half ago – when investors should have been buying stocks – the media was busy telling them about The Great Recession and how the world was coming apart at the seams.
Today, it provides saturation coverage of home foreclosures, personal bankruptcies and endless political carping. And because we’re blanketed with bad news, few investors see the positives. Consider, for example:
- The Fed has taken interest rates to near zero. That makes it cheaper for consumers and businesses to borrow. It also makes ultra-low-yielding cash a horrible investment.
- Inflation – the great bane of both stock and bond investors – is M.I.A. With the consumer price index showing virtually no increase, businesses don’t have to battle rising costs.
- Around the globe, most stocks are unloved and undervalued. Historically, when the P/E of the S&P 500 has dropped dramatically – as it has since the highs of May – it isn’t long before the market puts on a significant rally.
A Leaner Corporate America Could Drive the Next Rally
I know analysts are saying that earnings won’t be anything great. But they could be wrong – yet again – for two key reasons.
- Businesses have tightened up their cost structure, laid off unnecessary personnel and refinanced debt at lower levels. Even a modest uptick in sales could deliver surprisingly good bottom-line growth.
- It’s so cheap for businesses to borrow right now that I expect we’ll see many of them issuing debt to buy back their own shares. This could lead to robust growth in earnings per share, even if growth in gross earnings is less dramatic.
The bottom line?
Investing in Stocks: The Ultimate Contrarian Indicator Right Now
Stocks today are almost as cheap as they were when the Dow hit 6,500 18 months ago. And the macro-economic picture – while always cloudy – is a heck of a lot better now than it was then.
As an investor, look at your options. Cash pays next to nothing. Treasuries yield little more and could easily drop precipitously. Real estate is a non-starter, due to illiquidity, a flood of foreclosures and tough new lending rules.
But stocks offer excellent potential. And if you know anything about contrarian indicators, the fact that so few believe it only confirms it.
Good investing,
Alexander Green
18
Why Value Investing and Trading Don’t Mix
0 Comments | Posted by Alexander Green in Alexander Green
Why Value Investing and Trading Don’t Mix
by Alexander Green, Chief Investment Strategist
Tuesday, May 18, 2010: Issue #1262
Last week, I spoke at a special conference on value investing at the beautiful Driskill Hotel in Austin, TX.
Virtually every stock market investor talks about “recognizing value.” I’ve found that interest in value investing ebbs and flows depending on the market. No one wants to overpay for a stock, or keep holding one if the price gets nutty.
And that leads to a basic question: How do you find value in the stock market?
It depends whom you ask…
The Fathers of Value Investing
The fathers of value investing, of course, were Ben Graham and David Dodd, two teachers at Columbia Business School who wrote the investment classic, Security Analysis.
They argued that value investing is about buying companies that are selling below their intrinsic value.
How do you determine that? According to Graham & Dodd, that means buying companies that…
- Trade at significant discounts to book value.
- Have high dividend yields.
- Have low price-to-earnings (P/E) ratios.
Buying this way is not only supposed to lead to higher returns. It’s also designed to provide a significant “margin of safety.” The idea is that if you buy a security right, your downside is limited.
A number of academic studies have shown that if you follow the principles of Graham and Dodd, you should do very well over the long term.
But there are potential problems with this approach…
Don’t Let a Cheap Stock Suck You In
First of all, stocks are rarely as cheap as they were back in the 1930s when Security Analysis was written. Or even as cheap as they were back in 1982 when the typical stock sold for less than book value and eight times earnings and yielded more than 6%.
And if you sat out the last 28 years out because stocks were too expensive, you missed an awful lot of opportunities.
When you do find a stock that does meets Graham and Dodd’s stringent requirements, you also need to be patient. Why? Because companies that are very cheap are out of favor for a reason. Sales are often flat or down. Earnings are weak. Profit margins are low.
You can’t succeed just by buying a company that’s cheap. (It can always become cheaper.) You have to buy a company that will someday – and perhaps not too far off – be dear to others. Otherwise, when will you take profits?
So maybe Graham and Dodd’s message needs modifying. (Warren Buffett, Graham’s most famous student, has certainly found ways to modify it.)
The Problem With Defining “Value”
I’ve found that the definition of value and the tools to achieve a margin of safety are flexible. And The Oxford Club has found successful ways to bend them.
To my mind, any stock that goes from $10 to $50 was a “value” at $10. I don’t care what the P/E or price-to-book was at the time. With the luxury of hindsight, it was clearly a bargain. Why quibble?
But die-hard value investors will argue that if the stock was “overvalued” at $10, it’s only more grossly so at $50 – and therefore, you’re at great risk holding it.
I disagree. If you use our customary trailing stops, your upside is unlimited and your profits fully protected. As long as a stock keeps trending up, we’re content to hold on – no matter what the valuation. When the stock eventually turns, as all do eventually, our stops will keep the profits from slipping through our fingers.
As for value analysis, quite frankly, we don’t spend a lot of time poring over P/Es and book values. We’re just interested in identifying companies that are likely to show dramatic, better-than-expected growth in the quarters ahead. These stocks tend to be more expensive than average, just as companies that will show little or no growth tend to be cheaper than average.
This method works, too…
Do You Have the Key Traits to Profit From This Approach?
The independent Hulbert Financial Digest has ranked our Communiqué among the top five newsletters in the United States for 10-year performance.
And our approach has one significant advantage over value investing. It works quickly.
- Growth stocks tend to sprint.
- Profits often come sooner rather than later.
As someone who spent 16 years as a money manager, I know that most investors don’t have the patience to be good value investors. (John Templeton, for instance, held companies in his flagship Templeton Growth Fund an average of 7.5 years.)
Yet clients will start to grouse if a stock doesn’t move for six months. They call it “dead money” and start itching to move it elsewhere.
I understand this instinct. But deep value investing and rapid trading don’t mix.
If you’re a patient, truly long-term oriented investor, value investing can work wonders. If you’re not, you’ll be better off searching for companies that are set to smash estimates.
When a stock doubles or triples – or rises 50-fold or more like Apple (Nasdaq: AAPL) and Amazon (Nasdaq: AMZN) – don’t worry, other investors will concede it was a “value” before.
Good investing,
Alexander Green
P.S. If it’s value you’re looking for, look no further than The Oxford Club. For just $79, you’ll receive a whole year’s worth of our experts’ top stock recommendations, investment ideas and strategies that you can use to amass profits and build wealth.
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