Good quality company but trading at high price - Add this to your "watch list."

If the price is too high, you should add the company to your "watch list."  You have found the company to be a good quality company but the price is too high.  If it's much too high, put it on your "watch list" and wait for it to come down.

In rare circumstances, you may wish to put in a market order; but you will not want to do this in every case.

The "buy price" is the price at which both your risk and reward criteria are met.  This is the highest price you can pay and realize both a Total Return that will double your money every five years and where the risk of loss is less than one third of the potential gain.

The reward should be at least three times the risk.  Even though you may sometimes accept a total return of less than 15% because of the contribution that the stock can make to your portfolio's stability, you don't want to accept a Risk index of much above 25%.

If the Risk index is zero or negative, you should question your assumptions about the quality issues.  You will want to question why the price of the stock is so low.  What do others know about the company that you don't know?  If you're a new investor, you should move on to another candidate.  If you can satisfy yourself that the price is depressed for no good reason, then you can be a contrarian and buy the stock.


Additional note:

Definition of 'Market Order'

An order that an investor makes through a broker or brokerage service to buy or sell an investment immediately at the best available current price. A market order is the default option and is likely to be executed because it does not contain restrictions on the buy/sell price or the timeframe in which the order can be executed.

A market order is also sometimes referred to as an "unrestricted order."

Investopedia explains 'Market Order'

A market order guarantees execution, and it often has low commissions due to the minimal work brokers need to do. Be wary of using market orders on stocks with a low average daily volume: in such market conditions the ask price can be a lot higher than the current market price (resulting in a large spread). In other words, you may end up paying a whole lot more than you originally anticipated! It is much safer to use a market order on high-volume stocks.

Read more: http://www.investopedia.com/terms/m/marketorder.asp#ixzz2FjYO8xoI



Calculating the Risk Index

Risk Index
= (Current Price - Potential Low Price) / (Potential High Price - Potential Low Price)

The result is the risk index, the percentage of the deal that is risk.
We look for a risk index of 25 percent or less, meaning that only a quarter of the proposition or less is risk.
We would then have at least 75 percent to gain versus at most 25 percent to lose; so the reward is at least three times the risk.

Stocks with Low PE Multiples Outperform those with High Multiples. Investors are warned repeatedly about the dangers of very high-multiple stocks that are currently fashionable.

In 1934, Dodd and Graham argued that "value" wins over time for investors.  To find value, investors should look for stocks with low PE ratios and low prices relative to book value, P/BV.  Value is based on current realities rather than on projections of future growth.  This is consistent with the views that investors tend to be overconfident in their ability to project high earnings growth and thus overpay for "growth" stocks.

Stocks with Low PE Multiples Outperform those with High Multiples
One approach of stock selection is to look for companies with good growth prospects that have yet to be discovered by the stock market and thus are selling at relatively low earnings multiple.  This approach is often described as GARP, growth at a reasonable price.  

Earnings growth is so hard to forecast, it's far better to be in low-multiple stocks; if growth does materialize, both the earnings and the earnings multiple will likely increase, giving the investor a double benefit.  Buying a high-multiple stock whose earnings growth fails to materialize subjects investors to a double whammy.  Both the earnings and the multiple can fall.  Therefore investors are warned repeatedly about the dangers of very high-multiple stocks that are currently fashionable.

There is some evidence that a portfolio of stocks with relatively low earnings multiples (as well as low multiples of cash flow and of sales) produces above-average rates of return even after adjustment for risk.  This strategy was tested and had been confirmed by several researchers who showed that as the PE of a group of stocks increased, the return decreased.

This "PE effect," however, appears to vary over time - it is not dependable over every investment period.  And even if it does persist on average over a long period of time, one can never be sure whether the excess returns are due to increased risk or to market abnormalities.

And low PEs are often justified.  Companies on the verge of some financial disaster will frequently sell at very low multiples of reported earnings.  The low multiples might reflect not value but a profound concern about the viability of the companies.  

What should you do if you find that the price or P/E is significantly above or below the historically fair price or fair P/E mark?

"It is better to buy a wonderful company at fair price than a fair company at wonderful price."

In general, if you can buy a quality stock today for a historically fair price or fair P/E, you should probably do so, provided the reward and risk are attractive.

However, what should you do if you find that the price or P/E is significantly above or below the historically fair price or fair P/E mark?

A low price or low P/E is probably your biggest concern, because it suggests that people who are buying the stock today might know something negative about the company that you don't know.

Think about it.  Why would investors pay less for the stock than it has typically sold for?

• Is there something in the news that you haven't heard about?  
• Has an analyst - or have a number of analysts - announced a reduced expectation of future earnings based upon something they know that you don't know?  
• Have you missed something in your quality analysis - or (shame on you!) recklessly jumped over that barbed-wire fence, failing to evaluate quality deliberately enough before moving on to look at the value considerations? 

(E.g. Transmile, KNM).

If the price or P/E is too low - move on to another company and forget about looking at the risk and reward.  You may miss a few good stocks, but you won't have to lose any sleep worrying about being wrong.



If the price or P/E ratio is too high, this tells you two things.

1. The first is that other investors appear to agree with you about the quality issues, because they are paying a healthy price for the stock.  
2. The second is that it may be too healthy a price.  

• You may want to put off buying it until the price becomes more reasonable.  
• Or, it may be worth the premium if the risk and reward are satisfactory.

(E.g. _____________)

Just know that, if you buy a stock whose price or P/E is too far above the fair price or fair P/E, when it later comes back down - which it usually will - the decrease in P/E can reduce your gain considerably.  Your chances of having a superior portfolio are far better if you select stocks for which you don't have to make any allowances.  


As you gain more experience, you'll find that you can make some intelligent exceptions in cases of high or low price or P/E, but for now, the advice for those who are just starting out, don't.

A Pricey P/E

High Pricey P/E

A company may be selling at an exceptionally high P/E because it is considered to have remarkably good prospects for growth.

No matter how high the quality of the car you are looking at, there is a price at which it is no longer worth buying.  No matter how junky a car is, there is a price at which it is a bargain.  Stocks are no different.

Some stocks with high multiples work out, but investors who consistently buy high multiple stocks are likely to lose money in the long run.

Often the highest multiples are present in a bull market which increases the risk.  

Graham and Dodd observed, " It is a truism to say that the more impressive the record and the more promising the prospects of stability and growth, the more liberally the per-share earnings should be valued, subject always to our principle that a multiplier higher than 20 (i.e., 'earning basis' of less than 5%) will carry the issue out of the investment range."

It is not wrong to pay more, Graham and Dodd noted; it is simply that doing so enters the realm of speculation.

Buy Low - Sell High, Buy High - Sell Higher

Many investors prefer to pay low for a stock and hope that its price will eventually rise. However, they fail to realize that sometimes it is better to pay a higher price for a stock that has the potentials for a future growth. The money you will save from purchasing a down stock may not justify your investment if the stock continues to languish.

For example, let's assume that stock X has a P/E (price to earnings ratio) equal to 25, whereas stock Y has a P/E equal to 8. If you are ignorant enough and decide to make your investment decision based only on this metric, then stock X will seem as being overpriced.

Let us make another assumption, namely that stock X has experienced this overpricing for several periods of times. On the other hand, stock Y has consistently been under the fair price of the market.

What is more, stock X is experiencing a trading activity that is near the 52-week high, whereas stock Y has experienced a 20% down in its trailing 180-day average.

Typically, investors fail to recognize that the maxim stating that what goes down must come up and the vice versa, doesn't always hold truth. There are many exceptions back in the history.

If you follow this maxim, you will probably conclude that stock X is about to decrease. On the other hand, again under the maxim stated above, an investor may conclude that stock Y is about to make its big jump since its price is low and the stock market will recognize its strengths. Both assumptions may turn out to be completely wrong.

Buy High, Sell Higher

This strategy is highly recommended if you expect that the stock will continue to grow in the future. Thus, you should not be scared off by the high price. A stock that provides a steady percentage of growth is worth paying its higher price today, because if it continues to grow at this rate, its price will be even higher tomorrow.

You should make a careful research before following the Wall Street pack. You may probably regret that you haven't purchased the stock several months ago before its price has not jumped to the sky. However, if you make a careful research and verify that the stock possesses good potentials for future growth, then you should not be discouraged from investing in it.

Keep in mind that the stock's price will rise and fall in the short term, but over the long term a growth stock will move upwards.

Buy Low, Sell High

Many investors prefer to search for bargains, which they can later sell at a higher price. However, if you decide to apply this strategy you should be well aware that the price of the stock may not rise again.

Value investors tend to look for stocks that are overlooked and undervalued by the stock market. However, price is only one of the factors that are part of their selection process. The key consideration made is whether the stock provides steady potential for future growth.

Final Piece of Advice

Avoid making investment decisions based only on the price of the stock because a stock that is down is not obligatory to go up. Additionally, a stock that is up may come down and may not. Look at the other metrics in order to make a more educated and successful decision.

http://www.stock-market-investors.com/stock-market-advices-and-tips/buy-low-sell-high-buy-high-sell-higher.html

Price-Earning Ratio 101

What actually is PER?

It's often said that the PER is an estimate of the number of years it'll take investors to recoup their money. Unless all profits are paid out as dividends, something that rarely persists in real life, this is incorrect.

So ignore what you might read in simplistic articles and note this down: a PER is a reflection not of what you earn from a stock, but “what investors as a group are prepared to pay for the earnings of a company”.

All things being equal, the lower the PER, the better. 


But the list of caveats is long and vital to understand if you're to make full use of this metric.

PER:  Historical versus Forward or Forecast PER

The PER compares the current price of a stock with the prior year's (historical) or the current year's (forecast) earnings per share (EPS). Usually the prior year's EPS is used, but be sure to check first.

For example:

Last financial year, XYZ Ltd made $8 million in net profit (or earnings). 

The company has 1 million shares outstanding.

So it achieved earnings per share (EPS) of $8.00 ($8 million profit divided by 1 million shares). 

In the current year, XYZ is expected to earn $10 million; a forecast EPS of $10.00.

• At the current share price of $100, the stock is therefore trading on a historic PER of 12.5 ($100/$8). 
• Using the forecast for current year's earnings, the forward or “forecast PER” is 10 ($100/$10).

Quality has a price to match

Quality usually comes with a price to match. 


It costs more, for example, to buy handcrafted leather goods from France than it does a cheap substitute from China. Stocks are no different: high quality businesses generally, and rightfully, trade on higher PERs than poorer quality businesses.





Low PER doesn't alone guarantee quality business

• Value investors love a bargain. Indeed, they're defined by this quality. 
• But whilst a low PER for a quality business can indicate value, it doesn't alone guarantee it. 
• Because PERs are only a shortcut for valuation, further research is mandatory.
• 
  

High PER with strong future earnings growth maybe a bargain

• Likewise, a high PER doesn't ensure that a stock is expensive. 
• A company with strong future earnings growth may justify a high PER, and may even be a bargain. 
• A stock with temporarily depressed profits, especially if caused by a one-off event, may justifiably trade at a high PER. 
• But for a poor quality business with little prospects for growth, a high PER is likely to be undeserved.

Avoid a Common trap: Use underlying or normalised earnings in PER


There's another trap: PERs are often calculated using reported profit, especially in newspapers or on financial websites. 


But one-off events often distort headline profit numbers and therefore the PER. 


Using underlying, or “normalised”, earnings in your PER calculation is likely to give a truer picture of a stock's value.





What is a normalised level of earnings?

That begs the question; what is a normal level of earnings? That's the $64 million dollar question.


 If you don't know how to calculate these figures for the stocks in your portfolio, now is the time to establish whether it's skill or luck that's driving your returns. And if you don't know that, history may well make a monkey of you.




An old encounter with low PE stock: Hai-O


It is nostalgic to re-read an old post on Hai-O by ze Moola. 

http://whereiszemoola.blogspot.com/2008/04/more-on-haio.html

Sunday, April 13, 2008
MORE ON HAIO

My dearest BullBear,

A low PE stock means only one thing and that is the stock is trading on a lower valuation compared to what it is currently earning.

Some simply consider that what is happening is the stock is being ignored in the market despite its impressive earnings.

Why?

The market could be wrong and that perhaps this is a stock that's an ignored gem. Yeah, the classical hidden gem and if this is the case, investors who invests in the stock could be rewarded for their stock selection.

However, on the other hand, sometimes the market could be right and that they do sense something is not right within the stock.

And because of this reasoning, I have always realised that a low PE stock does not make a stock a QUALITY stock.

It just means the stock is trading 'cheaply'.

It could be a bargain but it could also be a trap.

The Perils of High-P/E Stocks

The Perils of High-P/E Stocks
The Higher They Are, the Harder They Fall

by Michael Maiello
30.7.2008


Financial journalist Jason Zweig has a well-known interest in behavioral finance, the study of how investors’ minds work — sometimes against their best interests. In his latest book, Your Money & Your Brain, he deals with the “story stock,” the must-have equity of the moment that only investors with the strongest convictions can avoid.



Think Krispy Kreme, which went public in 2000 after the market crash and climbed from $23 to over $100 a share. Yes, a doughnut company had a price-earnings ratio above 80. A doughnut company.

Krispy Kreme is losing money now and trades for just over $3 a share. But at the time it had exactly what investors craved — a simple business model, a good (some would say addictive) product, room to grow from a regional to a national chain and the attention of both the media and Wall Street analysts.

These are the types of stocks that play well in the human mind, Zweig says. Investors are naturally risk-averse and wary of potential surprises. High-profile companies that get a lot of attention and are mentioned on the nightly news and on financial websites seem less likely to surprise us. They seem safer.

There’s also a perceived safety in numbers. No matter how often we’re told that 50,000 people can indeed be wrong, we’re afraid to be seen as out of step with our neighbors. To be wrong while acting as part of a group is understandable. To be wrong on your own is just plain embarrassing.

The result of this, writes Zweig, is that a stock might do well for the wrong reasons in the short run. But eventually the fundamentals will catch up with it.

Remember, it’s negative surprises that send most investors fleeing, and when they seek safety, they wind up buying stocks that today are telling happy stories of high growth. This means the effects of any negative news about these stocks are amplified. And when the story turns ugly, it turns in a hurry.

Zweig calculates that if a growth company misses its earnings forecast by as little as 3 cents a share, its stock will drop two to three times faster compared with a value stock reporting the same bad news. When a high-growth company misses earnings, it can cause a crisis of confidence. Many analysts, for example, believe there’s no such thing as one bad quarter; when a high-growth company stumbles, investors fear more bad news is on the way.

But over time, less-popular, lower-P/E stocks do outperform. In his updated edition of Stocks for the Long Run, Wharton professor Jeremy Siegel measured the performances of low-P/E and high-P/E stock portfolios between 1957 and the end of 2006. The portfolio with $1,000 invested in stocks with the lowest P/E ratios was worth $700,000, for a 14.3 percent annual return. The portfolio with $1,000 invested in the highest-P/E stocks was worth $65,000, for a return of 8.9 percent a year.

What’s more, during the first 10 years the high- and low-P/E portfolios traded places a few times, depending on market conditions. But once the experiment passed the decade mark, returns on the low-P/E stocks were always higher.

Of course, it’s important to put P/Es in context. You should compare a stock’s P/E with that of its peers and to the rest of the market and remember that some stocks deserve a higher valuation.

Growth and value also go in and out of favor; cycles usually last five years to seven years. But investors with time on their side would do well to be wary of trendy story stocks because they can turn in an instant.




Michael Maiello, who wrote "Fly With the Fundamentals" for the January 2006 issue, is the author of Buy the Rumor, Sell the Fact (McGraw-Hill, 2004).

http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0808fundamentalspublic.htm