How Much Should You Invest in Stocks?

When it comes to deciding on the percentage you should devote to common stocks, there are several alternatives that should be considered. All have some merit, and none are perfect.

In fact, there is no such thing as a perfect formula for asset allocation.

It depends on such factors as

• your age, and
• your temperament.

It might also depend on what you think the market is going to do.

• If it's about to soar, you would want to be fully invested.
• But if you think stocks are poised to fall off the cliff, you might prefer to seek the safety of a money-market fund.

Related posts: Some Simple Formulas for Asset Allocation

• How Much Should You Invest in Stocks?
• Asset Allocation is not the same as Diversification
• A Simple Approach to Asset Allocation
• Forget about Everything Else and Buy Only Stocks
• Some asset allocation options to consider
• A favourite Formula for Asset Allocation

A favourite Formula for Asset Allocation

Age is the key to asset allocation. The older you are, the less you should have in common stocks.

If you are age 65, you should have 65% in common stocks, with the rest in a money-market fund.

If you are younger than 65, add 1% per year to your common stock sector. As an example, if you are 60 years old, you will have 70% in stocks.

If you are older than 65, deduct 1% a year. Thus, if you are age 70, you will have only 60% in stock.

Here is a table breaking down the 2 percentages by age:

Age--Stocks--Money-Market Funds

40---90%---10%
45---85%---15%
50---80%---20%
55---75%---25%
60---70%---30%
65---65%---35%
70---60%---40%
75---55%---45%
80---50%---50%
85---45%---55%


Related posts: Some Simple Formulas for Asset Allocation
How Much Should You Invest in Stocks?
Asset Allocation is not the same as Diversification
A Simple Approach to Asset Allocation
Forget about Everything Else and Buy Only Stocks
Some asset allocation options to consider
A favourite Formula for Asset Allocation

Benjamin Graham felt that individual investors fell into two camps

Types of Investors

Graham felt that individual investors fell into two camps :

• "defensive" investors and
• "aggressive" or "enterprising" investors.

These two groups are distinguished not by the amount of risk they are willing to take, but rather by the amount of "intelligent effort" they are "willing and able to bring to bear on the task."

Thus, for instance, he included in the defensive investor category professionals (his example--a doctor) unable to devote much time to the process and young investors (his example--a sharp young executive interested in finance) who are as-yet unfamiliar and inexperienced with investing.

Graham felt that the defensive investor should confine his holdings to the shares of important companies with a long record of profitable operations and that are in strong financial condition. By "important," he meant one of substantial size and with a leading position in the industry, ranking among the first quarter or first third in size within its industry group.

Aggressive investors, Graham felt, could expand their universe substantially, but purchases should be attractively priced as established by intelligent analysis. He also suggested that aggressive investors avoid new issues.

http://www.investinvalue.com/0/styles.php

(Check out the table in this site for rules for defensive versus enterprising investors.)


Also read:
Investment Policies (Based on Benjamin Graham)

Developing an approach to a 'tip'

What I did when someone suggested a stock to buy.

This is not uncommon. Your friend or a stranger will suggest a stock to buy.

My approach has always to take note of it. I do not dismiss these 'tips' straight off, unless I am very familiar with the stock already and have a preexisting valuation or opinion on this.

The better approach would be to just have a look at their 'tips'. During your free time, have a look at the stock's fundamentals. It only takes you a short time to decide whether you wish to study the stock more thoroughly or not.

Do not just accept tips from the professionals or the 'knowledgeable'. Embrace also the tips from the most unlikely person, the taxi driver, a cleaner, or a factory worker. You may sometimes be surprised the tip led to a 'gem' stock for you to invest in.

Three years ago, a stranger casually remarked that Company X's new business has started to prosper after a few years of slow growth. This company was a poor performer for many years. Many investors would have lost money in this stock for a prolonged period. It was a definitely shunned counter on KLSE. In fact, many investors would not even touch this stock due to their unpleasant previous experiences. Few had kind words for this company even in the discussions in the blogs. Various negatives were thrown up - it was either the quality of the management, the nature of the business, blah, blah, blah...

Anyway, looking at the fundamentals of this Company X, it was obvious that its revenues and earnings were growing strongly then. It was generating a lot of cash. It was also improving on its efficiency. Investing into this company over the last couple of years had been rewarding indeed, even though 2007 -2009 was a severe bear market.

What led me to invest in this stock? A casual remark from a stranger. Herein lies the lesson of this post.

Any tips? :-)

Core Tenets in Value Investing

Read this promotional pamplet. It contains all the core tenets of value investing in a single page. Very useful indeed.


5 Secrets of Buying Dream Stocks at Bargain Prices
How to Build Your Financial Dreams On a Foundation of Value

To make real money in today's market you need to be a stock picker. And no one does it better than Warren Buffett.

Buffett is the ultimate value investor. His results are legendary. He's beaten the S&P 500's total return by nearly 60 to 1. If you had invested in his Berkshire Hathaway stock in 1965, you would have… Turned Every $10,000 into nearly $50 Million!


To Buffett, value investing is the only way to invest. It's the art of finding great stocks selling below their real value.

But finding authentic value stocks is anything but easy these days. There are many once-great companies that look cheap, but are actually traps that aren't even worth their new lower price.

And judging a stock's real value is no simple feat either. In the age of Enron, company insiders have made an art form of disguising their true financial health.

How to Find Great Value Stocks
My name is Philip Durell. I'm Founder and Senior Advisor of Motley Fool Inside Value. It's my passion to help individual investors find great value stocks. I believe value investing is the key to building life-changing wealth.

That's why value stocks belong in every portfolio. And it's why every investor needs to learn to think like a value investor. As Warren Buffett's long-time business partner Charlie Munger says, “All intelligent investing is value investing.”

5 Secrets of Value Investing
So how do you do it? Here are some of the secrets the legendary value investors use to find great bargains:

Buy When Wall Street Won't — The big players on Wall Street are very short-term focused. They'll often dump stocks just for missing one earnings estimate. But value investors favor a longer-term view. We can find hidden value in stocks that may be down as much as 30%, based on small news items and diligent research.


Own Companies, Not Stocks — Don't buy “stocks.” Instead, become a business owner of companies with strong competitive advantages. Buffett looks for companies with solid financial performance managed by seasoned and savvy executives.


Beware of the ‘Value Trap’ —Don't be fooled by judging stocks on price alone. Just because a former high-flying stock is selling for half-price doesn't mean it's a good value. The stock may have much farther to fall and may never recover. Without knowing its intrinsic value, or possible catalysts for turnaround, you can't know if a low price is a good value or not.


Know the True Value —Price is what you pay, value is what you get. Cash flow is the real health of the business. As Buffett says, “Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.” Discounted Cash Flow (DCF) is a powerful tool to help you know whether to buy, hold, or sell. (We offer our subscribers a unique DCF calculator on our website that makes this simple to do.)


Don't Overpay for Growth — It's not true that value stocks can't be growth stocks. Growth is a component of value. It's just that value investors don't rely on growth. Value investors minimize risk by looking at the worst case first. They choose investments with a built-in margin of safety. That's why value stocks are the best way to follow Warren Buffett's famous rules: Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.


As Buffett's mentor Benjamin Graham wrote in The Intelligent Investor, “In the short-term, the market is a voting machine, in the long-term it is a weighing machine.” So as a value investor, you're not waiting on a rising market to lift your stock — only for the market to realize your stock's true worth. This is a much more certain way to make money.


Value Stocks Earn Market-Crushing Returns
Value beats every other type of stock investing across all types of markets hands down. Value stocks returned an average 12.6% annual return from 1926-2002, according to a study by Ibbotson Associates. $1,000 invested in 1926 have turned into more than $8,000,000!
Another study by Ibbotson looked at the period between December 1968 and December 2002. During that time value stocks returned 11.0% per year, growth stocks returned 8.8%, and the S&P 500 returned 10.2%.

At those rates

$10,000 invested in the S&P 500 grew to $270,081.
$10,000 invested in growth stocks grew to $175,200.
$10,000 invested in value stocks grew to $346,300.
Value stocks beat growth stocks nearly 2 to 1 and beat the S&P 500 more than 4 to 1!

Invest Like the Masters
I follow the trails blazed by legendary investors such as Benjamin Graham and Warren Buffett. In their value-investing approaches, they've searched for companies with beaten-down stocks that still had solid management, free cash flow, and attractive assets.
To spot the great turnarounds, I constantly search the market for out-of-favor companies. I run numerous stock screens. And then, for the few select companies that make it on my watch list, I run a series of metrics — including discounted cash flow (DCF) analysis — to give me my estimate of a company's intrinsic value.

Once I have the fair value, based on my required margin of safety, I sit back … and wait patiently. I then wait for the share price to drop below my “Buy Below” price. This gives me a margin of safety for my investment. When I spot such a bargain, I buy. Then I again patiently wait, this time for the market to recognize the stock's real value. It usually doesn't take long until the market drives up the price of the stock to levels at or above my intrinsic value estimate.

In short, I seek good deals at great prices. Having a margin of safety allows me to minimize the risk while aiming for solid returns.

Get Great Stocks at Bargain Prices
Buying great stocks at bargain prices is the surest way to get rich. You've estimated your profit before you put down your money. Value investing is the polar opposite of speculation. You squeeze out risk at every step. Then, you can buy a dollar's worth of value for as little as 50 cents because you know what you're buying. You're not basing your decision just on price, but the intrinsic value of the company you're buying. That's why…

Value Investors Sleep Well
If you're like many investors, you're still suffering from the current market meltdown. You're painfully aware that it takes a 100% gain just to break even after a 50% loss. That's why you want to avoid losing money at all costs. Value investing is the best way to find safe stocks. And they're the best way to make great profits across all types of markets.

Market-Beating Returns
So, how are we doing? Since we launched Inside Value in September 2004, we've been soundly beating the market. Even though many of my picks are very recent in a value investor's time frame, we've had great results with stocks such as:

MasterCard — locked in a 279% gain
Omnicare — locked in a 102% gain
Intuit — locked in a 84% gain

We're also collectively beating the S&P 500 since our service was founded. That's all my stocks, the winners and the losers. And, on a risk-adjusted basis, the returns are even better.

Value is the key to investing success. And that's why I invite you to join me and profit from the best values in the stock market. My commitment is to help you find great value stocks. INSIDE VALUE is the best way I know to find solid, well-managed companies that are worth more than you are paying.

Inside Value will help you:
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Experience new freedom from worry — No matter what the market does, you'll own stocks that are already priced below their value. They'll better hold their prices in bear markets and will soar higher in bull markets. Most of my recommendations are long-term “buy-and-holds,” so you don't need to worry about trading or timing the market. But when it's time to take profits, or if there's another reason to sell, I'll let you know.

Discover your true potential as an investor — Value investing is what intelligent investing is all about. You'll expand your “circle of competence” as a knowledgeable value investor. You'll find that the tools and outlook of a value investor will help you in every investing situation, from choosing new stocks to managing your portfolio to knowing when to sell.
Simplify your life — There's never been an easier way to use all the tools of value investing. We make it easy for you to grab great bargains in companies you'll want to own for the long term.

All told, Inside Value is a total investor information system to help you build real wealth in the fastest, most reliable way possible.


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Your Subscription Includes:

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Each Issue of Inside Value includes these features:

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An industrial juggernaut averaging 25% gains per year since 1991. Despite worldwide turmoil, this company increased revenues 32% in the latest quarter, and senior analyst Tim Hanson conservatively values the company at twice its current price.

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http://www.fool.com/shop/newsletters/14/4163628d-26ae-4904-ab30-30006213e8d9.aspx?tuid=1812089&source=iivedilnk8251986

7 Stocks That Could Cause Permanent Losses

7 Stocks That Could Cause Permanent Losses
By Alex Dumortier, CFA
February 12, 2009





In a recent research note to clients, Societe Generale investment strategist James Montier identified 42 stocks worldwide that he believes threaten investors with a permanent loss of capital.

So what?
Montier is not your run-of-the mill investment strategist, which is one of the reasons I follow him. For instance, he once published a research note on the psychology of happiness with 10 suggestions, including the following: "Have sex (preferably with someone you love)."

Don't be fooled by this unorthodox style, though. Montier is no charlatan -- he's an expert on behavioral finance, and his work is steeped in the no-nonsense principles of value investing, as laid out by legendary teacher-investor Ben Graham.

In other words, it's worth your time and money to listen to what he has to say -- particularly on a matter as serious as preserving your assets.

Permanent loss of capital vs. stock price drop
First, let me emphasize what value investors refer to by a permanent loss of capital. Whether stock losses are permanent can be determined only if you have a notion of the stock's intrinsic value. Two sets of circumstances can result in permanent loss. Either :

• your cost basis was materially higher than the intrinsic value, or


• the intrinsic value itself has declined.

It's vital to understand that a drop in stock price does not cause a permanent loss of capital.

• Rather, if there is a mismatch between price and intrinsic value, there will be a downward adjustment in the stock price -- don't confuse cause and effect.


• Furthermore, not all stock-price drops are the product of latent permanent losses -- they may have other causes, such as forced selling and investor irrationality.

The trinity of risks
Now that we know what it is we are trying to avoid, let's focus on the three factors Montier refers to as the "trinity of risks" that can produce such losses:

1. Valuation risk: If earnings are at a cyclical high, the current P/E may be masking an overvalued stock. Montier uses an adjusted P/E ratio that replaces current earnings per share (EPS) in the denominator with a 10-year average EPS. This approach smooths out the effect of earnings volatility and comes straight from the Ben Graham playbook. When screening for danger, Montier looks for stocks that have an adjusted P/E ratio of greater than 16.

2. Balance sheet / financial risk: Excessive leverage can put a company into bankruptcy, no matter how sound the underlying business. Investors need to be particularly sensitive to financial risk in an environment that combines a contracting economy and tight credit.

The Z-Score is a statistical indicator of bankruptcy risk developed by Edward Altman of NYU. Montier's screen identifies companies with a Z-score below 1.8, the "distressed" range in which companies run a significant risk of bankruptcy.

3. Business / earnings risk: If current earnings are significantly higher than their recent historical average, investors may extrapolate future earnings from an inflated base and award the stock a valuation it doesn't deserve. This risk is exacerbated at the tail of a bubble. Montier looks for companies with current earnings per share that are double or more the 10-year average.

Using Montier's three criteria, I ran a screen and came up with 19 mid- and large-cap U.S. stocks. The following table contains seven of them:

Stock
Adjusted Price/ Earnings Ratio*
Z-Score
Current EPS/ 10-year Average EPS*

Wynn Resorts (Nasdaq: WYNN)
73.3
1.32
5.8

CME Group (Nasdaq: CME)
29.9
0.69
2.6

XTO Energy (NYSE: XTO)
26.4
1.44
2.6

Transocean (NYSE: RIG)
26.2
1.74
6.9

Williams (NYSE: WMB)
24.0
1.20
2.5

NYSE Euronext (NYSE: NYX)
18.5
1.39
2.6

Norfolk Southern
17.5
1.79
2.11


*Note that, in certain cases, the average earnings were calculated over fewer than 10 years for lack of data. Source: Capital IQ, a division of Standard & Poor's, as of Feb. 3, 2009.


A couple of surprise guests
I was surprised to find exchange operators CME Group and NYSE Euronext on the list, as theirs is a sector I find attractive right now. Perhaps this illustrates one of the limitations of mechanically screening by adjusted P/E and comparing current earnings to the 10-year average: It doesn't allow you to distinguish between secular increases (or declines) in earnings and cyclicality. Both companies became publicly traded within the past 10 years, so their focus on profit growth is boosted.

Here's an extreme example: Google's (Nasdaq: GOOG) earnings per share have, on average, doubled every year over the past five years; in this instance, it's pretty clear that using the 10-year average EPS to calculate the P/E would actually muddy the waters. An average earnings figure calculated over a period of strong growth is inadequate to describe the company's true earnings power at the end of the period.

Safety first
All the same, the results should give investors pause -- the other companies in the table are clearly cyclical, particularly those in the energy sector (Transocean, XTO Energy, and Williams). Cyclical or not, if you own any of the stocks in the table, it may be worth revisiting your analysis in light of these results.

James Montier's methodology is an excellent illustration of the way value investors think about avoiding permanent losses. The team at Motley Fool Inside Value follows the same principles to help their members sidestep sinkholes and invest in well-run, well-capitalized businesses trading at cheap prices.

Fool contributor Alex Dumortier, CFA, has no beneficial interest in any of the companies mentioned in this article. Google and NYSE Euronext are Motley Fool Rule Breakers picks. The Motley Fool has a disclosure policy.

http://www.fool.com/investing/value/2009/02/12/7-stocks-that-could-cause-permanent-losses.aspx

Can You Stomach Another 40% Drop?

Can You Stomach Another 40% Drop?
By Dan Caplinger
February 20, 2009




After seeing the stock market lose half its value and head down toward six-year lows, you may feel like you've suffered more than you'd ever expected with your stock portfolio. Yet as another dour earnings season comes to a close, many see the potential for a much larger drop right around the corner.

The valuation conundrum
As dramatic as the drop in stocks has been since last summer, some market observers who focus on relative valuation wonder how the market has held up even as well as it has. If you focus on recent earnings numbers, the collapse in corporate profits among S&P 500 stocks paints an even bleaker picture of where the stock market ought to be trading.

According to The Wall Street Journal, trailing 12-month earnings for the S&P as a whole are likely to drop below $30, thanks to the recession. At least one pundit has applied an average earnings multiple of 15 to that number and come up with a projected value for the S&P 500 index below 450 -- more than 40% below its close at around 780 on Thursday.

Fair value, or foul?
The obvious counterargument to that dire prediction is that the recession has temporarily depressed earnings. After all, earnings for the S&P 500 a year ago were closer to $80, which works out to a P/E below 10 at current levels. If earnings eventually recover to their 2007 levels, then stocks look exceedingly cheap at this point.

But there's no guarantee that earnings will recover anytime soon. Leaving the length of the recession aside, many of the businesses that drove growth over the past several years won't get back to their previous levels of profitability. Even among financial firms that seem likely to survive the crisis, such as Goldman Sachs (NYSE: GS) and JPMorgan Chase (NYSE: JPM), the business model and market conditions that allowed Wall Street to maintain strong profit growth for years no longer exist.

Put another way, even if earnings for the S&P 500 recover fairly strongly -- say 50% from their recession lows -- that still only gets them up to $45. And with the specter of inflation, huge budget deficits, and potentially higher interest rates on the horizon, a P/E ratio of 17 based on that $45 figure sounds fairly pricey.

Protecting against market risk
So with that gloomy prediction, what can you do to cover yourself no matter which way the market moves? One possibility is finding stocks that don't move in lockstep with the market -- and one way to find such stocks is by looking at their betas. Here are some examples of low-beta stocks, which you can see have held up pretty well in the recent bear market:

Stock
Beta (Past 3 Years)
1-Year Return
5-Year Average Return

Altria (NYSE: MO)
0
(25.8%)
9.3%

Aqua America (NYSE: WTR)
(0.05)
(0.5%)
5.6%

Genentech (NYSE: DNA)
0.11
17.1%
12.2%

Strayer Education (Nasdaq: STRA)
0.01
9.2%
12.4%

Fairfax Financial (NYSE: FFH)
0.05
0%
15. 7%


Source: Yahoo! Finance.


The concept of beta is often misunderstood. Many rely on beta as a pure measure of volatility, counting on high-beta stocks to be more volatile than stocks with low beta values. But that's only true to the extent that a stock's returns are correlated with the overall market. A stock that moves independently, however, might well show a low beta, but its overall price movements might be fairly volatile.

So while low-beta stocks may provide some protection against a crash, they're no guarantee of positive performance. And of course, if the market rebounds, you'd do better in high-beta stocks that take greater advantage of bull markets.

Be ready
No matter what you do to protect your money, you need to be prepared mentally for what you'll do if stocks crash again. As unfair as it might seem to have to consider further losses after what you've already been through, counting on this being the worst of it is just too dangerous. As cheap as many stocks are right now, they could get cheaper -- and if you're on the edge of panicking already, you need to steel yourself for whatever comes next.



http://www.fool.com/retirement/general/2009/02/20/can-you-stomach-another-40-drop.aspx



For more on investing in tough times, read about:
Companies that will get better in a recession.
How you can profit when the recovery comes.
Stocks that could cause permanent losses.

How We Tripled Our Money in a Year

How We Tripled Our Money in a Year
By Tim Hanson
June 24, 2009


This past year was an exciting one to be an investor. At one point in March, stocks were down well more than 50% from their 2008 highs. Yet amid this chaos, we at Motley Fool Global Gains identified a promising small company with a strong and growing core business that was selling for a dirt cheap 4.5 times earnings.

Since we recommended that stock to our members in October 2008, it's returned more than 200%. During that time, it has also listed on a major exchange and vastly expanded its production and distribution capacity. Thus, even though it's not quite the deal we got back in October, the stock remains on our Best Buys list.

But before I get to the stock, I want to tell you how we found it and provide a few points that can help you identify similar things for yourself.

You find what you're looking for
You may have heard (sometime, somewhere) that the market is efficient. That means that at any moment, all of the available information on a stock has been incorporated into its price. While I believe that's generally true, I don't believe it's true all the time. What's more, it's less true in certain market segments than others.

For example, take a popular U.S. megacap like Apple (Nasdaq: AAPL). It's tracked by 45 sell-side analysts, has earned a rabid following of fans and detractors, and everything from its products to the health of its CEO are reported on every day in the media. This, in other words, is a stock whose price is largely efficient. If you choose to buy or sell Apple stock, you're likely not doing so with any kind of informational advantage over your counterparty.

That, however, is less likely to be the case if you're buying and selling stocks that most other market participants aren't even paying attention to. Specifically, that's small stocks, foreign stocks, and especially small and foreign stocks.

Which brings me back to my story
The stock we discovered at Global Gains that's more than tripled in less than one year is a small Chinese fertilizer company called China Green Agriculture (AMEX: CGA). In hindsight, at less than 5 times earnings last October, it looked like a clear winner. The company's organic fertilizers were coming into favor as the government encouraged farmers to increase food production without a destructive environmental impact. Further, government efforts to aid rural farmers were giving those farmers -- China Green's customers -- increased purchasing power. Finally, there was a clear catalyst in the new 40,000-metric-ton manufacturing facility that the company planned to open with the capital it raised in a private placement.

Yet the market either wasn't paying attention here, or it was far too focused on the perceived risks of investing in China Green Agriculture. Those included a very short track record as a public company, an over-the-counter stock listing, and no permanent CFO.

How, then, were we able to get comfortable with recommending China Green's stock?

Elementary, my dear Watson
The simple fact is that we traveled to Xi'an, China, last June, and spent two days visiting with the company and touring its R&D and production facilities. We talked extensively with management about their plans for the future and their perceived market opportunities. And we got answers to every question we had about the company.

This doesn't mean we walked away 100% confident. After all, a company visit, while an important part of our research process at Global Gains, will never reveal the full story. But the visit enabled us to get comfortable enough to recommend that our members buy shares at less than 5 times earnings within the context of a diversified portfolio.

And the result speaks for itself. Not only is it up more than 200%, but it's outperformed other well-known China plays, such as PetroChina (NYSE: PTR), Baidu (Nasdaq: BIDU), and China Mobile (NYSE: CHL), as well as other well-known fertilizer plays, such as PotashCorp (NYSE: POT) and Mosaic (NYSE: MOS).

Your takeaway
Now, you may not have the resources to travel to China to check up on all of the small, cheap, and fast-growing companies there that you may be interested in owning. But short of that, the lesson is that the only way you're going to be able to take advantage of the inefficiencies that exist in the stock market is by doing an extraordinary level of due diligence. That means going through the filings with a fine-toothed comb, checking up on a company's auditor to make sure it has a good reputation, and doing extensive analysis of the numbers to make sure they're good, but not too good to be true.

Yet if you can make company visits a part of your research process, I encourage you to do so. We travel to China each and every year with Motley Fool Global Gains and have found that it's the best way to identify both the most promising ideas as well as potential disasters.

In fact, we're headed back to China in July to meet with more than a dozen promising names in cities such as Shanghai, Xi'an, and Harbin. While we may not find another company that will triple our money in less than a year, we do believe our intelligence from the ground gives us -- and can give you -- an advantage in the market.

Tim Hanson is co-advisor of Motley Fool Global Gains. He does not own shares of any company mentioned. China Green Agriculture is a Global Gains recommendation. Apple is a Stock Advisor pick. Baidu is a Rule Breakers selection. The Fool's disclosure policy is Zen.

http://www.fool.com/investing/international/2009/06/24/how-we-tripled-our-money-in-a-year.aspx

Don't Rely on This Stock Measure

Don't Rely on This Stock Measure
By Selena Maranjian
June 24, 2009


Should you care about a stock's beta? I recently learned that it might be even less of a meaningful sign of a great stock than I'd originally thought.

But let's back up a bit and review what it is. Beta is a measure of a stock's volatility. A beta of 1.0 means that a stock rises and falls in sync with the overall market. A beta greater than 1.0 suggests wider swings, while a beta less than 1.0 indicates a sleepier stock.

Imagine that the stock of Meteorite Insurance (ticker: HEDSUP) has a beta of 1.2. If in the past, the market as a whole advanced 10% in a given period, Meteorite Insurance tended to advance 12%. If the market fell 20%, Meteorite Insurance typically fell around 24%. Conversely, if Acme Explosives Co. (ticker: KABOOM) has a beta of 0.50, it is roughly half as volatile as the market. With a market drop of 8%, we'd expect Acme to slump about 4%. With a market surge of 10%, we'd expect Acme to rise about 5%. Got it?

Beta in real life
Below are the recent betas for some of the Dow's components, just to give you a sense of how some major companies' volatilities compare. I'll also include their star rating from our Motley Fool CAPS community to give you an idea of how bullish on them our thousands of members are:

Company
CAPS rating (out of five)
Beta

Wal-Mart (NYSE: WMT)
***
0.23

ExxonMobil (NYSE: XOM)
****
0.41

McDonald's (NYSE: MCD)
****
0.67

Microsoft (Nasdaq: MSFT)
***
1.06

Cisco Systems (Nasdaq: CSCO)
****
1.18

American Express (NYSE: AXP)
***
2.17

Bank of America (NYSE: BAC)
***
2.66


Data: Motley Fool CAPS, Yahoo! Finance.


As a long-term investor, I haven't paid too much attention to beta. Obviously, if I think the market's going to rise over time, I'd love to have a high-beta stock that outpaces the market's return. But as the examples above show, high-beta stocks during downturns are dangerous to your portfolio.

More importantly, when I buy stock in a company, I usually hope and plan to hang on for a long time. I also expect the stock to rise over that time, ideally substantially. So, to the extent that beta measures volatility, I don't care so much about it. As long as the stock grows over time, I'm not too concerned with how volatile it is as it advances. Many stocks that have proven to be wonderful long-term investments have been very volatile.

What's new?
Here's what I just learned, though: According to an article by researchers Pablo Fernandez and Vicente Bermejo from last month, beta measures vary widely from data provider to data provider. (They mentioned a range of 0.13 to 0.71 for Wal-Mart, for example.) One reason is that the number relies greatly on the time period involved. If one data provider calculates beta based on the past three years and another based on the past five or 10, their results will probably be quite different.

In addition, the researchers concluded that comparing betas of different stocks can be misleading, as even with a given set of data and method of calculation, beta values can differ, making it impossible to be sure that one stock's beta is actually higher than another's.

Lastly, the researchers found that returns of the vast majority of Dow stocks didn't correlate well with their calculated beta values. The researchers found stronger return correlations just by plugging in a fixed beta value of 1. That reduces its usefulness for many investing strategies.

So, even though beta can be interesting as a measure of volatility, don't give the measure more importance than it has. Even if past results suggest a stock will move in a certain direction, always keep in mind that future performance may take a completely different path


http://www.fool.com/investing/value/2009/06/24/dont-rely-on-this-stock-measure.aspx

Learn more:
Can You Stomach Another 40% Drop?
Early Signs of Winning Stocks
The 10 Hottest Stocks of 2008

3 Ways to Beat Lower Stock Returns

3 Ways to Beat Lower Stock Returns
By Dan Caplinger
June 24, 2009


When 18 months of losses recently gave way to a nice three-month rally, many investors started to see a glimmer of hope that maybe, just maybe, the stock market was starting to get back to normal. Unfortunately, though, the "new normal" may not give you the kinds of results you got used to before the bear market.

For decades, investors have counted on rules of thumb, such as the 10% long-term average annual return on stocks, to guide their investing decisions. Nearly every financial plan has assumed that while investors would still see bumps in the road, you'd eventually get back to that 10% trajectory.

Getting used to less
Now, though, top investors have started to question that basic assumption. As Foolish fund expert Amanda Kish discusses in the brand-new issue of the Fool's Champion Funds newsletter -- which is available today at 4 p.m. ET -- the recent Morningstar Investment Conference featured two well-known investors, both of whom warned against excessive optimism about any potential recovery.

Both bond guru Bill Gross and index fund pioneer Jack Bogle spoke about the future of the world economy and where the U.S. will fit into it. Gross believes that as a more mature economy, the U.S. can't expect to sustain its past economic growth rates, and so the era of high stock returns is over. As Gross sees it, investors will be better served finding stable sources of income, along with a greater emphasis on overseas investing.

Bogle comes at the problem from a slightly different tack, but he comes to much the same conclusions. With his projections of an 8% average return on stocks and a much smaller payoff from bonds, the conservative allocations he recommends aren't going to get you anywhere near the 10% returns to which many people have grown accustomed.

How to meet the challenge
The toughest thing about lower returns is the impact they have on compounding. Over a typical 35-year career, you can expect to see the money you first invest grow to more than 28 times its original value if you earn 10%. If you assume you'll only earn 7% on your money, though -- not unreasonable if Gross and Bogle's projections are anywhere close -- then the same money will grow less than 11-fold. That will leave you with less than half of what you would have earned with higher returns.

So, what's the right solution? The Champion Funds article recommends three ways to get the most from your portfolio, along with smart fund choices to go with all three methods:

Demand dividends.
While Amanda likes the idea of getting income from your portfolio, she prefers not to rely entirely on bonds. She recommends a fund that invests in ExxonMobil (NYSE: XOM), Hershey (NYSE: HSY), and Home Depot (NYSE: HD) -- strong dividend-paying stocks with yields that can supplement the current low rates that bonds pay now.

Go global.
The premise here is that if the U.S. economy stays slow, then you may get better results from companies with greater overseas exposure. The newsletter's fund recommendation here will help you load up on shares of global giants like Sanofi-Aventis (NYSE: SNY) and Nokia (NYSE: NOK).

Seek out strong growth.
Even in the depths of the recession, some countries are still seeing their economies grow, albeit at a somewhat slower pace. If you prefer the strong growth of emerging markets over developed countries like Japan and Germany, then Amanda has the fund for you, offering an easy way to own parts of America Movil (NYSE: AMX), Petroleo Brasileiro (NYSE: PBR), and other powerhouses of the emerging world.


Weaker returns from your investments can make your life more challenging. The right mix of investments, however, can help you make the most of whatever market environment you face in the years and decades to come.

http://www.fool.com/investing/mutual-funds/2009/06/24/3-ways-to-beat-lower-stock-returns.aspx

5 Traits of Great Stocks

5 Traits of Great Stocks
By Jeff Fischer
June 15, 2009

A recent study revealed that three of four stocks on the U.S. markets lost value between 1980 and 2008, despite the S&P 500 returning 10.4% annualized. What this means is the winning stocks won big, thereby compensating for the overwhelming number of losing stocks. However, if you hope to be invested in the winners, you need to choose carefully.

More than two decades of investing experience has helped us at Motley Fool Pro zero in on what makes for a winning business. Here are five of the key traits we seek in each stock before we buy it.

1. Sustainable competitive advantage
Healthy profits in a business attract competition -- everyone wants a piece of the profit pie. The only way a company can maintain profit margins and grow is to have a sustainable competitive advantage that serves as a protective moat around the business. You hear this quality talked about often, from Warren Buffett on down, but many investors still fail to buy companies that sustainably meet the bill. That's because it's the rare company that truly has lasting advantages -- but they are out there.

They're usually midsized or larger, have a long history of steady growth, and own assets or market share that provide enduring advantages over all others. Think Cameco (NYSE: CCJ), the largest uranium owner on the planet (the world isn't producing more uranium anytime soon); or Intel (Nasdaq: INTC), which enjoys 80% market share in computer CPUs. eBay (Nasdaq: EBAY) has sustainable competitive advantages, but it hasn't evolved quickly enough to keep all of its customers happy. However, network effects and market share -- competitive advantages -- are buying it time to right the ship.

2. Diverse customer base
A competitive advantage isn't worth much if the business is dependent on only a few customers. We like our businesses to have widely diverse and growing customer bases. This way, when some customers are lost, the business is not in peril and will continue to grow. We shy away from buying companies where just one or two customers account for 10% -- or more -- of annual sales.

3. Pricing power
With a lasting competitive edge and a broad customer base, a company usually enjoys some degree of pricing power. When costs rise, the company can pass them on to customers rather than suffering them itself. The strongest companies can implement modest price increases every few years without losing or alienating customers. Pricing power gives a company one more important arrow in its quiver as it hunts for long-term annualized growth.

4. Significant recurring revenue
If a business enjoys our first three criteria and also has significant recurring revenue, we become even more interested. By recurring revenue, we mean sales that repeat all but automatically, often with the same customers again and again, and usually without the company needing to spend more on marketing or reinventing itself or its products.

Revenue at the largest electronic exchange in the world, Nasdaq OMX (Nasdaq: NDAQ), recurs whenever someone makes a stock or option trade on its exchanges. Elsewhere, insurance companies enjoy recurring revenue every time a policy is auto-renewed, which happens more than 80% of the time at the best providers. Software companies have also gotten wise and sell annual subscriptions to their wares.

As General Motors collapsed in the first major recession in years, we're reminded that automakers are an example of anything but easy recurring revenue. They need to advertise continually to drive each sale, making for an expensive business that's vulnerable when the economy stumbles.

Easily or "naturally" recurring revenue results in more predictable and more profitable results, and helps maintain a business even during recessions. Some of the stocks we buy in Pro won't have naturally recurring revenue, but when it drives at least 30% of annual sales, the company gets a close second look from us.

5. Expanding free cash flow
The qualities we've mentioned so far will usually lead to strong free cash flow, which is the lifeblood of any company. By definition, free cash flow is cash from operations minus capital expenditures and any other nonoperational cash income, such as tax benefits from stock options. Much more reliable than mere earnings per share numbers, we're looking for free cash flow that's growing at least 8% to 10% annualized over the long term.

No company grows in a straight line, but over time we want expanding free cash flow to drive the value of the businesses we own. Strong free cash flow growers over recent years include software provider Oracle (Nasdaq: ORCL) and credit card giant MasterCard (NYSE: MA). Meanwhile, a rebound in free cash flow can revitalize a company, as has happened with BMC Software (NYSE: BMC) since 2004, more than doubling its share price. All three companies, incidentally, also enjoy all of the four traits above.



http://www.fool.com/investing/general/2009/06/15/five-traits-of-great-stocks.aspx

How to value this stock?

Wednesday June 24, 2009
John Master’s ‘retirement’ an eye-opener
Comment by Jagdev Singh Sidhu



THE circumstances in which a company proposes to sell its assets, distribute all the cash to shareholders and eventually remove itself from the stock exchange are usually done when conditions are dire.

It’s either that the company is financially haemorrhaging or affected by some cataclysmic event that has destroyed its balance sheet.

Rarely would that scenario be pictured of a still healthy albeit marginally profitable listed company that has basically decided to call it a day on the stock exchange.

When John Master Industries Bhd (JMI) said it wanted to “retire” as a listed company, the motive itself was a little perplexing. In its latest annual report, John Master did not sound like it was preparing to throw in the towel. Nor did it indicate such a desire in its latest quarterly announcement.

Yes, low trading volumes are an indication of investor interest and JMI said its average trading volume of just 7,300 shares a day over the past 12 months shows how illiquid and thinly traded its stock is.

Meagre volumes might be a reflection of investor interest but is that sufficient reason to exit the exchange? Based on yesterday’s trading on Bursa Malaysia, there were 317 companies on the stock exchange with fewer shares traded.

Financially, JMI has hinted that it was treading on water. It says its financial future is uncertain and the prospects for the industry it operates in are tough.

Competition in this business is fierce and there will always be places where it’s cheaper to produce a piece of garment than Malaysia. Economics and profitability will rule and the directors might feel that the company is fighting a losing battle on that front.

It argues those conditions make any future dividend payments doubtful. Even though business conditions are tough and outlook uncertain, there is an offer to bid for the assets of JMI from three directors of the company related to the founder of the company who retired in May last year.

Nobody knows whether shareholders would get full value of the company’s net tangible assets which was RM1.07. The company’s last traded share price was 49 sen a share.

The company is relatively debt free with only RM5.5mil in short-term borrowings. It has RM43mil in cash, or a cash backing of 35 sen a share.

Most of its assets are in the form of inventories (RM67mil) and receivables (RM39.7mil). Plant and machinery carries a value of RM2.8mil on the balance sheet and land for development is another RM2.4mil.

The company, however, has promised that its assets would be sold via an open tender and under the watchful eye of Ferrier Hodgson MH Sdn Bhd.

Cashing out of JMI would give shareholders of the company the financial flexibility to decide on what to do with their money. It’s also an avenue for shareholders to maybe realise the value of their current investment in a thinly traded counter with over 122 million shares.

The entire exercise might be a quasi privatisation process of JMI but whatever it is, the entire exercise would be a test case for other companies on Bursa.

It’s for the directors, who act as custodians of a company, to advice and recommend the best course of action to be taken by a company. And in this case, they have decided that the latest proposal is in the best interest of the listed company.


Ultimately it will be a decision for the company’s shareholders to make.


JMI : [Stock Watch] [News]


http://biz.thestar.com.my/news/story.asp?file=/2009/6/24/business/4182449&sec=business


Ref: Asset valuation approach in liquidation


Company Name: JOHN MASTER INDUSTRIES BERHAD
Stock Name: JMI
Date Announced: 29/05/2009
Financial Year End: 31/03/2009
Quarter: 4
Announce - 0309(Ann).xls
Announce - 0309 (Ann).doc

When valuing a business for liquidation, most assets are marked down and the liabilities treated at face value.

• Cash and securities are taken at face value.
  
• Receivables require a small discount (perhaps 15 percent to 25 percent off).
  
• Inventory a larger discount (perhaps 50 percent to 75 percent off).
  
• Fixed assets at least as much as inventory.
  
• Any goodwill should probably be ignored.
  
• Most intangible assets and prepaid expenses should be ignored.

Applying the following to the latest balance sheet of JMI:

• a 50% discount to fixed assets and inventories,
• 25% discount to receivables, and
• all liabilities are at face value,

I deduced a liquidation NTA value of $ 0.70 per share (equivalent to net worth for the whole company of $ 110.5 m).

http://spreadsheets.google.com/pub?key=rMg4CdEMPdLx-jOwZM-ecKA&output=html

This contrast with the reported NTA of $ 1.0754 per share in its latest quarterly report.

Today, the market price per share of JMI is $ 0.60 giving a market capitalization of $ 73.70 m. Therefore there is little potential upside here.

Always buy, hold or sell based on fundamentals.

To summarise:

We should buy, hold or sell based on fundamentals.

The basic premise behind our "buy" strategy - over the long term, investors gravitate toward stocks with strong fundamentals because those are the strongest companies, and that causes those stocks' prices to rise over time.

If you're buying stocks based on the above basic premise, that is, they have strong fundamentals, and over the long term, stocks with strong fundamentals tend to rise, you should hold on to a stock as long as it continues to meet the fundamental criteria you used to select it.

It's time to sell and replace the stock with another stock that does meet your criteria (and one that thereby has better prospects of rising in value), if the stock's fundamentals have slipped, so that it no longer meets the criteria you used to buy it. Also consider selling, if the stock is grossly overpriced, not justifiable even by the good fundamentals of the company.


Price should always be related to the fundamentals.

We should NOT buy, hold or sell based solely on the price is low or high or rising or falling


Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.


Because the goal is always:

• look closely at what to hold and what to sell now
• to maximize return on capital and
• to take advantage of the time value of money,

One must look forward at future prospects rather than backward at now-irrelevant old (higher or lower) prices.

Also read:
To guide you on holding or selling a stock in your portfolio.
To guide you in re-balancing and re-weighting of your portfolio.
Weathering a Panic
Stock Selling Guide - Gain/Loss Worksheet (Part 1 of 5)
Stock Sale Considerations (Part 2 of 5)
Evaluating Changing Fundamentals (Part 3 of 5)
To Sell or to Hold Checklist (Part 4 of 5)
Selling and Holding mistakes Checklist (Part 5 of 5)

Why we sell? Because of the fundamentals

When you're building your portfolio, then, you want to pick the stocks that have the best fundamentals - because (sorry again) over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.

If the stock's fundamentals have slipped, however, so that it no longer meets the criteria you used to buy it, it's time to sell and replace it with another stock that does meet your criteria(and one that thereby has better prospects of rising in value).



Your selling is based on ongoing re-evaluation of portfolio at regular intervals

The selling assessment is thus an ongoing re-evaluation of where a stock stands right now. You must continually reassess what the stock's prospects are going forward - not what they were a month ago, six months ago, or whenever you bought it.

On average, using monthly rebalancing period produce the highest raw return.

The important point here, whether you use a one-month rebalancing or a different time frame that works for you, is this - you need to re-examine your portfolio at set intervals, to assess how your holdings stand relative to the reasons you bought them. If they no longer meet the criteria you used to pick them, you should consider replacing them with new stocks that do make the grade.

By sticking to a firm rebalancing and reweighting plan, you keep emotion and hype from impacting your selling decisions. You sell at regular intervals, and you sell based on fundamentals. Just as with buying stocks, there's no place for hunch-playing or knee-jerk reactions here.



Price matters in how it is related to fundamentals

Whether the stock price has dropped sharply since you bought it or whether it has skyrocketed is no matter; what matters is where the stock's fundamentals stand right now.

Price - just as with buying - matters only in terms of how it relates to the fundamentals (what the stock's PE or P/S ratios are, for example).

Many investors will sell a stock:

• because its price has fallen and they think they need to cut their losses, or
  
• because the price has risen and they think the "smart" thing to do is to take the profits rather than risk the stock coming back down.

But those are arbitrary, emotional decisions.




When stock should be sold immediately

There are a couple rare occasions, however, when you should sell a stock without waiting for the rebalancing date to arrive.

• If a firm is involved or allegedly involved in a major accounting or earnings scandal, you should sell the stock immediately, because you can no longer trust its publicly disclosed financial data.
  
• In addition, if a firm has become a serious bankruptcy risk since the last rebalancing, you should also sell its stock immediately.

So with all of these challenges, how do you stave off emotion and make good, sensible "sell" decisions? The same way that you keep emotion at bay when deciding what stocks to buy: By using a disciplined system that makes sell decisions based on cold, hard fundamentals - not emotion-driven hunches, or arbitrary price targets.

Making good sell decisions is another reason for better returns in your investment portfolio.


Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.

Why we hold? Because of the fundamentals

When you're building your portfolio, then, you want to pick the stocks that have the best fundamentals - because (sorry to repeat) over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.

If you're buying stocks because they have strong fundamentals, and (everyone now), over the long term, stocks with strong fundamentals tend to rise, you should hold on to a stock as long as it continues to meet the fundamental criteria you used to select it.

Whether the stock price has dropped sharply since you bought it or whether it has skyrocketed is no matter; what matters is where the stock's fundamentals stand right now.


Price - just as with buying - matters only in terms of how it relates to the fundamentals (what the stock's PE or P/S ratios are, for example). Many invetors will sell a stock because its price has fallen and they think they need to cut their losses, or because the price has risen and they think the "smart" thing to do is to take the profits rather than risk the stock coming back down. But those are arbitrary, emotional decisions.

Remember, you bought the stock because its strong fundamentals made it a good bet to gain value; if its fundamentals are still strong, why wouldn't it still be a good bet to gain more value?

Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.

Why we buy? Because of the fundamentals

Let us examine the basic premise behind our "buy" strategy - over the long term, investors gravitate toward stocks with strong fundamentals because those are the strongest companies, and that causes those stocks' prices to rise over time.

We buy because of the fundamentals - not just because the price is high or low or rising or falling.

Remember, the only way price comes into the decision to buy is in how it relates to the stock's fundamentals - that is, in the form of such variables as the price-sales ratio or price-earnings ratio.

When you're building your portfolio, then, you want to pick the stocks that have the best fundamentals - because (sorry to repeat) over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.



Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.

Determining When to Sell

While a lot of strategies out there tell you how to buy stocks that will make nice gains, there are few that address the second half of the stock investing equation: when to sell.

• For many investors, deciding when to sell is a harder decision than deciding what to buy.
• Cabot Research, a behavioural finance consulting firm, has found that even top-performing mutual fund managers may be missing out on 100 to 200 basis points per year because of poor sell decisions.
• Seeing as how amateur investors tend to do much worse than the professionals, it is likely that the average, nonprofessional investor suffers even greater losses because of poor sell decisions.

Why are investors struggling with selling?

• Advice on this topic is somewhat lacking in the investment world. A survey found that more than 70% of professionals investors used a selling approach that was not highly disciplined or driven by research and objective criteria. So it seems most of the pros aren't offering a whole lot of guidance here.
• Just as our brains tell us to avoid unpopular stocks and jump on hot stocks when we're buying, they also cause havoc when we're trying to figure out when we should sell a stock.

A few phenomena make selling - and sticking to a selling plan - a difficult task.

- There's the 'fear of regret."

When we make an error of judgment, we feel badly; which is never pleasant. This is certainly true when we take a loss on a stock. Hindsight is always 20/20, and we end up thinking that we could have easily avoided what turned out to be a bad move.

• Because of the unpleasantness of those feelings, the investor avoid selling stocks that have lost value, instinctively wanting to postpone those feelings of pain and regret - even if those stocks now have little prospect of rebounding.
• Loss aversion refers "to the observed tendency for decision makers to weigh losses more heavily than gains; losses hurt roughly twice as much as gains feel good."
• As locking in losses hurts a lot, investors avoid selling stocks for a loss even after they no longer have good prospects, to delay that hurt.

- Another common mistake many investors make is holding on to winners too long.

Growth fund managers often do just that "because they are encouraged to do so by all the good news regarding companies prospects."

• A perfect example would seem to be the tech stock boom of the late 1990s.
• Many investors - professional and amateur, made a fortune as the Internet bubble grew. The problem was that the bubble kept growing, long, long after these stocks had risen above reasonable values.
• Still the buzzs was that the "Internet Era" had arrived, and would fundamentally change the stock market; when it came to the World Wide Web, the theory went, there were limitless possibilities - and thus limitless returns.
• Blinded by the hype, most of those people who had made huge sums of money ignored logic and held on to their stocks too long, only to see them come crashing down.

To try to avoid some of these problems, some people will set price targets for stocks they buy.

• They'll determine ahead of time that, if the stock gains, say 30%, they will sell it and take the profits. This sounds good on the surface, but really it's just another problem.
• All gaining stocks were not created equal; one stock may gain 30% and then drops, but another may gain 30% and then gain another 200%.
• Setting arbitrary selling targets like this can hurt just as much as they help, if not more.

The most difficult decision - when to sell

The most difficult decision for an investor isn't deciding which stock to buy, but deciding when to sell.

"You can be right about a stock's potential, but if you hold on too long, you may end up with nothing."

Many experts give detailed advice on how to buy stocks, few give advice about when to sell, despite the importance of that decision.



Discipline plays a key role in any selling strategy.

- One problem investors run into is that they fall in love with a winning stock and hold onto it too long.

- Many investors also fear that they will sell winners too soon and miss out on even greater gains.

• "Instead of groping for the last dollar, you should gladly leave some upside on the table. Catching market tops is not your game. This is preferable to getting caught in a subsequent downdraft."

There are two main reasons to sell stocks:

• deterioration in the stock's fundamentals (particular in its earnings estimates or five-year growth rates), or
• the stock's price approached the firm's expectations. You can devel0p these price expectations for each stock you own, using earnings estimates, and the projected expansion of the stock's PE ratio. These targets should also be adjsuted based on market climate.

One of the most important things an investor can do is stick to a firm selling strategy - whatever the details of that strategy may be.

Low Price-Earnings Investor

What does PE ratio signifies?

1. One of the common explanations of the PE ratio is that it tells you how much investors are willing to pay for every dollar in earnings that a company is generating.
2. However, PE ratio is also a measure of what kind of growth, investors are expecting from a company in the future.

• For example, take two stocks, one with a PE of 50 and the other with a PE of 10. Earnings drive stock prices, so if investors are willing to pay 5 x as much for one company's dollar of current earnings as they are for the other company's dollar in current earnings, they must be expecting that the first company will grow earnings much more rapidly than the second.

This idea of expectation was key.

• High-flying growth stocks with high PEs had so much expectation built into them that they often fell at the slightest sign of disappointment.
• Low PE stocks, however, have little anticipation or expectation built into their price. Therefore, any improvement in performance is likely to boost the attention they get, while they suffer little if their results don't meet the Market's already low expectation.

Low PE Investing

John Neff wrote, "Indifferent financial performance by low PE companies seldom exacts a penalty. Hints of improved prospects trigger fresh interest. If you buy stocks when they are out of favour and unloved, and sell them into strength when other investors recognize their merits, you'll often go home with handsome gains."

Neff continuously searched the newspapers for companies with low PE ratios (i.e. the least popular stocks in the market), also keeping tabs on those that had just posted new lows or were getting hammered in the press. From these shunned firms, he used a series of quantitative measures to identify those that were good bets to rebound.

He explained, "Swept up by flavours of the moment, prevailing wisdom frequently undervalues good companies. Many - but not all - that languish out of favour deserve better treatment. Despite their solid earnings, they are rejected and ignored by investors caught in the clutch of groupthink."

The challenge of course, is separating the stocks that are unfairly being beaten down because of overreaction from those that deserve their low prices.

What is 'low' PE ratio?

"You should look for stocks with a low PE ratio." What is 'low'?
Depending on your point of view, low PE ratios could mean:

• PE of 5 or below
• PE of 15 or below
• anything less than the median PE of the S&P 500 industrials
• PE in the bottom 20% of the market
• PE that is less than the annual EPS growth rate of the company (PE/EPSGR ratio less than 1)

All the above precise definitions of 'low' PE have been used by various investors.