http://www.gurufocus.com/news.php?id=109169
Historically the P/E ratio of the broad market has been about 16. Anytime the ratio has been at that level average returns have been about 10% (corporate growth rate of 6 plus dividend yields of 4%). When the market was booming in the late 90s it was due almost entirely to a rise in the P/E ration. So buying in the late 90s was a bad decision because the P/E was near 30. Since the P/E average is around 16, if you bought in the late 90s you were buying when the market was likely to drop 50% to reach normal valuations. On the other hand, in 1982 the P/E was lower than 8. If you bought at that time you were nearly guaranteed to have doubled the average returns over a long period of time, as the P/E was likely to double back to its historic average of 16.
This is much easier said than done. How many people really bought in 1982, or March 2009 when it looked like the economy was collapsing? Very few. A lot of what you will learn about value investing has to do with temperament. Investing has much to do with numbers, but having the right mindset might be even more important. Even with numbers investing only involves simple algebra. As Warren Buffett famously stated- "If you need to use a computer or a calculator to make the calculation, you shouldn't buy it." Buffett means that to be a good investor you do not need to be a genius mathematician. Common sense and patience are for more important for investors than knowing how to solve complex mathematical problems.
Above I mentioned not to time the market, however now I suggest buying low and selling high this is not a contradiction. When buying low you have no idea what the stock market will do tomorrow, in a week or even a year. However, according to numerous studies it is likely this approach will be very successful over a long period of time say 5-10 years. Just because you bought low, also does not mean the market will not go lower. There is no way to predict short term market movements. However, it is much more prudent to buy low than buy high.
Lesson #3 A Good Company Does Not Equal a Good Stock
This is another big mistake people make. We are all familiar with many of the big chains all around the country many of which are publically traded; Wal-Mart, Coke, Disney, Proctor & Gamble, Starbucks Exxon, Google etc. the list is really endless. Sometimes people think they should invest in a stock based on how much you like its product is a recipe for disaster. As mentioned above an important factor in purchasing stocks is how what price you are paying for it. During the tech bubble in the late 1990s people were buying stocks that had a price earnings ratio of 600. That means if you bought the stock at that price, it would take 600 years for the company to earn the money you paid for it. Now think of a stock as a business , would you buy a business that would take 600 years for you to break even? Of course not. Yet when it comes to stocks people get very greedy, and are look to buy a stock and hope someone will buy it at a higher price. This is thinking with your emotions and not with your logic, which is a big investing mistake.
Google might be a great company but at what price is it worth paying? Well it depends at what price. To paraphrase Benjamin Graham, “there is no such thing as a good stock, at a certain price it is a good stock, and at a different price it is not a good stock". Google was trading at over $700 at one point and got as low as $250 at one point. Without going into the valuation of what Google is worth, it is possible Google was a great buy at $250, but an awful buy at $700.
Disclosure: Long Coke
http://www.valuewalk.com/
Historically the P/E ratio of the broad market has been about 16. Anytime the ratio has been at that level average returns have been about 10% (corporate growth rate of 6 plus dividend yields of 4%). When the market was booming in the late 90s it was due almost entirely to a rise in the P/E ration. So buying in the late 90s was a bad decision because the P/E was near 30. Since the P/E average is around 16, if you bought in the late 90s you were buying when the market was likely to drop 50% to reach normal valuations. On the other hand, in 1982 the P/E was lower than 8. If you bought at that time you were nearly guaranteed to have doubled the average returns over a long period of time, as the P/E was likely to double back to its historic average of 16.
This is much easier said than done. How many people really bought in 1982, or March 2009 when it looked like the economy was collapsing? Very few. A lot of what you will learn about value investing has to do with temperament. Investing has much to do with numbers, but having the right mindset might be even more important. Even with numbers investing only involves simple algebra. As Warren Buffett famously stated- "If you need to use a computer or a calculator to make the calculation, you shouldn't buy it." Buffett means that to be a good investor you do not need to be a genius mathematician. Common sense and patience are for more important for investors than knowing how to solve complex mathematical problems.
Above I mentioned not to time the market, however now I suggest buying low and selling high this is not a contradiction. When buying low you have no idea what the stock market will do tomorrow, in a week or even a year. However, according to numerous studies it is likely this approach will be very successful over a long period of time say 5-10 years. Just because you bought low, also does not mean the market will not go lower. There is no way to predict short term market movements. However, it is much more prudent to buy low than buy high.
Lesson #3 A Good Company Does Not Equal a Good Stock
This is another big mistake people make. We are all familiar with many of the big chains all around the country many of which are publically traded; Wal-Mart, Coke, Disney, Proctor & Gamble, Starbucks Exxon, Google etc. the list is really endless. Sometimes people think they should invest in a stock based on how much you like its product is a recipe for disaster. As mentioned above an important factor in purchasing stocks is how what price you are paying for it. During the tech bubble in the late 1990s people were buying stocks that had a price earnings ratio of 600. That means if you bought the stock at that price, it would take 600 years for the company to earn the money you paid for it. Now think of a stock as a business , would you buy a business that would take 600 years for you to break even? Of course not. Yet when it comes to stocks people get very greedy, and are look to buy a stock and hope someone will buy it at a higher price. This is thinking with your emotions and not with your logic, which is a big investing mistake.
Google might be a great company but at what price is it worth paying? Well it depends at what price. To paraphrase Benjamin Graham, “there is no such thing as a good stock, at a certain price it is a good stock, and at a different price it is not a good stock". Google was trading at over $700 at one point and got as low as $250 at one point. Without going into the valuation of what Google is worth, it is possible Google was a great buy at $250, but an awful buy at $700.
Disclosure: Long Coke
http://www.valuewalk.com/
