Stock Valuation – Is It Important ?

Stock Valuation – Is it important ?

I was reading an article this weekend and thought I would just do a quick post about stock valuations. Honestly, many small investors tend to be swayed by magazines or CNBC or an analyst recommendation indicating that a stock is cheap or expensive,etc……

Unfortunately, endless studies have shown that the stock market usually does the opposite of what wall street analysts consensus is or what a magazine cover article predicts. Realize that the stock market is very good at pricing in the future so by the time a stock is popular among the mainstream media then you are usually too late to the party. The same is true especially for mutual funds. Lots of studies have shown that the top rated morningstar funds end up under-performing in future years vs the lower ranked, essentially confirming the rule that when something gets hot it will eventually revert to the mean/averages….Speaking of mutual funds(I don’t like them), did you know:

• Less than 11% funds outperform SP 500 over 10yrs and 4% over previous 15yrs.
• Value line found that only 16funds out of 1300 achieves top 20% for 1, 5, and 10yr periods.

PRETTY SAD STATISTICS.

I’ll discuss my problems with mutual funds some other time but back to stock valuation. Yes, you can still buy well-known stocks and make money on them but most people don’t know how to buy at the right time and lose money or sell before the stock does what they wanted it to. How many times have you honestly sold a stock, only to watch it move higher over the ensuing months/years ?

The article I reading was talking about the most popular valuation indicator PE Ratio (Stock Price/Annual Earnings Per Share). In 2000 WalMart traded at a P/E of 42.5 and the company earned $1.25 a share in earnings. Since 2000 the earnings per share have almost tripled to $3.41(so a good 12% growth per year) but Walmart’s stock price has gone no where despite tripling earnings per share.

The point of the example above is that buying stocks only based on valuations when you don’t have a knowledge of all the other variables like market’s overall valuation, industry valuation, catalysts for why the stock will move higher, is the stock EPS low because it has high debt, etc……..Remember that the stock market has millions of investors determining what a stock should be priced so you better make sure you have a unique understanding why the stock will do well (and not from watching CNBC or reading the latest cover story of a financial magazine)

For most small investors if you decide to use valuations that make sure you have a thorough understanding and method for investing. It a tough road being a value investor as the “cheap” companies can go much lower or take forever to move higher until the market puts them back in favor. For individual investors a better method would be to follow a growth method if trying to trade. Use some stock screen that weed out the best companies and then pull up a chart to see which look like they are moving higher but haven’t already made big moves. The best known companies of today(Cisco/Miscrosoft,Apple,etc…) were unloved or unknown at one point so you have to always keep lo0king.

a free screener is http://finviz.com/ or there are go great stock screens on www.thekirkreport.com (is costs $100 a year to access his members section). On that note if you are trying to figure out trading and what it takes being a full time trader, then www.thekirkreport.com is an excellent resource for learning and reading about trading and realizing that is takes a lot of time and education to be successful at trading for a living (Despite what all those radio ads and spam penny stock emails tell you )