Do you think stocks are overpriced?
How to assign value to a stock
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Do you think stocks are overpriced? Wait 20 years. Nick Murray
Here are a few steps, with practice, you can learn to come to a fair value of a company you are interested in. For this method you only need a few details. It is important to know that the share of stock you buy is an actual piece of ownership of that company. You own it exactly the way the CEO or founder own it, at the same price and you have all of the same benefits and the debt and the risk. Buy these shares the way you would if you were buying the whole company. You are looking at hundreds or thousands of choices. Be choosy but not chicken.
Don’t try to guess bubbles or bottoms. Don’t pay attention to headlines like the one below. If you let your emotions be in charge you will not succeed.
The above is from March of 2020. February 19, 2020 was the peak for the stock indexes. After that, Covid panic created the greatest buying opportunity in my lifetime. And it was a quick rebound. Had you bought while others panicked in late March of 2020 you would have made a lot of money. Also, If you stayed in at the peak on 2-19-20 you would be way ahead today. Like always there is never a reason to sell your wonderful companies. Either way, don’t watch the headlines of the financail news industry. The goal of financial media is not to make you wealthy. It is to sell more stuff. The Nasdaq index was 9,817 at the pre-covid peak on 2-19-20. Today it is 17,133. Still, you will run into “Frank,” who lost “all his money” in the Covid crash.
Valutaion: Start with the PE. Why PE is important?
You want to know how much the company makes first of all. That starts with the earnings per share or EPS. The PE ratio or just PE is very simple. Simply take the share price of the company and divide it by the earnings per share. Price per share $50. Earnings = $2.50. (You can easily see the Earnings per share by looking up a stock, through a search egine. $50/2.50 =20 PE. Then you want to know how much they are growing. Now you must determine if they are making enough money to justify the share price. Peter Lynch uses an easy way to screen. He needs to see earnings growing at a rate that is the same as PE.
Further, Lynch started using PEG, (price-earnings ratio/ growth) that is extremely simple and now widely used. It quickly gives you an idea if your company is getting the growth it “should.” The above $50 share price/ $2.50 EPS gives us the 20 PE. If the projected growth rate is 15% the PEG is 20/15 or PEG= 1.33. A PEG of 1 means the company is growing earnings at the same rate as the PE. PEG is a great screen to get you a bunch of stocks that are growing in sync with the PE or close to it.
To figure the growth rate from this year to next, take the earnings projected for this year, say $2.50 divided by next years projected earnngs. Let’s say next year they are projected to make $3.00 a share. That is a $.50 per share increase. Take the increase and divide by the earnings from current year. $.50/$2.50 = 0.2 or 20% growth. Conversely you may see that the number $2.50 has to grow at 20% to be $3.00 in one year. Years after that get foggier and foggier. This is where you have to do as much as you can to get a 5-10 year growth rate, then commit to owning a company.
You must have a source of these things. You can do that for free on any number of websites. I have used Yahoo Finance for over 20 years. It is what I got used to but you may see another that looks better to you. As far as estimating growth rates, sometimes you can do a search for it. Value Line, the tried and true source of stock research gives you their estimates for long term growth and a wealth of other information. That will cost you $500-$1500 or so per year. Yahoo also gives you estimated growth for free. The premium version for $349.00 a year is pretty good. I also use Morningstar Premium. Sometimes a search engine is all you need.
When you buy stock in XYZ for $100 a share and it doesn’t have any profits yet, you are purely speculating. Sometimes this works out. But in general you want companies that are actually making you money.
A few other factors -before you decide
Your own eyes. Have you used the product? Do you like the idea, is it logical to you? Have you been in a store? Be careful. You know how you are:)
Are they regularly repurchasing shares of their own stock? This is to your benefit since it reduces the number of shares available. That means that earnings are going to fewer shares when earnings per share EPS is calculated. Thus lowering the PE ratio. You need to see how much that adds to the price per share.
Are insiders (Executives, 10% owners, Founders, board members and some employees) buying more of the stock they know, or are they selling?
Have they got a popular, growing, relevant product line? Is obsolescence going to be a problem?
Do new competitors have a “better mousetrap?”
Has a boring stock done well in market crashes? It should be a haven.
How much debt is it carrying?
Is the dividend growth rate attractive, assuming they have a dividend? You can search “dividend growth rate for XYZ.” The average dividend of a company in the S&P index increases at a rate of about 5.5% a year. A great inflation hedge. That means this: if a company pays a $1.00 dividend per share, the next year on it would be $1.055.
And a a lot of other factors. You can come up with your own intuitive questions, such as, “Will Tesla start making more money on batteries?”
Even though there are many factors, it’s all about 1) the growth of earnings and/or dividends. 2) See number 1.
See you soon,
Craig Verdi - craig@craigverdi.com