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Subject:  Re: Evaluating a Stock with a "Higher" Date:  8/8/2008  6:38 AM
Author:  PaulEngr Number:  3668 of 3816

Data will help here:


My response is that there are some investment strategies that will consistently beat bonds and have almost zero required brain power to apply that do not involve mutual funds (the criteria). These strategies will beat out bonds very trivially. Buying a small amount of a "mega-cap" such as GE on a set schedule over a long period of time is one such strategy.

This particular one exposes you to company-specific risk. In other words, GE does have it's ups and downs. A better strategy would be to apply the same one except to rotate among 5-10 different stocks. Say you buy GE in January, BRK in February, MMM (3M) in March, etc., etc.

It is the same thing that happens if you buy a single bond issuance, except that typically bond returns do not vary all that are paying for an almost fixed return in the end after all. So if you buy a half dozen different issuances from different companies or agencies, even if one defaults, the others will compensate.

This strategy pretty much eliminates company-specific risk. A simpler strategy which may or may not have lower costs (depends on how low you can make your costs go) is to buy an index fund or an index ETF such as SPY and let someone else do all the trading to average everything out for you. This obscures the "stock-only" strategy because there's now a mutual fund company doing the actual individual buying and selling but saves you the trouble of keeping track.

If you apply some amount of investment strategy to pick when companies are performing poorly, even if it's just to look at long term performance (over say 20-30 years), you can capture some additional returns by catching stocks when they are available at bargain prices. The BMW method is one such approach. Mike Klein's chart is a graphical interpretation of that method. You simply chart what a stock's average return is over a very long period of time (20-30 years) and buy the stock when it is well below it's average return, selling when it is at or above the average return.

By the way, I consider "low PE" to be less than about 10-15, not 15-23. Historically over the past 20-30 years stocks have been averaging about 20-25 for PE's (depending on who crunches the numbers). When stocks dip well below this (with a safety margin), say under 15, two things are at work. The company is obviously performing poorly. The question is whether the market is punishing them for a short term problem or if it's a long term issue.

For example, Sun Hydraulics is a small cap but has been producing market beating results for a few years, netting them a PE in the high 20's. They returns have been fairly steady as well. I bailed out when the PE got just plain too high and shortly after, the stock price dropped quite a bit. More recently in the past few days, the stock failed to meet analyst expectations by about 5-6%. The stock price dropped substantially again. The reason for the drop was a one-time tax hit of about 5%. So right now the company is a high profit company (a typical growth stock) and the stock is cheap. I'm getting back in for another ride from undervalued to overvalued territory.
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