P/E Ratios
 

We've talked about this "metric" (a way to measure things) in the past -- and I've said that I don't really look at it - because a fast growing company could have a sky high P/E (Price to Earnings ratio)... yet - isn't growth what you want in a stock?? Or there may be some other compelling story as to why the P/E is a little out of whack vs it's peers. It is ONLY ONE metric... useful yes - but not a sole criteria!

Here's a very good explanation of a whacked out P/E in a stock I own (20,000 shares)... So I thought I'd share it here.


http://www.fool.com/investing/genera...ok-pricey.aspx

I don't know about everyone else, but the market activity the last two months has been a great learning experience for me. In years past, when I had a Financial Advisor that set my portfolio up for me and didn't really understand the objective, watching my net asset value plummet like it has a couple of times recently used to set me off the edge and make me lose sleep. I'll admit to being guilty of asking him to pull at at times like these, sometimes he'd talk me out, other times he wouldn't.

This time around, after watching the investments that I personally chose (and knowing WHY I chose them) dip in value...my first thought was to pick up more of them while on sale instead of running for the hills. I've been reaping the rewards of those actions the past few weeks now.

Nobody can tell where Mr Market is going to go from here on out, but as long as we all just keep on building up shares of the companies we like...eventually we'll have the dividend paydays that we need to enjoy our retirement years.

Glad you're more at ease this time around, Lance. I'm in the same boat.

WOW!!! I think you're my most successful "convert".

One's view of the market must be in terms of years - not days.... it's a long slow up and down battle... which takes time to play out. But like houses - and commercial property - and many other assets - UP is the general long term result. Collecting cash payments (cash or re-invested) is so satisfying along the way!!!

Greg,
I recently was having a text conversation with a buddy of mine and we were briefly talking about investing. What sparked the conversation was in 2008 when we were in Iraq he had showed me some stocks he held at that time. He was only 18 and light years ahead of me when it came to investing apparently. I remembered he had AAPL shares and was showing me they had gone up and of course I told him to sell and he said I was crazy. I guess he was right! Regardless of that I asked him if he still held shares in anything and he said NLY. I looked at the chart and it has been on a steady decline for a while now. I said ouch and then he said "Its a yield play. Dividend is stong, share depreciation is a good entry. Its positive when it goes down."

Can somebody explain this to me?

Annaly Capital Management (NLY) is something that I used in the past to "park" cash and create a yield stream. For a long while it was a fairly constant price - so was relatively safe from a price standpoint. However, It is largely a "mortgage interest rate" play -- and as such -- I had warned LONG AGO that if interest rates were to rise.... this type of holding will get punished as the spreads on what they hold will be devalued (like holding a low % bond) and that can more than offset (decline) any yield you'll see.

So let me put this very simply. Money chases YIELD.... if the bond market was paying a tax free 10% -- that's where the big money would go. Where would the big money come from (there's a finite amount of investible cash)? From the Stock market! Why would you invest in the stock market with a yield of 5 or so percent - and pay taxes - when you could get 10% tax free on a bond? So the market would go DOWN as the BOND yield became more attractive. What holds the stock market "up" is it's yield -- because as the prices of dividend paying stocks declined - provided they're paying the same dividend rate - their yield would go UP. A stock that is valued at $10 - that pays a $1 dividend - has a 10% yield.... but if that stock price declined to $8... and it continues to pay the $1 dividend -- it's yield is now 12.5%.

Dividends are declared and paid in dollar terms - not percentages. As the price of the stock goes UP -- and the dividend payout stays the same -- the yield % goes down -- as the price declines -- the yield % rises.


If you're a long term holder of a stock that declines -- but has a sufficient yield -- then "eventually" you'll be made whole. That's not a smart way to think about it - but it might be the only way to think about it versus selling the shares at a big loss and taking the capital hit. This works especially well if you're having the dividend reinvested -- as the dividend is then buying more shares (you'd get more shares at $8 than you would at $10) and over time this will bring your average cost down. It's not as simple as that --- because there is a "cost" associated with money... and you're potentially losing out on capital growth etc.


So fundamentally what you have to be aware of is ----- is the stock price declining because there is a fundamental change in the business - or the perceived fundamental change in the business.... therefore rendering it a bad holding ------ or is there potential for the share price to recover? In NLY case -- it's a dangerous holding in a rising interest rate market. Perhaps your buddy just doesn't really understand what NLY is really all about. He could be "blinded" by chasing yield rather than understanding the relationships of what interest rates can do to an interest rate sensitive company.

Thanks. That helps me understand it better. Not sure if it's something I would chase. Its all about comfort and that seems like a lot of variables to consider.

If it's too complicated to understand the business you're thinking about being a partner in (as that is what buying the stock makes you - a partner).... stay away from it (whatever "it" is). There are far too many big great companies that you can invest in that are "easy" to click with. Why make life complicated.


I have used several companies over the years to "park" cash.... a couple ETF's (JNK and HYG and PFF)... GE.... NLY....KO... MO.... PM... AT&T and VZ. These are all "steady" shares that pay decent dividends. What I find about JNK and HYG and PFF is that they pay MONTHLY so I don't have to park for an entire quarter in order to pick up the dividend. But I'm talking about what would be quite large amounts of money for "most" folks reading this. As an example -- I hold over 1MM in EACH JNK and PFF currently (30,000 shares of each). Those two pay me over 10 grand per month... but --- big BUTT --- doesn't take much of a change when you're holding that many shares and you can lose way more than you're getting. This is okay for someone like me -- because I'm watching this stuff DAILY -- and perhaps multiple times per day. These are not buy and forget "investments"... they're "I have some cash I don't know what to do with right now and want to make some pocket money" buys.

This is why - throughout this thread I've preached to invest in best of breed stocks that a guy knows what the company does... That the average guy can buy with confidence and not need to check the price 8 times a day.... (I've got nothing better to do).

Hey Greg, great thread.

Ive got a generalized question. Tax on dividends goes to personal income rates, then what u see happening?

Thanks

Oh boy.... a loaded question that really is a tough one. For me personally -- it would change what I do to a certain degree as that would take a lot of disposable income away.

But, I need to make money on my money. How am I going to do that? Stocks? Bonds? Real estate?

The tax rate comes into play when BOND Yields have normalized returns (not the ultra low FED induced rates we have seen lately). That's when you look to tax free bonds - because you can calculate the tax free rate of return vs the taxable rate of some other investment. The problem with Bonds is you don't have the capital growth... so there is actual "risk" there that people fail to calculate.

Stocks have survived - and paid dividends - thru all manor of tax "schemes" by the government. Ditto real estate. Ditto bonds. So it's not a zero sum game regardless of what the tax scheme is. People still need to invest their money "somewhere".

Here's the way I look at it..... If I make 100,000 and I have to pay 35% - I still kept 65,000 for me. Obviously I like keeping 80,000 of the 100... and one can discuss the benefits (or not) of that free cash flowing back to the economy vs flowing back to Uncle Sam.

But the short response is -- I think it depends on how many other things are going in the economy. A big change would be a definite shock to the economy. Ala interest rates rising too quickly. It would really depend on how the change would roll in. If they gradually raised rates - people would have time to make the proper adjustments.

I remember when (1991) the Gov decided they were going to tax "luxury". So they put a 10% penalty tax on Boats and Furs and high dollar cars etc. It cost 60,000 jobs in the boat building industry in the US and put the fur industry virtually out of business (when was the last time you saw a woman wearing a fur or saw a fur store). But we know the "government" is not the best and brightest... That tax was repealed two years later because of the damage it did. Personally, I think raising the tax rate to ordinary income tax rates would do similar damage to the economy.

As usual -- it's a thorny issue. Many people believe the "rich" should be taxed - but what happens is that the man in the street pays a far heavier price when they loose their jobs.

On a personal note --- what people don't see is how many people make a living off the "rich" guy. The building of my home here in Sun Valley will keep some people employed for over two years. If I was taxed at ordinary rates - I'd have built a smaller project - or not built at all! I could have bought some other place (only the real estate agents would have gotten any income). That would have affected an awful lot of people here in the valley. The excavator - the cement guys - the framers - the plumbers - the electricians - the HVAC guys - the roofers - the sheet rockers - the painters... NONE of those guys would have made a dime off this project - and therefore neither would they pay ordinary income taxes on their earnings. So they can tax ONE guy (me) or they can collect taxes on a 100 people. I go out and have a meal regardless of the taxes I pay. But think about the 100 people. Do they go out or stay home? Do they buy some new equipment or not? Do they buy a new snow machine or have to sell the old one to pay the rent?


Like I said -- taxes are a thorny issue, and need careful consideration of the cause and effects. What sounds good on paper and in theory - can have debilitating effects down the chain.