Buy, Sell or Hold ? – Investors frozen in a “melt up”
Move over Times Square, there’s a new countdown in town just a short Cab drive south to 11 Wall – Dow 20,000! Nobody is quite sure what’s causing the stock market to venture into this oxygen deficient atmosphere, but everyone seems to be loving it. We’re already hearing the 21, 22 and even 25,000 predictions before the big 20,000 has officially been reached. The NASDAQ composite index is also soaring to new highs and working it’s way to the 6,000 level. The soaring Dow Jones Industrial Average, although quite overvalued according to many experts, is concerning but pales in comparison to astronomical values of company shares on other exchanges.
I’ve learned that members of the human species have two major downfalls; short term memory loss and the ability to be easily distracted. When markets are soaring, we see only butterflies, zebras and fairy tales, (for my fellow Jimi Hendrix fans) and we forget what a down arrow even looks like, let alone a red one. Same goes for the reverse, when markets are dropping all we hear about is wealthy bankers, crooked CEOs and how real estate is the place to put your money. If you doubt my memory theory, try this little experiment: Next time you’re leaning back and loosening your belt after enjoying a hearty 4 coarse meal, try imagining what it feels like to be absolutely starving. As far as being easily distracted goes, we all know how hard it is to avoid the shiny object.
DAMN THE VALUATIONS – FULL SPEED AHEAD
I would venture to guess that 90% or more of individual investors haven’t got the slightest clue how to properly determine the value of their equity holdings – but hey, who cares it’s just a numbers game, right? When you’re buying stock in a particular company, you need treat the per share price the same way you would if you were buying the whole company.
Take Netflix for example, you like the shows and you hear they have a ton of subscribers – all sounds great except there’s that numbers thing. According to Yahoo Finance, the market capitalization(the price it would cost to buy the whole company) for Netflix is $53.5 Billion. Okay, so if you were to shell out a cool $53.5 Billion to buy the company, how much will you make per year on your investment? For that we go to the “revenue” (total sales) and the”net income” (net profits after taxes and expenses) sections of the financials which in this case shows a net income of $163 Million on $8 Billion in sales. How many years of pocketing $163 Million would it take to recapture your $53.5 Billion investment? Answer: 325 years! An annual return of .003% – or three one hundredths of one percent.
Another example is Amazon.com. With $2.1 Billion in net income and a market capitalization of $360 Billion, it would take approximately 180 years to recapture your original investment – a .005% annual return on your money – or five one hundredths of one percent. Would you buy either one of these companies? If the answer is no, then you should not own stock in them. Owning a share of stock is the same as owning a very small piece of the company at its current market capitalization (market cap).
I only used these 2 examples because of their name recognition, not to isolate them for any particular reason. They are both well run, successful companies, but a good company and a good stock are two totally different things. There’s a time to avoid buying stock in a great company, just as there is a time to buy stock in a not so great company – market cap is one of the first places I look for guidance. There are many approaches you can take when evaluating a stock price for potential purchase, some are simple and some can be complicated – more to come in the future.
“Buy Your Straw Hats in Winter.’” – Bernard Baruch
Disclosure: The commentary, analysis, and opinions represent the personal and subjective views of the Author, and are subject to change at any time without notice. The information provided in the Reports is obtained from sources which the Author believes to be reliable. However, the Author has not independently verified or otherwise investigated all such information. Neither the Author, the publisher, nor any of their respective affiliates guarantee the accuracy or completeness of any such information.
*This story has been updated