Morning Market Thoughts
Good morning. We’re looking at a flat open this morning. After the type of moves we’ve had last week, a flat open is welcome. It’s healthy. Heck, I’d even welcome a pullback because I know that healthy markets don’t go up every day. They oscillate and churn. So here’s to hoping for some churning and oscillation.One concept that so many traders and investors struggle with is remembering what really matters. The ultimate arbiter of success versus failure is whether you make more money, or lose the money you have. That’s it. Nothing else matters. Seems easy enough, but there are many enticing routes that lead you down the wrong path.
One of the more tortuous paths that traders follow is the focus on going for the cheap stock. Lots of folks focus on buying “cheap” stocks. After all, we all like a good bargain, right? Why buy a stock with a 300 P/E when you can buy one in the same sector with a P/E of 14? Buy low and sell high, right? Well, the problem is that no one has ever made a dime on the P/E (Price divided by Earnings per Share) of a stock. Not one dime. Now, this may seem like blasphemy and ridiculousness to you value investors. You like to buy ‘em while they’re cheap – before the market catches on to your little gem.
Well, here’s some tough love. The market has already caught onto your little gem and doesn’t think much of it. The collective wisdom of the Crowd (the marketplace of buyers, sellers and sideline sitters) knows more than you or anyone else does. And the P/E of the stock is a reflection of the opinion of the Crowd. If the P/E of the stock is low, it’s because the Crowd doesn’t find much value in the company. And if the P/E of the stock is high, it’s because there is so much demand for the stock that investors will pay more for the privilege of owning it.
Warren Buffet cares about the earnings of a company that he is considering buying. He’s buying the cash flow, the assets and liabilities, etc. But you aren’t buying the company. You aren’t even buying paper. There was a time when you could physically own a certificate granting you a certain number of shares. Now, you are buying numbers on a computer monitor.
The only thing that truly matters is whether you can sell a stock at a higher price than you bought it for. Things like P/E are fine places to start, as long as you realize that it is only a starting place. The P/E of the S&P is a data point that is widely watched because of the notion that it tells us when the market is “cheap” or “expensive.” But what many fail to realize is that, when it relates to the S&P 500, P/E has to compete with interest rates and inflation. It’s not just a “stock v stock” situation. When interest rates are high, stocks need to compete with the bond market. Higher yields attract money. And when money is going into bonds rather than stocks, stock prices will be lower, and drag the P/E along with them. Similarly, when inflation is high, stock prices will be dragged down by the consumer’s greater difficulty in buying goods and services. So high bond yields and high inflation will ultimately lead to “cheaper” stocks with lower P/Es.
Today, inflation is nonexistent, and the Fed has been brutally efficient in destroying any kind of attractive yield on fixed income securities. In essence, we are in an expensive, high P/E environment because there is nowhere else to go.
So don’t let high P/Es keep you on the sidelines. That’s the way of the financial world right now.
You should be focusing more on the trend of the price. Newton’s Law of inertia essentially states that an object in motion remains in motion unless an external force is applied to it. Put another way, you should find an up trending stock, and then ride it until it bucks you off. If you can do that, you’ll make money.
If you aren’t riding the trend, then you are focusing on things other than simply making money.
Have a great day. See you in the forum.
–Dan
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