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Listen in as Teeka Tiwari, Chris Rowe, Costas Bocelli, Ed Pawelec and special guests give you the world financial news that you need to be profitable every market day... Sign up today to receive audio commentary every morning from some of the brightest minds in the industry.
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By Teeka Tiwari - Creator: ETF Master Trader
My article last week raised the ire of at least one of our subscribers. He railed against my blue chip selection method, saying that he had bought GE -- "the bluest of blue chips" in his words -- and that he still lost money.In my article I explained how to use a "quick & dirty" little formula to determine whether a blue chip stock was over valued or under valued.
The formula again is PE < (LESS THAN) Earnings Yield + Earnings Growth Rate. So if the stock's PE is lower than the combined value of the earnings yield and earnings growth rate, then we would consider the stock under valued and worthy of our consideration.
I also said that there are two caveats. The first is that this method is best suited to companies that have a durable competitive advantage, meaning that their business is not easily displaced. Coca Cola is a prime example of a company with a durable competitive advantage, and GE certainly has a durable competitive advantage in many of its different businesses.
However the second caveat is debt, and by that measure I would be careful using this formula to buy GE, because GE's current debt load stands at $440 billion, with $210 billion of that debt due in 5 years or less!
You must stay away from blue chips that have large amounts of debt because, no matter how cheap the stock gets if times get tough and credit dries up, having too much debt can choke a company to death.
This is exactly what happened to GE during the financial crisis: As the credit markets froze, GE couldn't find any buyers for its debt. The stock looked cheap at $17 in 2008, and yet that didn't stop it from falling to $5 in 2009. It was the debt that killed GE's stock.
In fact, if the Federal reserve hadn't stepped in, GE would have gone under. Any company that is dependent on the continual issuance of debt in order to stay in business is a company at risk during times of extreme crisis.
So GE is not a good candidate for this method, but let's apply it anyway and take a look-see at how our subscriber could have saved himself the pain of GE ownership.
Let's assume that it's the year 2000, the stock market is just starting to roll over, but on a relative basis stocks are starting to look cheap. So our subscriber friend takes a look at GE -- the "bluest of blue chips" -- with an eye to buy a bargain.
Was GE a bargain?
Let's run the numbers...
From 1996 - 2000, GE's compound annual earnings growth rate was 12%, and earnings for 2009 were $1.29. On December 29, 2000, GE closed at $48, down from its high of $60. It certainly got beat up... but was it cheap?
Here is our formula again: PE < (LESS THAN) Earnings Yield + Growth Rate. And here it is with the relevant parts filled in:
Dec 29th PE (37.2) < 2.68% Earnings Yield + 12% Earnings Growth Rate = 14.68
So our formula tells us that the most we can pay for the stock is 14.68 times earnings. Earnings for 2009 were $1.29, which gives us a price of $18.94. Remember, that’s fair value, that’s not even a discount. So we can see that we absolutely cannot, and will not pay $48 for GE.
Now that didn't stop GE from gunning higher 5 months later. The stock ran up to $53 during the May rally of 2000 before resuming its slide and bottoming at $21.40 during the 2002 low. So by using this method we saved ourselves from suffering a 50%+ drop!
Time well spent, don't you think?
So was GE a buy based on its 2002 low? Lets take a look once again...
From 1996 to 2002, earnings grew at an 11% compounded rate. Earnings for 2002 were $1.51, and the stock's low for the year was $21.40.
2009 PE (14.17) < 7% Earnings Yield + 11% Earnings Growth Rate = 18
Our formula tells us that the most we can pay is 18 X earnings, which would give us a price of $27.18. The stock is at $21.40 and so, at least by this one metric, it would be a buy. If our subscriber was really intent on owning GE, this would have been the time for him to buy it based on this method.
Was it successful?
Indeed it was, as the stock soared from $21 and change to $42.
And yet for those poor souls who bought the stock at $48 back in 2000, they were still under water!
So, was it GE to blame, or was the subscriber to blame for over paying? I can tell you this: No matter the business you are in, if you don't know how to value the "stock" that makes up your business, you will get clipped by other people that do.
So, even though I don't like GE because of its debt load, if you must buy this type of blue chip, make sure you but it cheaply enough to protect yourself. Because it doesn’t matter how blue a blue chip may be, nothing can help you if you over pay for a stock.
And please remember, using this formula will not guarantee that you get the bottom. But if you apply it to companies that have low debt levels and a durable competitive advantage, then you will be assured of getting a good price.
You still may have to deal with some extreme price volatility, but for long term investors looking to assure themselves that they did not over pay, this one formula is enough to get by on.
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Teeka Tiwari epitomizes the American Dream. He came to the United States from England at sixteen with just $150 in his pocket and the clothes on his back. By eighteen, Teeka had become the youngest employee at Lehman Brothers, and two years later he shattered convention by becoming the youngest Vice President in the history of Shearson Lehman. By the time he was 23 Teeka had made and lost a million dollars. At 27, he was a millionaire several times over. In June 2005, Teeka co-founded the Institute for Individual Investors and created Point & Profit, the trading service. Point and Profit made his wealth-building acumen available to the average individual investor for the first time. Since then, Teeka has been developing and perfecting the ETF Master Trader System, an interactive education program that teaches a complete Sector Trading investment methodology, and gives ordinary investors the confidence they need to master the markets using Exchange Traded Funds. In June 2008, Teeka launched Sector Hunter, the world's first fully-automated ETF trading technology. Sector Hunter provides individual investors with an institutional quality tool for identifying big money moves in 46 narrow sector groups, and then selecting those ETFs and stocks best positioned to yield profits from the move. Teeka is a regular contributor to FOX Business Network, and has appeared on FOX News Channel, The Daily Show with Jon Stewart, and international television networks. He manages a hedge-fund which is closed to new investors. Teeka's recent Tycoon Report articles can be found below. |
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Today's Laugh Line
"Federal Reserve chairman Ben Bernanke told a congressional committee the economic recovery is weakening. But the good news is most Americans will not be affected because they had no idea there was a recovery." -- Jay Leno
(Got Jokes? Send your best jokes or funny videos to editor@tycoonresearch.com ... if it makes us laugh, you might just see it in The Tycoon Report some day!)
1904: Workers Hit the Picket Line in Fall River
1904: Workers Hit the Picket Line in Fall River
Throughout the 19th and early 20th centuries the booming textile mills in Fall River, Mass., were lightning rods for labor action. Mill managers and textile honchos, who had first descended upon Fall River in 1811, pushed their largely female work force to toil for long hours in abysmal conditions. By 1871, Fall River had become one of the textile capitals of the United States and many of the mill owners had raked in hefty profits. The prosperity, though, didn't trickle down to the textile workers, prompting them to stage a series of increasingly bitter strikes. But, despite the torrent of protests, and the female employees' decision to form their own union in 1875, the textile workers struggled to gain rights or recognition from the mill owners. The advent of the industrial revolution only exacerbated the situation, as the textile chiefs took the advent of automation as an excuse to hire young children to staff their mills. Much like their adult cohorts, the ch ildren worked for hours on end in the local mills. This pernicious development outraged the adult work force and prompted them to take action on an unprecedented scale. Indeed, on this day in 1904, some 25,000 textile workers in Fall River hit the picket line to protest against conditions at the mills. The strike stretched on for most of the late summer and, though they hardly toppled the textile owners, the workers helped force the situation at mills, as well as the plight of child laborers, onto the national stage. The child labor issue, which was symptomatic of a larger phenomenon (in 1900 roughly 250,000 children under the age of 15 worked in mills, factories and mines) proved to be particularly resonant and prompted the formation of the National Child Labor Committee later that year.
Source: www.history.com
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