Inflation is an economy-wide, sustained trend of increasing prices of goods and services, and loss of dollar purchasing power from one year to the next.It affects investments in several ways:
Real Value Erosion:
The rate of inflation represents how quickly investments lose their real value and how quickly prices increase over time.
As prices rise, the purchasing power of money decreases. For example, if you can buy a burger for $2 this year and the yearly inflation rate is 10%, next year the same burger will cost $2.20.
To maintain your standard of living, your investments need to generate returns equal to or greater than inflation.
Investment Returns and Inflation:
If your investment returns do not outpace inflation, your real returns (adjusted for inflation) may be negative.
Suppose ABC stock returned 4% and inflation was 5%. The real return on investment would be minus 1% (5% – 4%).
Asset Classes and Inflation:
Liquid assets (e.g., cash, short-term deposits) tend to appreciate more slowly than other assets. They are more vulnerable to the negative impact of inflation.
Illiquid assets (e.g., real estate, long-term investments) are also affected by inflation but may appreciate in value or generate interest, providing a natural defense.
In summary, understanding inflation is crucial for making informed investment decisions. Consider investments that can keep pace with or exceed inflation to protect your purchasing power over time.
“A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world.” ~ Seth Klarman
Berkshire Hathaway CEO and Chairman, Warren Buffett, is known for his value investing approach, which involves finding companies that are undervalued by the market and investing in them for the long term. To invest like Warren Buffett, there are a few things you need to know.
First, you need to have a clear understanding of what value investing is and how it works.
Second, you need to be patient and be willing to hold onto your investments for the long term.
Third, you need to have the discipline to stick to your investing strategy even when the market is going against you.
When deciding on how to invest in a company, the first step is to determine its worth or intrinsic value. According to Warren Buffett, the best companies to buy are those that are inexpensive to buy. His investment strategy is based on a few simple principles:
Buy quality companies that have a competitive advantage (moat),
Buy them at a reasonable price with a margin of safety, and
Hold them for the long term.
These principles of margin of safety have helped Buffett generate incredible returns over his career. Margin of safety is a strategy that involves investing only in securities at a significantly lower intrinsic value than their market price.
The margin of safety (MOS) allows investors to avoid overpaying for an investment or asset, and it protects investors from the potential of loss if the market price of the asset falls. Buffett has said that the margin of safety is the key to his investing success.
The margin of safety is a measure of how much room there is between the price of the stock and its inherent value. The wider your margin of safety, the less likely it is that overly optimistic valuation inputs will harm your investment.
Value investing is the process of making investment decisions using margin of safety. It is critical for value investors to find a high-quality, easy-to-understand company with good management priced below its intrinsic value.
The purpose of using a margin of safety in buying is twofold.
If your investment does not grow as quickly as you originally anticipated, you may be forced to make more conservative investments in your portfolio. If your estimates are correct, you will be able to achieve a better rate of return over time due.
If you purchased the investment at an extremely low price.
Discounted cash flow (DCF) is a method of valuing a company or asset using the principles of time value of money.
The objective of DCF is to find the value of an investment today, given its expected cash flows in the future. One popular way to value a company is using the discounted cash flow (DCF) method. This approach discounts a company’s future expected cash flows back to the present day, using a required rate of return or “hurdle rate” as the discount rate. The idea is that a company is worth the sum of all its future cash flows, discounted back to the present.
The DCF formula is: Value of Investment = Sum of (Cash Flow in Year / (1 + Discount Rate)^Year)
The “discount rate” is the required rate of return that an investor demands for investing in a company. This rate is also known as the “hurdle rate.” There are two ways to calculate the discount rate.
There are two ways to calculate the discount rate.
The first is the weighted average cost of capital (WACC). This approach considers the cost of all the different types of capital that a company has, including debt and equity.
The second way to calculate the discount rate is the discount rate for equity. This approach only considers the cost of equity, which is the return that investors demand for investing in a company.
Once the discount rate is determined, the next step is to estimate the cash flows that a company is expected to generate in the future. These cash flows can come from a variety of sources, including operating income, investments, and financing activities. After the cash flows have been estimated, they need to be discounted back to the present using the discount rate.
The present value of the cash flows is then the sum of all the future cash flows, discounted back to the present.
“If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it’s over the Grand Canyon, you may want a little larger margin of safety.” ~ Warren Buffett
“Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time.” ~ Seth Klarman
At an early age, Billionaire and Baupost Capital CEO Seth Klarman was fascinated with business and making money. By the age of ten he was investing in the stock market.
During Klarman’s time in the investing world, he’s been able to compound capital at a 20% annual return.
In 1991 Klarman wrote his book, Margin of Safety, and there have only been 5,000 copies printed. As a result of such a small supply and enormous demand, Klarman’s book is very expensive reselling for $1,500 to $2,500.
James Clear — who writes about habits, decision making, and is the author of the #1 New York Times bestseller, Atomic Habits — summarizes the book, Margin of Safety, as follows:
“Avoiding loss should be the primary goal of every investor. The way to avoid loss is by investing with a significant margin of safety. A margin of safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and make mistakes.”
2010 Baupost Capital’s annual letter
Here is an excerpt from the 2010 annual letter of Baupost Capital written by Seth Klarman. He was shocked at how quickly investors have returned to the risky investing and financial behaviors that got them in trouble during the 2008 Financial Crisis;
1. Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected (the Black Swan) event, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can and will be far worse.
2. When excesses such as lax lending standards become widespread and persist for some time (e.g., ninja (no income, no job and no assets) loans), people are lulled into a false sense of security, creating an even more dangerous situation. In some cases, excesses migrate beyond regional or national borders, raising the ante for investors and governments. These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses. Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.
3. Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return. Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell. Portfolio hedges must be in place before a crisis hits. One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis.
4. Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.
5. Do not trust financial market risk models. Reality is always too complex to be accurately modeled. Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.
6. Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.
7. The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of “private market value” as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.
8. A broad and flexible investment approach is essential during a crisis. Opportunities can be vast, ephemeral, and dispersed through various sectors and markets. Rigid silos can be an enormous disadvantage at such times.
9. You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.
10. Financial innovation can be highly dangerous, (think cryptocurrency) though almost no one will tell you this. New financial products are typically created for sunny days and are almost never stress-tested for stormy weather. Securitization is an area that almost perfectly fits this description; markets for securitized assets such as subprime mortgages completely collapsed in 2008 and have not fully recovered. Ironically, the government is eager to restore the securitization markets back to their pre-collapse stature.
11. Ratings agencies are highly conflicted, unimaginative dupes. They are blissfully unaware of adverse selection and moral hazard. Investors should never trust them.
12. Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.
13. At equal returns, public investments are generally superior to private investments not only because they are more liquid but also because amidst distress, public markets are more likely than private ones to offer attractive opportunities to average down.
14. Beware leverage in all its forms. Borrowers – individual, corporate, or government – should always match fund their liabilities against the duration of their assets. Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over. Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn.
15. Many leveraged buyouts (LBOs) are man-made disasters. When the price paid is excessive, the equity portion of an LBO is really an out-of-the-money call option. Many fiduciaries placed large amounts of the capital under their stewardship into such options in 2006 and 2007.
16. Financial stocks are particularly risky. Banking, in particular, is a highly leveraged, extremely competitive, and challenging business. A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years. Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used. What is the bank’s management to do if it cannot readily get to 20%? Leverage up? Hold riskier assets? Ignore the risk of loss? In some ways, for a major financial institution even to have a ROE goal is to court disaster.
17. Having clients with a long-term orientation is crucial. Nothing else is as important to the success of an investment firm.
18. When a government official says a problem has been “contained,” pay no attention.
19. The government – the ultimate short-term-oriented player – cannot withstand much pain in the economy or the financial markets. Bailouts and rescues are likely to occur, though not with sufficient predictability for investors to comfortably take advantage. The government will take enormous risks in such interventions, especially if the expenses can be conveniently deferred to the future. Some of the price-tag is in the form of back- stops and guarantees, whose cost is almost impossible to determine.
20. Almost no one will accept responsibility for his or her role in precipitating a crisis: not leveraged speculators, not willfully blind leaders of financial institutions, and certainly not regulators, government officials, ratings agencies or politicians.
Walt Disney World is raising the range of prices for some of its single-day, single-park tickets at Magic Kingdom, Epcot, and Hollywood Studios in Orlando, FL ~ Janet H. Cho
Families will have to splurge more for their Walt Disney World vacations starting December 8, 2022, because some single-day, single-park ticket prices at Disney’s Magic Kingdom, Epcot, and Hollywood Studios in Orlando could cost as much as $189 a person during the nine-day peak period around Christmas and New Year’s Day.
Single-day ticket prices to Disney’s Magic Kingdom Park are increasing to between $124 and $189 a person. The $189 ticket price is specifically for that peak holiday season around Christmas and the new year, and not all year, the Disney spokesperson told Barron’s.
Single-day tickets to Disney’s Animal Kingdom are staying at the current $109 to $159 range for visitors ages 10 and up.
Single-day tickets to Epcot are increasing to a range of $114 to $179; and
Single-day tickets to Hollywood Studios are increasing to $124 to $179.
Instead of the current system, which lets visitors make their theme park reservations only after buying their tickets, the new single-day tickets automatically include theme park reservations. The price of the Park Hopper option that lets people visit a second park the same day for $65 more is also changing.
What’s Next: Except for renewals by current annual pass holders, Disney has paused new sales of all but its Pixie Dust annual passes, available to FL residents only, which are staying at $399 a person. It is raising the price of its other annual passes, including the Incredi-Pass, which is going up to $1,399.
Under a separate program, discounted multiday tickets for active or retired members of the U.S. military, their families and friends, are increasing by $20 to $369 plus tax a person for the five-day ticket package plus Park Hopper, or $349 plus tax a person for the four-day package.
Disney also added more blackout dates when military tickets aren’t eligible, including around Christmas and New Year’s this year, and around spring break and Thanksgiving next year.
Value investing involves determining the intrinsic value — the true, inherent worth of an asset — and buying it at a level that represents a substantial discount to that price.
The gap between a stock’s intrinsic value and the price it is currently selling for is known as the margin of safety.
The greater the margin of safety, the more an investor’s projections can be off while still profitably gaining from an investment in the shares of the company being evaluated.
It can be helpful to ensure you understand what value investing is and is not. It is not searching for stocks with low price-to-earnings ratios and blindly buying the stocks that make that first cut. Instead, value investors employ a series of metrics and ratios to help them determine a stock’s intrinsic value and a sufficient margin of safety.
Value investing in stocks often means looking for mispriced shares in out-of-the-way places. This can include looking at companies in out-of-favor sectors, businesses in frowned-upon industries, companies that are going through some type of scandal, or stocks currently enduring a bear market. Unpopular sectors and companies are often treasure troves for the successful value investor, requiring the possession of both a long-term approach and a contrarian mindset. Regardless of where the investments come from, though, value investing is the art and science of identifying stocks priced below their actual worth.
Successful value investing exercise patience and hold during lean times. Taking just one example, in early 2015, American Express shareholders learned that AmEx lost its exclusive credit-card deal with Costco Wholesale locations. In the following months, Amex lost almost 50% of its market-cap value. Yet far from being a moment to panic, savvy investors might have seen an opportunity to buy AmEx for outsized gains. Within three years of its lowest point, American Express had almost doubled and reached new all-time highs.
Selling at lows while negative sentiment is at its highest will guarantee frustration and permanent loss of capital. It can be hard to wait while your thesis plays out, but patience is absolutely necessary for value investors who want to beat the market.
Of course, value investing is more than a waiting game. Investors must remain diligent in staying up to date on a company to ensure their thesis is proceeding as planned. This means paying attention to the company’s business performance — not its stock price.
The Big 5 Numbers
Phil Town, founder and CEO of Rule #1 Investing, says there are “the big 5 numbers” in value investing.
The Big 5 numbers are:
Return on Invested Capital (ROIC)
Equity (Book Value) Growth
Earnings per Share (EPS) Growth
Sales (Revenue) Growth
Cash Growth
All the big 5 numbers will be 10% or greater if the company, and he numbers should be stable or growing over the past 10 years.
The big takeaway
Value investing is not easy. It requires time, focus, discipline, patience and dedication to the craft. It will often mean looking and feeling foolish while you wait for an investment thesis to play out. If this doesn’t sound like it’s for you, investing in passive index funds is a perfectly suitable alternative.
For investors who enjoy the hunt of looking for undervalued assets — and beating the market at its own game — value investing can be richly rewarding in more ways than one. By following this simple guide, investors can be well on their way to understanding how value investing can beat the market.
Attitude, habit and daily life choices can make a difference in your health and longevity.
Dr. Michael Roizen, M.D., founder of the Reboot Your Age program, writes in the new book The Great Age Reboot: Cracking the Longevity Code for a Younger Tomorow, 40 percent of premature deaths (premature meaning before you turn 75) are related to lifestyle choices.
According to Dr. Roizen, not enough people realize that their attitude, habits and daily life choices can make a difference in their long-term health and longevity. “The largest error is thinking that your choices do not make a difference, but making healthy choices early and consistently allows you to enjoy good health and a longer life,” says Roizen.
By the time you turn 60 years old, “75 percent of your health outcomes are determined by your habits (healthy or unhealthy) and choices”, submits Dr. Roizen.
Focus on 6 + 2
Roizen’s barometer for health success and healthy aging is “6 Normals + 2”. Here are the “Normals” and “Plus 2”, writes Jeff Haden, in Inc. Magazine.
Regain and maintain normal blood pressure. The target is 110/75.
Regain and maintain a healthy level of LDL cholesterol. The target is 100 mg per deciliter.
Regain and maintain a healthy fasting blood glucose level. The target is 100 mg/dL or below.
Maintain a healthy weight for your height. Here’s where it gets tricky. Most people use body mass index (BMI) to determine a “healthy” weight. But muscle, or lack of, matters. A 6′ tall NFL cornerback who weighs 215 pounds has a BMI of 29.2. That puts him at the high end of the “overweight” category, even though by any objective measure he’s incredibly fit. Your body fat percentage is probably a better indication of whether you’re maintaining a healthy weight.
Practice ongoing stress management. Roizen’s target is to “sleep well and feel at ease in your own skin.” But don’t just think of sleep in terms of longevity; a 2018 study found that lack of sleep correlates with tension, anxiety, and lower overall mood. Sleep is good for you later, and good for you now. Aim to get 7 to 9 hours a night. For the best rest, do it on schedule — turning in and waking up at about the same times every day.
Have no primary, secondary or tertiary smoke from tobacco in your body. If you aren’t familiar, tertiary smoke involves pollutants that settle indoors when tobacco is smoked. Think couches, curtains, bedspreads, etc. Your body repairs itself quickly once you quit smoking. As soon as 20 minutes after your last cigarette, your heart rate and blood pressure drop. In other words, don’t smoke. And, if feasible, try to avoid being around people who smoke.
Now for the “Plus 2.”
Get a full body check up. You are what you measure, and you can’t know your numbers — and if necessary work to improve them — until you get your numbers.
Keep your vaccinations up to date. Roizen recommends that everyone get an annual flu shot since it can decrease flu and lung problems as well as reduce the risk of heart attack and stroke. He also recommends people aged 50-plus get the shingles vaccine, and those 65 and over get the pneumonia vaccine.
The key is to consistently make healthy choices that help prevent chronic disease and set you up for a long life.
Don’t smoke, and if you do smoke, quit today.
Don’t drink alcohol beverages to excess, but drink plenty of water.
Get a good night’s sleep and practice mindfulness.
Eat a healthy, low refined carbohydrates, no processed food, high fiber diet.
Discounted cash flow model can be used for financial valuation of a project, company, stock, bond or any income producing asset.
Discounted cash flow is a financial valuation method that calculates the value of an investment based on the present value of its future income or cash flow. The method helps to evaluate the attractiveness of an investment opportunity based on its projected future cash flows.
Free Cash flow to the firm (FCFF) means the amount of surplus cash flow available to a business after a it pays its operational expenses like inventory, rent, salaries etc. and also invests in fixed assets like plant and machinery, property etc. Cash is an important element of business. It is required for business functioning; some investors provide more value to cash flow statements than other financial statements.
Free cash flow is important metric as it tells about the company’s ability to deploy capital in future projects. Without cash, it’s tough to develop new products, make acquisitions, pay dividends, buyback shares and reduce debt. Also, as cash is difficult to manipulate compared to other variables, FCFF is more reliable indicator of a company’s performance than net earnings.
DCF model can be used for valuation of a project, company, stock, bond or any income producing asset. The DCF method can be used for the companies which have positive Free cash flows and these FCFF can be reasonably forecasted. So, it cannot be used for new and small companies or industries which have greater exposure to seasonal or economic cycles.
To use the Discounted Cash Flow Model to Value Stock:
Step 1 : Calculate the Free Cash flow to the firm
Step 2 : Project the future FCFF – You need to project the future FCFF for the next couple of years. You can analyze the historical data to understand the past FCFF growth trend. However, relying on historical data only won’t give you the right result, so consider the present financials as well as future potential of the company while projecting the growth rate. When conducting a DCF analysis, investors and businesses must make estimations for future cash flows and the future value of the investment. For instance, a company considering a new business acquisition must estimate the future cash flows from expanding its processes and operations with the acquisition. The estimates the company makes can help determine if the investment is worth the cost of the acquisition.
Step 3 : Discount the FCFF — Calculate the present value of this cash flow by adjusting it with the discount rate. Discount rate is your expected return %. The discount rate is one of the most important elements of the DCF formula. Businesses need to identify an appropriate value for the discount rate if they are unable to rely on a weighted average cost of capital. Additionally, the discount rate can vary depending on a range of factors like an organization’s risk profile and the current conditions of capital markets. If you are unable to determine a discount rate or rely on a WACC value, an alternative model may be more beneficial and accurate.
Step 4 : Calculate the Terminal Value — It is the value of the business projected beyond the forecasting period. It is calculated by assuming the constant growth of a company beyond a certain period known as terminal rate.
When valuing a business, the annual forecasted cash flows typically used are 5 years into the future, at which point a terminal value is used. The reason is that it becomes hard to make reliable estimates of how a business will perform that far out into the future. There are two common methods of calculating the terminal value:
Exit multiple (where the business is assumed to be sold)
Perpetual growth (where the business is assumed to grow at a reasonable, fixed growth rate forever)
Step 5 : Add discounted FCFF with Terminal value and adjust the total cash and debt.
Step 6 : Divide the Figure calculated in Step 5 by the outstanding number of shares to find out the DCF Value.
Step 7 : Adjust the Margin of Safety to find out the Fair value. Margin of Safety provides discount for uncertainties in the business.
When assessing a potential investment, it’s important to take into account the time value of money or the required rate of return that you expect to receive.
The DCF formula takes into account how much return you expect to earn, and the resulting value is how much you would be willing to pay for something to receive exactly that rate of return.
If you pay less than the DCF value, your rate of return will be higher than the discount rate.
If you pay more than the DCF value, your rate of return will be lower than the discount.
The DCF formula is used to determine the value of a business or a security. It represents the value an investor would be willing to pay for an investment, given a required rate of return on their investment (the discount rate).
When using the DCF analysis, determine the discount rate and have estimates for future cash flows. Apply these values in the DCF formula to create a future outline that details expected returns. If the results appear at or above a company’s initial projections for future cash flows, then investing can be beneficial. However, if the discounted cash flow formula results in a value below a company’s projected future returns, it may consider alternative investments.
The Environmental, Social, and Governance (ESG) movement has shaken up the oil and gas industry over the past 10 to 15 years.
Rising energy prices points ti the reality that the global demand for oil and natural gas exceeds its current supply.
Investments in oil and gas companies and the development of new projects are increasingly under scrutiny due to ESG, which, according to analysts at Deutsche Bank, could increase inflation in the long run. And higher inflation is already one of the biggest worries people have.
ESG stands for environment, social and governance. It is characterized as a responsible or sustainable investment.
According to ESG philosophy, a portfolio manager may not invest in a company if, for example, he or she considers the risk due to climate change to be too severe. Another scenario is that investors may only invest provided the company works to reduce the environmental risks such as climate change.
“If you systematically underinvest in oil and gas production for years, then that necessarily increases your reliance on foreign dictatorships abroad that don’t care about the green energy transition,” says Vivek Ramaswamy. “This is not by accident, this is by design.”
Home sellers are contending with apprehensive buyers amid rising mortgage rates and the possibility of an oncoming recession. RedFin
Single family home sales in June showed the first signs of leveling off after steady monthly increases for more than a year, according to the Jacksonville Daily Record. Although, sellers still were receiving slightly above 100% of asking price in June in certain housing markets, the general trend is mixed nationwide.
Price drops have become a common feature of the cooling housing market, particularly in places that were popular with homebuyers earlier in the pandemic, writes Dana Anderson, a data journalist at Redfin. Nearly two-thirds (61.5%) of homes for sale in Boise, ID, had a price drop in June, the highest share of the 97 metros in RedFin’s analysis. Next came Denver (55.1%) and Salt Lake City (51.6%), each metros where more than half of for-sale homes had a price drop.
Home prices rise in June
In June 2022, home prices were up 11.2% compared to last year, selling for a median price of $428,379, according to Redfin.
On average, the number of homes sold was down 17.4% year over year and there were 609,147 homes sold in June this year, down 737,598 homes sold in June last year. The national average 30 year fixed rate mortgage rate is at 5.5% and is up 2.5 points year over year.
While also in June 2022, the number of homes for sale was 1,647,846, up 1.6% year over year.
The number of newly listed homes was 782,083 and down 4.4% year over year. The median days on the market was 18 days, up from 3 year over year. The average months of supply is 18 months, up from 3 year over year.
Additionally, 55.5% of homes sold lower list price, down 0.86 points year over year. There were only 17.9% of homes that had price drops, up from 9.0% of homes in June last year. There was a 102.3% sale-to-list price, down 0.24 points year over year.
Prices keep dropping amid a cooling housing market, particularly in places that were popular earlier in the pandemic. #realestate
Moreover, inflation and higher mortgage rates have slowed sales and priced out of the housing market many potential home buyers. As a result, the inventory of homes are beginning to pile up on the market and prices are slowly falling nationwide.
Takeaway…the once red hot U.S. housing market is showing signs of cooling and housing prices are contracting. Instead of over eager buyers and multiple offers on listed homes for sale, buyers are canceling sales contracts in increasing numbers and walking away from earnest money. And, what was unthinkable just a year ago, home sellers and builders are cutting home prices to entice potential home buyers and close sales.
For sellers, there is still money to be made in the housing market, but asking prices need to be very attractive to home buyers.
The price-to-earnings ratio, or P/E ratio, helps investors compare the price of a company’s stock to the earnings the company generates. The P/E ratio helps investors determine whether a stock is overvalued or undervalued.
By comparing the P/E ratios companies in the same industry, investors can determine which companies are relatively under or over valued in comparison to their industrial peers.
The P/E ratio is derived by dividing the market price of a stock by the stock’s earnings.
The market price of a stock tells you how much people are willing to pay to own the shares, but the P/E ratio tells you whether the price accurately reflects the company’s earnings potential, or it’s value over time.
If the P/E ratio is much higher than comparable companies, investors may end up paying more for every dollar of earnings.
The typical value investor search for companies with lower than average P/E ratios with the expectation that either the earnings will increase or the valuation will increase, which will cause the stock price to rise.
On occasion, a high P/E ratio can indicate the market is pricing in greater growth that’s expected in the future years.
A negative P/E ratio shows that a company has not reported profits, something that is not uncommon for new, early stage companies or companies undergoing financial perturbations.
Current stock price may be important in choosing a stock, but it shouldn’t be the only factor. A low market stock price does not necessarily correlate to a undervalued or cheap stock.
The P/E ratio is a key tool to help you compare the valuations of individual stocks or entire stock indexes, such as the S&P 500.
References:
Rajcevic, Eddie, Greenbacks & Green Energy, Luckbox, May 2022, pg. 58.
