Investing Marbles Part 1 - Valuation

Being a self-taught investor for almost a decade now it behooves on me to share some of the investing marbles I have picked up over the years that may benefit others. My liaison during that stretch with the markets have been nothing but a series of baptisms of fire that left me with a few humbling scars as well as some jubilant recollections to boast of. One of the key aspects of market behavior that emerged during that liaisoning is that it never conforms to your opinionated infatuations for that darling stock of yours for long periods. If you are not on your nimble toes you will suffer. Just because you have an obsession for a company that manufactures really slick gadgets does not necessarily mean its stock prices will always spiral upwards. Several factors both internal and external are at play that decides whether that investment is a good one. We take a look at one such internal one.

As most investing evangelists will preach, the valuation of the stock really matters measured by its P/E (Price/Earnings) ratio - the price tag you are willing to pay over its earnings. If the ticker has very high P/E, it means the stock is expensive and should not be touched. Value stocks are always surgically examined with the P/E scalpel because these stocks are not pillared on the dynamics of skyrocketing growth. These are bellwether stocks that always carry some kind of quarterly dividend like a Johnson & Johnson (JNJ) or a Coke. Barring an odd stretch here and there mostly your returns will not fly in high multiples but measured gains of say 10-15% YOY along with those bonus dividends that will keep your investments rock solid. In contrast growth stocks that have tremendous growth potential compared to its more saturated value peers have more traction on the P/E value and takes leeway to discount this vital stat.  In such situations the investors are willing to pay a premium even at the expense of discounting the earnings. Take for example one of the recent heart-throbs of many, Netflix (NFLX) which forced many to ignore its high valuations because it came with a scorching tagline - scope for staggering growth. In no time the speculators and market wolves jumped into the fray and unloaded millions that resulted in the stock prices shooting through the $300 ceiling. The early gate-crashers filled up their deep pockets while the ones late to the party eventually got slaughtered. I will pick this one up in more detail in one of my upcoming posts - Investing Mistakes that made me wiser" where I will recite my own telltale that bought into NFLX's market frenzy and had to take some serious body blows. Thankfully the knock out punch never came and I am still in the bout. 

Ultimately it comes down to an investor's appetite that will decide what kind of stock he should be hovering over metaphorically. If you are a realist, you go for the value stocks that pays dividends, however if you are dreamer who has the conviction backed with solid research on a specific growth stock like an Amazon (AMZN) or VMWare  (VMW) that you know is going to be hot soon and sustain that hotness thereafter you opt for those growth ones. You will have no choice but to hop on that volatility ride that may also bring some possible bumps along the way, not to mention a fatal crash. Having an exit strategy in place such as a trailing stop or even regular stop losses is a must. Well if you don't you will surely get ambushed by that chest-thumping Bear out of nowhere.

Talking of stop losses, in my  next writing we will try and unlock that marble that has been a life saver for me on numerous instances - a necessary tool for risk management.