Vicenarian Stock Picking
Posted by T.W. Hanson - Feb 14th, 2008 at 19:02
You have just purchased what you believe is a great product (an iPhone, a pair of Crox, a Jamba Juice smoothie, etc.). For your own sanity’s sake, I hope the first thought that enters your mind isn’t about the owning a portion of the company that makes this product. However, it is possible to buy shares of Apple, Crox and Jamba Juice, and you may entertain thoughts of owning these companies. Should you buy them? By concluding that a company has a good product, you only have half of the investing picture and may as well be throwing darts at lists of companies in the business section of your paper.
Many vicenarians and virgin investors will pick stocks using affinity toward a product as a primary means of investing analysis. This strategy is flawed because it omits considering the value at which you are buying a part of the company. If that value is too high, you may be buying into a great company with great products that is worth less in 10 years than it is now. For example, Nortel Networks is a solid company with a $5 billion market cap. Adjusted for spits, its stock traded at levels 0ver $600/share in 2000. It closed today at $11.43/share. Another parallel example is with automobiles. A BMW is a good product, but no one I know would pay $6,000,0000 for a new 7 series.
Similar logic should be applied when looking at buying stakes in companies. The company’s products must be something you believe in, and the value of your portion of the company needs to be appropriate.
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A corollary : I cringe whenever I hear someone say “oh, that stock is too expensive. It’s trading for $100 a share”.
In the discussion of relative cost of a stock, the dollar value is not very indicative. Depending on the size of the company and the number of shares outstanding, a $5 stock could be more “expensive” than a $100 stock.
Ratios like P/E and PEG are more indicative of the relative price of a stock. TWH, your thoughts?
Comment by tad — February 14, 2008 #
I agree with everything you write. A stock price quote, as most people think of it, is for one share of company common stock. The number of shares for companies varies. For example, Microsoft (MSFT) has 9,306,979,746 shares outstanding while Tootsie Roll Industries (TR) has 54,941,131 shares outstanding. This means that it does not make sense to look at stock price alone to determine value.
P/E and PEG are two widely used measures. The most important metric for a generalist is Enterprise Value/EBITDA. That mutliple is relevant across almost all industries, and we will get to explaining it in more detail at a later date.
Comment by TWH — February 15, 2008 #
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