In today’s Smart Investing in Turbulent Times update, I answer that question the same way that professional equity portfolio managers answer the question: by focusing on earnings per share (EPS) and price/earnings ratios (P/Es).
When I speak with individual investors, they’re often surprised and pleased that I combine a growth stock strategy with a value stock strategy. I do this for two reasons:
- I want to identify the highest-quality stocks possible; and
- I want to minimize the inherent risk in stock investing.
If I only look for growth stocks, they might have astronomical P/Es. High P/Es add to the risk associated with owning stocks.
If I only look for value stocks, most often characterized by low P/Es, dividends, low debt ratios, and/or share repurchases, I could easily end up with stocks that have slowly growing or falling EPS.
But if I combine both growth and value stock selection strategies, I end up with stocks that have strong projected EPS growth and P/Es that are undervalued. As a bonus, dividends add to the EPS side of the equation, so that investors can look forward to both income and potential capital gains.
I want to show you how rare it is to find strong earnings growth and undervalued P/Es in well-known stocks, so that you can better appreciate the financial condition and prospects for the Smart Investing portfolio stocks.
Here’s a list of well-known companies, none of which I would buy right now. Some of these stocks have good projected earnings growth, while others will see their earnings fall in the coming year. Every single stock on this list is overvalued compared to its earnings growth rate.
* The P/E is based on the fiscal year-end in the chart, not on 2014 or 2015 numbers. At this late point in 2015, stock market professionals are using next year’s full-year numbers to make their investment decisions.
If you compare the stocks in the chart to the stocks in the Smart Investing portfolios, you can see how my stock selection process identifies the cream of the crop in undervalued growth stocks.
As most of you know, U.S. stock markets continue to bounce around with higher-than-usual volatility. Many high quality stocks are revisiting their August-September lows right now. The S&P 500 is down -2.26% and the Dow Jones Industrial Average is down -3.13% year-to-date through December 11. That’s not fun, but it’s also not a disaster.
Falling oil prices and problems in the junk bond market are affecting good and bad stocks alike. Especially hard-hit sectors include energy, chemicals, metals and curiously, retail stocks. (I’m scratching my head over that one, but it is what it is. I expect the retail stock pricing problem to be temporary.)
Investors should hold on to quality stocks, pare back lesser-quality stocks—those with falling earnings—and add to their positions in stocks that have stable chart patterns.
