You Might Be Playing Under The Old Set of Rules
28-Aug-01 01:21 ET
[BRIEFING.COM - Robert V. Green] We are in a new era of investing. It started in early 2000 when the bubble burst. But, as we have noted in several related Stock Briefs over the past few weeks there are still stocks with bubble era valuations. But there are also investors who are still behaving as if it were the previous era. Here are six indications that you might be playing under the old rules.
You Don't Know Your Stock's Multiples
The previous era was all about momentum and daytrading. Today's environment is all about valuation.
Valuation is the worth of a company and means more than just the market capitalization (number of shares outstanding times the price). The market capitalization of a company is the net result of the valuation process.
Valuation refers to the process of determining a company's worth by examining measurable attributes of its business. The measurable attributes are evaluated, principally revenue and earnings. The market's determination of the "worth" of a measurable attribute is reflected in the price of the stock as a "multiple." Determining proper multiples is called the "valuation process."
You have to know your company's market multiples. The most important multiples are:
Price/earnings - P/E
Price/sales - P/S
The price/earnings ratio is the price per share divided by the earnings per share. As a ratio, it is also equivalent to the market capitalization divided by the entire earnings of the company. You can think of market capitalization is "what it would cost to buy the entire company," which would, of course, give you the entire earnings. Price/earnings vary widely, but for profitable companies, and today's environment, a price/earnings ratio higher than 40 is a danger sign. Higher than 20 for a large cap company is dangerous.
The price/sales ratio is the market capitalization divided by the total revenue of the company. Ratios range from 0.5 to 10 for most companies now. The extremes of the bubble era, where hundreds of stocks had P/S ratios higher than 100 is over.
You must know the multiples on every stock you own. Under the rules of the old game, many people made money without having a clue as to their investment multiples. Today that would be foolish. Furthermore, you should probably know how your stock compares, on multiples, to its competitors.
If you don't know your stock's multiples, you might be playing under the old set of rules.
You Are Waiting for the Next Press Release
This is another sign that you are still operating under the rules of the old game. Two years ago, stocks could experience doubling in a single day, based upon well timed press releases. A press release announcing a new distribution channel or partnership deal could send an internet stock into a day-trading frenzy.
Today, press releases other than earnings reports rarely drive stocks. There are positive effects from press release, but they don't cause feeding frenzies anymore.
If you find yourself hoping for that next great press release, you might be playing under the old set of rules.
You Are Projecting Revenues Based On Press Releases
When you do get a press release, do you find yourself calculating, on your own, the possible future revenue implications of the announcement?
This was pretty common over the last two years. Investors looked at any deal announced, whether new distribution agreements or new products, and began the "string of multiplications" on which all fantastic revenues are based. This is the "X-dollars-times-Y-customers-times-Z-deals" using whatever figures happen to casually appear in a press release. Usually the end result is a mind-boggling increase over today's revenue levels.
The problem with this is that the markets today have little tolerance for unproven future revenue. The extreme projections made by analysts for most internet stocks and the severe repercussions from the bubble burst have made sky-high projections subject to extreme skepticism. No one calculates future business possibilities using press release data anymore. Press releases don't cover the assumptions and risks that a business plan would.
If you find yourself running your own business plan for your company, you might be playing under the old set of rules.
You Don't Know When Your Company Will Be Profitable
This is an era where the market has little tolerance for unprofitable companies. Particularly undesirable are companies which cannot articulate a clear path to profitability before they run out of money.
The previous era rewarded revenue growth, with little regard for profitability. Future incredible revenue growth was going to make up for it. The old joke of "losing money on every sale, but making up for it in volume" seemed forgotten. Stocks that have never made money generally need more capital. But in today's market, few are willing to fund a company which cannot prove that they will become profitable. And if they can't get new funding, why should you hold on?
If you own a stock which has never shown a profit, and you have no idea when it will, you might be playing under the old set of rules.
You Are Waiting for the Company To Be Bought Out
Many investors in troubled stocks, particularly the ones hovering around $1 (there are plenty!) are hoping for someone to acquire the company, and bring them a profit.
Companies with stock prices of $1 have low prices because of problems! Big losses, big debt, no growth, whatever the reason is, the stock reflects the trouble. Who want trouble? A severely lowered price on a troubled company often means acquisition is less likely not more likely.
This observation seems lost on many investors. Acquisitions gave exit plans to many unprofitable businesses over the past two years. But they were just lucky by timing.
If you find yourself hoping that your below $5 stock will be acquired to give you a return, you may be playing under the old set of rules.
You Argue With People In Message Boards
Do you find yourself spending a lot of time in message boards, arguing with other people about the future of the company?
If you do, you should seriously consider whether you have become emotional about your stock. The problem with emotion is that you tend to view negative information in as positive a light as you can. This is great for entrepreneurs, but terrible for investors. If negative information about a stock you own on a message board moves you deeply, be cautious.
After all, message boards don't drive stock prices any more, even in thinly traded bulletin board stocks. So who cares what people say there?
Message boards can be good sources of information (occasionally), or good entertainment (sometimes), or a huge waste of time (usually.) When something in a message board angers you or deeply moves you to post and debate the other posters, you might be playing under the old set of rules.
The Buyer Next To You
Why is it important to play by the current set of rules?
Because stock prices are always set by the person next to you, not by you. In order to make a profit, you must understand what drives the buyer, not what drives you.
That's one rule that hasn't changed. |
