Top 10 Investing Myths: First In A Series
“To make money, buy some good stock, hold it until it goes up, and then sell it,” said Will Rogers. “If it doesn’t go up, don’t buy it.”
In his own way, Rogers pointed out one of the fallacies of the “buy low, sell high” investment myth. How low is low? How high is high? Without parameters, you’re flailing about in the dark.
But Rogers started out right: Buy some good stock. What’s “good”?
You probably already know. Outstanding earnings and sales growth in recent quarters and over the past three years. Solid accumulation by institutions. Sweet margins and return on equity. And a new product or service that takes the country by storm.
What does “buy low” mean to you? That’s bargain-hunting. Some investors do well by this approach, but they don’t end up with Apple (AAPL) or Intuitive Surgical (ISRG).
More likely, a bargain-hunting approach would lure you into buying someone else’s problems. Dated technology, a waning customer base, stiffer competition, patent expirations, or — worst of all — a world that had moved on without your “bargain” company.
You’ll pick up some out-of-favor airline stock. Or solar energy. Sure, maybe it’s the future, but right now those stocks are deep in the toilet.
Are you afraid to pay the higher price-earnings ratios? Those are the real bargains. This is buy-high, sell-higher. And this is how you end up with the great winners.
Look at Baidu (BIDU), China’s leading search engine. Baidu has been in the lead of every market uptrend from 2006 through 2011.
At the bottom of its first base, the stock traded at a split-adjusted 4.44 in February 2006 1 (monthly chart is shown). At the time, the P-E ratio was still near 100. But when it finished a long, deep base and broke out to 52-week highs in May 2007, the P-E contracted to a still-high 69 2. Baidu rallied 220%, then went into a correction.
At the worst of the panic selling of 2008 3, Baidu fell to 10.05 per share — for a P-E ratio of 24. But the P-E rebounded as the stock formed new bases and hit new highs.
So we can see that P-E ratios can fall, as a company’s earnings catch up with optimistic projections. Remember, too, that P-Es can rise along with the stock’s price as it breaks out and builds big gains.
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