Adam’s Note: Quick, urgent note before we turn to Mike Carr for this morning’s Stock Power Daily.
Yesterday marked the launch of my brand-new, market-trouncing trading strategy Infinite Momentum Alert.
Shortly after my presentation went live, I released the first group of 10 stocks designed to outpace the market’s return over the next four weeks. These stocks are hot buys now, but I’m doubly excited for what’s to come.
If you’ve been looking for a simple, no-nonsense trading strategy that beats the pants off of the world’s top hedge fund managers, with just a few minutes of work a month … you’ve found it.
We’re only opening up access for a short time, so I highly encourage you to watch my launch presentation here and decide if becoming a charter member of Infinite Momentum Alert is right for you.
Now, over to Mike…
Value investing sounds easy.
Some investors think they can focus only on a single variable — like the price-to-earnings (P/E) ratio. This is one of the most commonly used metrics. It divides the current market price of a stock by its earnings per share.
Some investors set a P/E ratio limit, maybe 15. If a stock’s ratio is under 15, it’s a value stock. These stocks are buys. Stocks with P/Es above 15 are avoided.
This is a popular way to look at stocks. But it’s also ineffective.
That’s because there’s no reason to select 15 as the cutoff. Some investors might use 12. Others 18. Most of the time, it’s an arbitrary decision.
Another problem is that high P/Es aren’t always bad. If a company is growing earnings at 50% a year and is likely to do so for several years, the P/E should be high.
Of course, low P/Es could also be bad. If a company is headed to bankruptcy, its P/E ratio may be falling as the price moves toward zero.
A more effective way to use P/Es is to compare them to the ratios of a company’s peers. For example, the utility stock with the lowest P/E ratio might be a buy.
This approach is a type of “relative valuation.” It determines value by comparing it with the value of other similar assets. Relative valuation can be applied to a narrow group, such as all the stocks in a certain industry. Or it can be applied to the broad market as a whole.
The latter approach might be more useful. Let’s take a look at how we would do that…
A More Effective Way to Use P/E Ratios
The first step in this process is to find the P/E ratio for all stocks. These values are sorted from high to low. Then percentile values are assigned to each P/E ratio.
Percentiles are values between 1 and 99, with each stock being placed into one of the buckets. The lowest P/E ratios, the stocks value investors target, are assigned a value of 99. The highest P/E ratios get a value of 1.
Now, P/E ratios are adjusted for market conditions. For example, when interest rates are low, all stocks should have high P/E ratios. That’s because stocks and bonds are alternative investments.
When rates are low, stocks are worth more under this theory. Relative value shows which high values are attractive and which are excessive.
Relative valuation isn’t confined to P/E ratios. It can be applied to any metric. Popular tools include the price-to-book ratio, price-to-sales ratios, as well as enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA).
Investors also use relative valuation with more complex metrics like the price-to-earnings growth (PEG) ratio or return on equity.
Many investors use simpler approaches like limiting their buys to stocks with a P/E ratio under 15 because it’s more difficult to calculate relative valuation.
You need access to fundamental data for all publicly traded stocks. Then you need a program to calculate ratios, sort the values and assign percentiles. It’s a lot of work, to say the least.
Fortunately, Money & Markets and Adam O’Dell have done all that heavy lifting for us. The Green Zone Power Ratings system includes a Value factor rating which combines different fundamental metrics into a single number. Stocks with “Bullish” ratings are expected to outperform the market by 2X over the next 12 months — “Strong Bullish” stocks by 3X.
And you can find the rating of more than 6,000 stocks by looking for the search bar on this very page.
Until next time,
Mike Carr
Senior Technical Analyst
P.S. Relatively strong valuations are just one sign of a stock worth owning. You also need to consider the quality of the company’s fundamentals … and, as I’ve said time and again, whether the stock is going up at all.
Adam O’Dell recently launched a stock trading strategy that does exactly this … with exemplary results.
He found that by holding a portfolio of the top 10 stocks with strong Momentum, Quality and Value scores and refreshing it every four weeks, he could outperform the S&P 500 by 300-to-1 over the long haul.
Adam just released the inaugural list of stocks that you must own over the next four weeks for a strong chance at trouncing the market. I’ve seen the list myself … and judging by what’s happening in the markets lately, I think it has tremendous potential.
For all the details on how you can access this list, and join Adam on what may be the most promising stock-trading strategy I’ve ever seen, click here and watch the launch presentation for Infinite Momentum Alert.