Never met a rich pessimist

Never Met a Rich Pessimist: Interview with Dr. Paul Price

Paul Price said to me: “I’ve never met a rich pessimist.”

We have to be hopeful about something (even if it’s the assent of gold, farmland and guns). We need a plan, a strategy. Without those, what begins as trading or investing often ends in chaos and regrets.

In “Stop Calling Markets, Start Buying Individual Values” Paul explains his philosophy of not relying on isolated chart patterns and absolute numbers. Looking at a history of prices and valuations makes more sense when answering questions such as whether Apple (AAPL) and Google (GOOG) are expensive, with their high prices per share; or whether Pandora (P), Zip Car (ZIP) and Groupon (GRPN) are bargains, at under $10/share, with no GAAP earnings.

Paul’s goal, in a nutshell, is to “buy low, sell high.” In looking at stock prices, Paul considers many company-specific factors. But in looking at the indices, he weighs macro-economic factors more heavily.

For example, Paul noted that when the DJIA peaked in October of 2007, the trailing P/E for the index was 17.7x. That’s high by historical standards. The chart below compares the valuations (P/Es) of stocks in the DJIA in October, 2007, to valuations today. While today’s market is catching up to 2007 levels, the P/E averages are significantly lower. 

(click to enlarge)

Below, is an interview with Paul on his thoughts about investing and valuations today.


Ilene: Paul, thank you for your generous and exciting offer to help us build the Market Shadows newsletter! Besides having been enjoying your work for many years, your investment strategy is a perfect match for our goals – to present solid, investment ideas for people struggling to earn returns in a Zero Interest Rate Policy (ZIRP) environment – people who don’t have the time, money or inclination to take on the fickle, unpredictable forces that gyrate the markets day-to-day.

According to your research, lately, higher corporate profits have placed trailing and forward P/Es at discounts to “normalized” market valuations. After the recent weakness in earnings, do you still think stocks are trading at discounts?

Paul: The overall market appears somewhat undervalued but there is a wide variation among individual stocks. I see both great bargains and some very overpriced companies.

Ilene: I’ve read other commentators complain that P/Es were on the high end. Are they comparing or calculating P/Es differently than you are?

Paul: The chart I used shows the forward P/E for the DJ Industrials based on current consensus views. If you feel strongly we’re headed for a global recession then the earnings will likely come in lighter than these estimates.

Ilene: You wrote,

“Equities must always compete with fixed income when fighting for market share of the total investment dollars that need to be put to work. CD, Treasury bond and corporate bond coupon rates have an inverse effect on where P/E ratios tend to settle out.

“When risk-free returns are high, multiples tend to be low and vice versa. Both 10 and 20 -year rates have plummeted over the past five years. In theory, P/E multiples should now be way above what they were at the time the DJIA peaked in 2007. Instead we have exactly the opposite situation.


(click to enlarge)


Ilene: Why do you think there’s a discrepancy between the lower yields, and lower than normal P/Es? Have there been other periods when both yields and P/Es have been uncharacteristically low?

Paul: These are unprecedented times. The Fed’s artificially low interest rates make any fixed-income investment a guaranteed loser.

Typically, rates even higher than today’s would have sent the market soaring to new heights. Even a 20 multiple equals a 5% after-tax return. That means anything less than an outrageously high P/E offers a better return than bonds, CDs or treasuries.

Ilene: For a strategy that results in less mental anguish than “futilely trying to outguess the market action,” you recommended 1) eliminating personal biases, 2) buying shares in companies selling for less than their normalized valuations, and 3) selling shares at “overextended” prices.

Below is your list of companies that were bargains a couple of weeks ago. Are they still bargains? Which ones of these, or others, would like to add to the new “Dr. Paul Price’s Virtual Portfolio” on Monday?

Paul: All the stocks on my list from a few weeks ago are still decent values. I’ve also bought Air Products (APD), Emerson Electric (EMR) and Lab Corp (LH) in the past few days.


(click to enlarge)


Ilene: The next table in the Seeking Alpha article is your list of companies selling at historically high valuations. Are these still on your “high-priced” list? At what P/Es would you buy any of these stocks?

Paul: None of those have come back into buying range yet. They have a ways to fall before I’d be interested, although a few have seen sell-offs already.

Ilene: Thank you, Paul.

Trying to predict the unpredictable is a fool’s game. Paul emphasized the importance of buying stocks when they are “on sale” and selling them when they are too high. Knowing the difference leads to better results. His strategy for distinguishing “on sale” vs. “pricey” involves knowing historical P/Es and valuations. He avoids stocks trading higher than their historic norms, while he likes acquiring stocks in good companies that are trading lower.

Disclosure Paul is long several stocks mentioned in this article including: COHCMIDEDOVESRXMOSORCLPOTSCHWSPLSTMO, APD, EMR, and LH.

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