Why You Should Never Fear Buying a Stock at All-Time Highs
It happens like clockwork…
Every time the markets tap new highs, I get asked by nervous investors if they should buy stocks.
My answer is always the same.
But only if this one condition holds true.
This Stock Could Turn Every $1 Invested into $6.28 Million (Again)
Let’s take a quick trip down memory lane as a means of setting the stage.
I can’t tell you how many people I heard from back in 1999 who said that stocks were “expensive,” there was “nothing to buy,” and that stocks were extremely overvalued.
All of which are sentiments you hear today under very similar circumstances. So much so, in fact, that the headlines we saw back then are almost interchangeable with those we see now.
The markets had enjoyed a healthy run that people feared was over. Huge changes in our economy were underway. And, last but not least, the war in Kosovo was in full swing as Serbian soldiers forced nearly a million ethnic Albanians from their homes… and worse.
This year alone, the stock market has hit nineteen new highs… that’s roughly a new high every fifteen days. The economy appears to be growing, earnings are on the mend, and the future is arguably brighter than it has been in years. And, once again, people are waiting for a market pullback… even if it never comes.
I wouldn’t hold it against you if you wanted to run for the hills or bury your head in the sand like an ostrich with a sign on your rear end saying “kick me when it’s over.” Just make sure you understand the irony of your actions if you do. To borrow an old expression, the more things change, the more they stay the same.
That sounds trite but what I want you to understand is that there is no more difficult time to invest than in a market that’s doing very well for the hesitant or the uncertain.
Take Nvidia Corp. (NasdaqGS:NVDA), for example.
The company was trading at or near all-time highs of $40 per share in 2007, which made it very “expensive” for a stock that produced video game chips – especially when the United States was looking a recession in the face. Nobody thought the chipmaker fit into the Unstoppable Trends…they made video games, after all.
Yet, Nvidia’s video game chips – called GPUs – did tap into the Unstoppable Trends: Technology, to be specific.
Even more, these GPUs could be used for futuristic graphics cards that would enable semi-self-driving cars, enhance their GPS systems, and further develop vehicle entertainment systems.
Beyond that, GPUs have been found to help assist top-level mathematical functions that would put excessive strain on CPUs, and could do these functions in a fraction of the time. Scientific image processing, linear algebra, 3D construction, statistics, and even stock options pricing determination could all be done by these “video game chips” that investors had been so quick to write off.
Since then, the stock has returned 2,090%, earnings have grown by 2,770%. So much for the ‘ol “that’s expensive for a tech company” argument, don’t you think?
Today, I hear shades of the same thinking from thousands of concerned investors, especially when it comes to the big tech companies we talk about frequently.
Only neither is a conventional company which is why conventional metrics often used to judge overall market conditions and the relative attractiveness of specific stocks don’t apply. Research, in fact, shows that PE ratios have very little predictive value when it comes to identifying the most successful investments.
For that, you’ve got to look forward to Unstoppable Trends, to a company’s products, to its competitive position and to its customers.
Both of these companies can add a million customers at a click of a button, or merely releasing a few lines of code. That means they can grow into the P – Price – while expanding the E – earnings.
What’s more, they can do that no matter who’s in the White House, no matter who’s in Congress, no matter whether Wall Street is muzzled or not. That, in turn, means they’re scaleable and potentially worth hundreds of billions of dollars more than they are today.
That’s what most investors are missing.
They’re so concerned with judging specific stocks by specific metrics that they fail to take in consideration the very real possibility that they may not apply in today’s markets.
Let me give you another example that’ll help put this in context.
Take a car maker – any car maker.
They make a 4-wheeled contraption that hasn’t changed since Karl Benz introduced his horseless carriage in 1885 – 132 years ago. What they sell is limited by what they produce so the PE ratio which measures a given stock’s price in relation to its earnings still applies.
You can argue that they can boost revenues by fancy financing, changing their R&D or even reducing expenses. I would argue that they’re still limited by the number of cars they can produce and sell to a finite customer base at the end of the day.
Remember, PE ratios don’t account for growth nor do they reflect the quality of earnings.
Many public companies can manipulate earnings (and do) in pursuit of higher stock prices. For instance, many publicly traded manufacturing companies boost their earnings by boosting their accounts receivable and counting them as “sales” even though there has been no value created and no related cash flow.
What matters – and what I want you to understand – is that most investors fear buying something that’s expensive because they cannot justify it using metrics that are based on the past.
And, instead, of reconciling why that may not be the best course of action they give up.
Perma-bears don’t help.
Every time the markets hit new highs they come out to offer sage commentary and all sorts of rational for their thinking…which usually comes down to some variation of “it’s expensive.” The unwritten implication, of course, is that the markets are ripe for a fall and you’d be a fool not to listen.
Nouriel Roubini started calling for a massive market crash in 2005 and he got one… three years later… which means he missed the run up. And the correction… and another run up.
You may recall the name Howard Ruff. He wrote a bestseller called How to Prosper During the Coming Bad Years and published it in 1979, right before one of the biggest bull runs in history. In February 2009 he surfaced again with alarmingly bearish commentary…exactly one month before the markets began a legendary triple digit run up.
Now there’s a new raft of folks cautioning against new highs merely because they fear new lows… and, of course, because stocks are “expensive.”
Only thing is, truly great stocks are never expensive because they can grow into earnings.
…at the click of a mouse.
…over long periods of time.
…when market dominance means more than traditional business.
…when customers must have what they make.
Until next time,