Wednesday, May 31, 2017

Stock Insurance for the Wise

In the movies, insurance is usually depicted as an Italian using the protection racket for the mob. In real life, it is the Wasp that sells home protection plans, but they seek lawyers and the courts from fulfilling their contractual obligations like the floods in Sandy Hook or the fires in San Diego. They offer low ball checks that pay pennies on the dollar and then, raise their premiums. So, who is the real crook? Dear reader, I'm not selling anything, but a word to the wise is said to be sufficient.
Stock Market
is at record highs as it grinds upward on the staircase of the wall of worry. Dear reader, the talking heads never remind you that when a correction comes, it uses the elevator when it goes down.
To put perspective to the market, one should look at the big picture of price to earnings or the P/E ratio. In our modern time or post WWII, value investors accepted a price range with a P/E that said 6 was a buy, 9 was a hold and 12 was risky. This intrinsic range held sway until the 1980s. During the 80s, the range was increased. The new buy level was 10 to 12, the new hold stood at 16 and risk entered after 20. Then, in October 1987, the market was reminded that the "old" range was the safe range when stocks crashed. Buyers who purchased following the old method suffered little or no harm. It was the new generation of buyers who paid a heavy price. Today's range reflects a time period of the 1990s. The P/E ratios increased dramatically. The buy bid moved to 16, the hold price jumped to 21 and risk appeared at 30. Then, in 2000, the market reminded everyone that the "old"  metric was the best advice for safe investing, "Buy when nobody wants it and sell when everyone wants it." With that meme let me throw out some pearls of today's market.
Gorilla Upgrades
I came across a memo from this advisory service. From their recent record, this group appears to be doing a good job, My point has nothing to do with them except use the information to relate to you my warning about stock prices and evaluations. The following 13 companies were upgraded to a new price by Gorilla.
Stock                                          P/E                               Current Price        Upgraded Target
Broadcom                                  22                                    241                                  290
Rockwell                                   19                                    107                                  130
Dominoes Pizza                        48                                    207                                  248
DTE Energy                              19                                   108                                  130
EBay                                         5                                     34                                    42
Intuit                                         39                                   138                                 165
Gartner                                     53                                   117                                  140
Lam                                          19                                   155                                 185
PRA Health                              16                                    36                                  86
 RTN(symbol)                          21                                   163                                195
  TSEM(symbol)                      -63                                    25                                    31
WEN(symbol)                         33                                     16                                   20
Zebra                                       53                                      105                                128
In looking at the list a few things jump at me. One, the majority of stocks are over $100 and in a minute, I will show you some over $1,000. Secondly, Tower Semiconductor is actually losing money. Not for me. The overall P/E ratio for the S & P 500 is approaching 30 and to me that spells DANGER. EBay looks like a bargain and Dominoes like a sell. I am not saying to buy or sell, but the evaluations will put you in a risky position at these levels. The stock market is like a Bell Curve and now, we are deviating to the high mean. If the market corrects, you will lose all your profits or worse, be in a negative position. When you consider the market also has the highest margin by total dollars invested, a small correction could turn into a major decline. People, institutions and most hedge funds can weather a movement of doubt, but people like you and me cannot. They call us the weak hands because our finances cannot take a 10% or higher decline, especially if you gamble and buy on margin. The plan to buy on dips has worked so far, but remember the creed of the market, "To take the most amount of money from the most people in the shortest amount of time." To that word of advice consider:
IBM                                      12                                       152  Down from 181
CVX                                     68                                        104            from 117.
Both of these strong companies pay a good dividend. IBM= 3.93 yield and Chevron= 4.13 yield. With that said, could you afford the 30 point drop in IBM? Could you face the pressure of low oil prices and hope to ride out the losses in CVX? You can rationalize that the price will go backup, but if the correction runs deep and long, you will suffer many sleepless nights. This is the danger of high P/E ratios and now, the darlings of the market, the FANG group.
Facebook                             38                                     152
Netflix                                 210                                    162
Amazon                               221                                    995 and upgraded to 1200
Google                                 45                                      969 and upgrade to 1175
The last two will form an exclusive club: $1,000 per share. In fact, Amazon hit that number on Tuesday. However, it retraced back to $996. which means thousands are in limbo and down $400.
We have been blessed with abundance, but like Nassim Taleb points out, a black swan can appear. Whether one appears or not, a market that approaches a P/E of 30 is in the danger zone. If you have profits, take them. If you think of joining the party, wait for a correction and a better P/E ratio to invest. There will always be a tomorrow and another party. You need to be patient and the worse that can happen with this approach is you will be safe rather than sorry. This is a free insurance policy.