The Markets Up Chuck

I believe, and there is plenty of evidence to back my belief, that current market conditions are at an extreme. Although rare, it’s not unusual for aberrant market action to occur. Warren Buffett once said: “The fact that people will be full of greed, fear or folly is predictable. The sequence is not predictable.” The important point is to understand the unpredictability of it all so as to not fall prey to the illusions. The late John Kenneth Galbraith, one of the most renowned economists of modern times once quipped: “In economics the majority is always wrong.” Therefore, what we really need to do is put our attention on and only on the important issues that are predictive in nature.

Regarding investing in common stocks there are two primary factors that can be relied upon as true determinants of future results. Neither can be viewed in a vacuum. However, when evaluated together, they are highly accurate return calculators. The first, and I believe the most important, is the rate of change the business grows its profits at, i.e., the company’s earnings growth rate. A company that grows at 8% can be expected to generate an 8% return and a 15% grower a 15% return, etc. The faster the growth the higher the return, and vice-versa. The other factor is the price or value you pay to buy the growth. So it all comes down to Growth AND Value. Today’s FRAT™ Videx™ illustrates the truth behind these principles.

FRAT™ VidEx™ (click to open in full screen)

The author manages portfolios owning: ORCL and CTSH.

A common investor tendency and a major mistake is the penchant for projecting the current situation to persist into the future ad infinitum. Common sense will tell you that nothing goes on forever. A booming economy will at some point end with a recession. A bull market will one day give way to a bear market. Conversely, a recession will evolve into a powerful growth cycle and bear markets will become bulls.

With common stocks, there will be many variations of growth, ranging from slow to fast. There can also be the total destruction or collapse of business prospects. Therefore, each company should be judged upon its own merits. The principles of value, however, are precise and only differ as they apply to each unique case. Once understood, determining the value of a single stock or a portfolio of stocks is straightforward. Evaluating your investments through the use of these time tested principles keeps emotion from eroding the framework of your decision process. It feels better too!

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This entry was posted on Thursday, March 26th, 2009 at 12:02 pm and is filed under Valuation. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.