Beware of Overpriced Stocks

Posted on July 19, 2016July 19, 2016 by Adam Lee

Today Netflix crashed 13% after lower than expected subscribers were reported for the second quarter. It now trades at $85.63 after falling $13.13. If you had invested in this stock just yesterday you would have lost over 13%. The first thing I do when I see stock headlines like this is pull up the stock and look at it’s P/E ratio. This is currently at an outstanding 266! That’s more than 20 times that of Apple, meaning people have much higher expectations of growth with this stock.

That being said, 266 is better than a P/E of 0 (sometimes denoted ‘-‘), which means that the company does not turn a profit at all. One big example of such a company is Tesla. People are so adamant that Tesla will be the wave of the future that they’ve heavily invested in this stock, which means that Tesla will probably have a high beta. When fluctuations happen you will see these high beta stocks swing much more violently than stable low risk stocks such as Proctor and Gamble, Johnson and Johnson, and utilities. That being said, certain events can still cause ‘stable’ companies to flop or gain/lose an incredible amount of value – buyouts, disasters, shortages are some of these types of events.

In my opinion, I would not consider buying any company with a P/E ratio higher than 100, and would discourage investing in an unprofitable company. If I had to use a stock screener to automatically buy stocks I suppose I would filter by P/E ratio between 10 and 22 with a dividend of between 1 and 3.5% and a return on equity of at least 10%. Return on equity means how much percentage profit each stock generates. For example Apple has in the first quarter had a return on average equity of over 30%, meaning if each dollar of stock generated 30 cents in profits. Not bad! A low return on equity means the profitability of the company based on its equity is low, so more money put into the company might not yield much profit so the incentive for price growth or dividend payouts is probably lower.

You Are Forced To Invest in Risky Assets

Posted on July 16, 2016July 16, 2016 by Adam Lee

Take a good hard look at the charts above. While mortgage and CD rates were over 10% in the mid 1980’s, mortgage rates have dropped to between 3 and 4 % starting in the 2010’s and the bank interest rates have fallen to around 0.1%. The problem with the current investment environment today is that there really is no where to get a great return except for higher risk assets. Stocks and bonds both carry risks, and have been heavily pumped up due to the lack of alternatives such as existed in the past. Central banks have been pushing people with assets to invest in the stock market for quite some time now, as such investments ostensibly drive economic growth and also people’s retirement accounts.

Retirement accounts in the US are not the same as they were in the past – in 1980 the 401k accounts were started by private companies take take advantage of section 135(a) of the Revenue Act of 1978. This became a trend among companies across the US and is now the standard. Companies would much rather have individuals put money into their 401k than be obligated to support them after retirement. The 401k is a type of defined contribution plan rather than a defined benefit plan. Federal law does not require employers to offer or to continue to offer a plan, but most white collar jobs do come with this benefit.

The IRS dictates that 401k beneficiaries being distributions at a certain age. The rules are a bit different for designated beneficiaries, but they should be closely followed otherwise penalties will be imposed. If an employee decides not to invest in a 401k, he or she does not receive any taxable benefits offered by the 401k which could either be:

Untaxed deferrals to the 401k plan
Untaxed gains for the Roth 401k plan

In short, money that goes into the normal 401k plan is not taxed up front but instead when removed from the account. Money that goes into the Roth 401k is already taxed but doesn’t get taxed when removed. Entire industries are supported on fees and administration costs related to people’s 401k accounts – if you haven’t yet, you should check out how much money you are charged for keeping money invested in each mutual fund, bond, ETF, etc. you are holding. Deciding to put your 401k money in fixed income will yield you close to nothing, but having money invested in international funds generally is more risky.

Unfortunately for the saver of today, the best investments tend to be stocks or real estate. Gone are the days of investing in bank CDs, at least in the US. If you’re looking overseas many countries still have double digit interest rates you can get on savings, but those countries tend to have higher inflation too. Keep in mind holding a foreign bank account you will need to report your assets with the IRS using the FBAR form.

Strategic De-Vesting

Posted on July 12, 2016July 12, 2016 by Adam Lee

My last post noted how investing during a stock market trough is a wise decision. Many financial advisers will never advise their clients to reduce exposure to the stock market, but given the current price valuations I suggest selling off some stocks to hold gold, silver, or practical real estate. The reason for this is clear – the stock market has had a great ride, but that ride is based on a handicap of low interest rates and valuations which exceed standard price/earning ratios of the past. Amazon has a P/E ratio of 300, Tesla has a P/E ratio of nothing because they don’t even turn a profit! Apple holds a pretty low P/E ratio of around 11 because of doubts on future profitability.

The point is, there is a frothiness to the US stock market which is alarming. In my opinion it would be best to sell of around 30% of your portfolio now and ensure your investments are in stable asset classes. I’ve mentioned investing in water almost almost one year ago, and here are the results (using 1 year return from today):

GE : up 22% (Current price $32.21)

ECL : up 6% ($119.10)

AWK: up 62.95% ($82.76)

WTS: up 21.47% ($61.05)

I would keep these water stocks except for ECL and sell high risk assets such as Tesla, Amazon, etc. to ride out the upcoming correction.

If you check out my post on how investing in the stock market is like a chess game you should note that my recommendation on gold/silver stocks has also paid off.

The particular company I linked in that post has gone up 151% and is now trading at 6.05. I suggest selling this stock at this time to retain the profits.

So in summary my suggestion:

Hold on to the water stocks

Cash out and perhaps put money into modest real estate