The stock market is filled with individuals who know the price of everything, but the value of nothing.
-- Philip Fisher
Despite the recent gains in the market, current economic data suggests we shouldn't expect a full recovery anytime too soon. So it may be fair to ask ourselves: How can we avoid the mistakes that got us here, and how can we find the top stocks to buy today?
Consider this
The mistakes that led to this downturn are reminiscent of the speculative frenzy known as the Dutch Tulip Craze. In 1636, Dutch citizens found themselves caught up in a tulip rampage that lead to skyrocketing orders and prices that grew by as much as 100% per week. Eventually, one tulip bulb was selling for the equivalent of thousands of modern-day dollars! The market became overbought, and the frenzy bottomed. By 1637, the price of tulips was less than 1% of what it had been before the crash. Value was an afterthought to the tulip "day traders" who sought to profit from irrationally soaring prices.
Quickly fast-forward to the dot-com bust around 2002. The growth of Internet companies and an overinvestment in information technology caused the Nasdaq to rise more than 600% from 1994 to early 2000. If you were alive or breathing in the last 10 years, surely you remember what happened next:
- In 18 short months, approximately $5 trillion was wiped out of the value of technology stocks.
- Silicon Valley stalwarts like Microsoft (Nasdaq: MSFT ) and Cisco Systems (Nasdaq: CSCO ) both experienced price depreciations of more than 50% in a similar time period.
As with the tulips, it seemed as though everyone was confident in the price of the next "big" stock. The classic example of the overhyped company of the time was Pets.com. After trading for more than $14 per share, it liquidated in less than 270 days at $0.22 per share. Everyone supposedly knew the right price -- but what was the value?
OK, let's talk 2008
Call last year what you want. The housing horror. The derivative debacle. The commodity crisis. The securitization scare. There are too many explanations for the collapse to isolate only one aspect. For the sake of argument, I'll arbitrarily choose crude oil to illustrate my point. The Commodity Futures Trading Commission recently announced it will release a report suggesting speculators played a role in driving last year's wild swings in oil prices, which saw crude spike at $145 a barrel in July before collapsing to $33 a barrel by December, representing a 77% decline in value over a six-month period.
National Oilwell Varco (NYSE: NOV ) , an upstream oil service provider, and Weatherford International, an oil and gas equipment provider, each lost 80% of their value from July 2008 to November 2008 ... and have gone on to double along with the recent crude oil rally. I don't mean to sound repetitive here, but from these numbers, it appears that many investors didn't evaluate these companies' competitive positions, but were instead making bets on oil prices.
What, if anything, have we learned?
We can be certain that there will always be ups and downs, booms and busts, good years and bad.
So what can we do? One philosophy is to invest in companies with great competitive advantages, clean balance sheets, and a history of success in their given industries. For example, investing in Google (Nasdaq: GOOG ) , a company with no debt and a long history of beating analyst expectations, would certainly seem like a good idea. But at more than 30 times earnings, does it provide you with much value today?
Similarly, Netflix (Nasdaq: NFLX ) , the largest online movie service -- which boasts more than 10 million subscribers and has a stellar reputation for innovative management -- also seems like a solid investment. But it's currently trading at 28 times earnings -- does that provide value to someone buying shares today? It's hard to know the answers. That's why we focus not only on exciting companies, but on ones that are exuding value, as well.
Here's a place to start
In both bear and bull markets, value investing has provided people with a logical and methodical approach to investing. The general ideas: Don't speculate on questionable growth potential or companies with debatable revenue streams. Look at companies that may be trading well below their intrinsic value for unfounded reasons, seem cheap compared to their industry, and have strong records of returning capital to their shareholders.
Here a just a few companies that presently fit the bill:
|
Company
|
% Below 12-Month High
|
Price-to-Earnings Ratio
|
Return on Equity
|
|
Satyam (NYSE: SAY ) *
|
77%
|
3.5
|
27%
|
|
Innophos Holdings
|
56%
|
2.2
|
25%**
|
|
Nokia (NYSE: NOK )
|
52%
|
16.1
|
18%
|
|
Star Bulk Carriers
|
67%
|
1.4
|
28%
|
Data from Capital IQ, a division of Standard & Poor's. *Satyam financial data based on most recent 20-F filing. **Most recent quarter.
Granted, in some cases these companies' P/Es are artificially low based on last year's higher earnings. But even if earnings decline, they're still cheap.
More ideas
Our Inside Value team seeks out companies that not only have great competitive advantages (Google and Netflix, for example), but that also trade at bargain prices. If you're looking for more cheap stock ideas, you can click here to read about all of the team's official recommendations, free for 30 days.
Fool contributor Jordan DiPietro doesn't own any of the shares mentioned above, but is always looking for a discount (mostly on sneakers). Google is a Motley Fool Rule Breakers recommendation. Netflix and National Oilwell Varco are Stock Advisor picks. Microsoft and Nokia are Inside Value selections. Innophos is a Motley Fool Hidden Gems recommendation and Fool holding. If I could buy the Fool's disclosure policy at a discount, you know I would.
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