I don't own any retail stocks, and at the moment I'm glad I don't. I don't own any oil company stocks, and I'm glad I don't own any of those either. I've never been to China, but it seems more and more of my stuff is coming from there.
Honestly, I would like to own a few retail stocks -- the larger ones, such as Target
The reason I don't own any of these stocks is because, in my opinion, they're too expensive, with the possible exception of Sears, which has a P/E of 3 and free cash flow of almost $12 per share.
By way of comparison, Wal-Mart has a P/E of 25 and free cash flow of $0.60 per share, Target has a P/E of 23 and free cash flow of $0.17 per share, and Kohl's has a P/E of 29 and free cash flow of $0.01 per share. Personally, I'm not willing to pay 20 to 25 times earnings for a stock -- any stock, much less one that has free cash flow of less than $1.50 a share. But that's just me. (By the way, I'll give you my own value for all these companies at the end of this article.)
The higher the price, the higher the risk
One of the key components in determining the price of a stock is earnings growth. The higher the earnings growth, the higher the price, and the higher the price, the higher the risk. I've always had a problem with earnings growth estimates because I think they are always unbelievably high. But I'm not a CFA, I'm just an average Joe trying to provide a safe haven for my savings, a safe haven that's long on growth and short on risk.
As an investor, I'm happy to see higher earnings growth (even if I seldom believe the estimates), but, as a consumer, I'm not. As an investor, I know that higher earnings growth should lead to higher stock prices, but as a consumer, higher earnings growth usually translates into higher prices, and with the price of oil seemingly almost out of control, as a consumer, I don't need higher prices.
But why does any of this really matter? I mean, prices are going to be what prices are going to be, which at the moment is too high for my investment dollars and too high for my consumer dollars. My saving grace is that I don't have much debt, and with what I believe is economic uncertainty, I don't think my debt level will be increasing anytime soon.
Higher consumer prices matter because they have an impact on my future dollars, the ones I'm saving today for use tomorrow. Higher investment prices matter because with higher consumer prices, there are fewer investment dollars available, and those that are available aren't going to help much if I put them to work buying companies priced at 29 times earnings, especially those expected to grow earnings at an incredible 19% per year for the next five years.
Of course, there is the probability that earnings won't increase as analysts are estimating, and if that happens, then what?
Well, from a consumer's perspective, if earnings don't increase as estimated, then there is a glimmer of hope that prices won't increase either. Hey, it could happen!
But from an investor's perspective, if earnings don't grow, then stock prices may not appreciate, and it's the price appreciation part of investing that is central to my investing discipline.
Consumer price increases, higher energy prices, saving for retirement, presidential elections, outsourcing -- not to mention saving for college, braces, prom dresses, and vacations -- the demands made on our dollars are unrelenting. No wonder Harley-Davidson
Consumer prices are something I can't do much about, except comparison shop, and buy in bulk when I can, and complain to nobody in particular. If I continue to manage my debt and pay attention to what I spend, I can manage higher consumer prices.
Price determines return
On the other hand, stock prices are something I can do a great deal about. I know, you're thinking I've lost my mind and that I can't do anything about stock prices. But I can, and so can you. When it comes to stock prices, all you have to do is remember that price determines return.
If you can remember that, you will always have an impact on stock prices. Just remember those three words: Price determines return. Go on, say it out loud. Who cares if the rest of the folks on the bus look at you like you've escaped from the funny farm? Price determines return.
The more I pay for a stock, the higher the price must escalate for me to get a reasonable return on my investment. But what's more important than my return is my risk. The more I pay for a stock, the greater my risk, and the greater my risk, the lower my chances of long-term investing success. The lower my chances of long-term investing success, the higher my chances of not having the money I need to live my chosen lifestyle when I'm too old to find my hat.
How to control stock prices
While the consumer side of me has to buy stuff even when I think the price may be too high, the investor side of me doesn't have to buy anything unless I think it's to my advantage to buy. So my investing discipline controls stock prices by not allowing me to purchase a stock until it's on sale, until I can get that proverbial dollar of value for 50 cents. If I can't find that bargain, then I'll just hedge my risk by staying in cash.
Looking for stocks on sale requires a lot of effort, a lot of discipline, and a bit of luck. I do it because I enjoy the philosophy associated with this particular style of investing. As you might imagine, it's a lot of work, but I like the challenge. Besides, it adds value to my portfolio and provides value for me as a person.
I said earlier that I wanted to own a retail stock but that prices were too high. But too high compared to what? Well, too high compared to what I think is a reasonable value for the stock. Remember I told you that price determines return? Here's how it works.
I think a reasonable value for Sears is $75. That means my entry target is $37.50 (remember, I want a dollar for 50 cents). Sears has been trading in the $38 range. I think a reasonable value for Wal-Mart is $26, making my entry target $13. Wal-Mart has been trading in the $54 range. I think a reasonable value for Target is $24, making my entry target $12. Target has been trading in the $46 range. Lastly, I think a reasonable value for Kohl's is $26, making my entry target $13. Kohl's has been trading in the $55 range. Price determines return.
The next step in my quest to add a big name retail stock to my portfolio is actually the hardest step: waiting. Most of the stocks I mentioned are trading beyond what I believe are their reasonable value levels and have been trading at those levels for the past several years. So, with the possible exception of Sears, waiting for the price of these stocks to reach my entry point could take a very long time. That is, it could take a very long time unless the price of oil, interest rates, and consumer debt levels continue to climb, in which case I might be in buy mode in the six to nine months.
So there you are, one average Joe's look at consuming and investing, having and not having, wishing and not getting -- in general, a microcosmic look at being alive. While I'm glad that I'm a consumer and can do my part to keep our economy moving, I'm also glad that I'm an investor and can do my part to keep my economy moving. And speaking of moving, it's time for me to be moving along.
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Not only does Wax not own any of the stocks mentioned in this article, he's always looking for things that aren't there. As you can imagine, it can be real scary when he finds stuff. Fooldom is investors writing for investors.
