The Only Two Numbers That Matter

Despite our recent rally, the market is still off its October 2007 highs by some 40%. And this week's descent is bringing back some bad memories.

Will it stop here? Will it teeter-totter? Will it resume that upward swing we all like so much? Oh, the uncertainty!

But focusing on what the market does today, or this week, or even this month is largely beside the point -- because when it comes to your investing performance, there are only two numbers that matter, and today's price isn't likely to be one of them.

Lessons from numbers
Remember buy low, sell high? The only two numbers that matter are the price at which you buy, and the price at which you sell. And unless you're planning to do either of those today, the market's most recent gyrations don't really matter all that much.

For illustration, let's look at some familiar names and see how they fared before, during, and after the market's last big tumble. (I'll look at prices from August of 2000, 2002, and 2007, which are close to some inflection points in the market's zig-zaggy history.)

Source: Yahoo! Finance.

There are several lessons in this table:

• Prices change. It's part of the game. Expect it.
• Quality matters. Even though the S&P 500 is close to where it was more than 11 years ago, many excellent companies are selling for quite a bit more than they were then -- even though they've see-sawed in the meantime.
• The price at which you buy is crucial. You can't time the market, but you can buy companies you think are currently undervalued -- because sooner or later, the market should value them at or close to their true worth.

Would it be nice if the market just kept marching upward? Sure. Does it matter if it doesn't? Not if you're buying with an eye toward the value of the underlying company, and a thesis about where it's going.

It's all relative
Ultimately, it's crucial to try to buy stocks when their prices seem low relative to the value of their underlying companies.

And while there are lots of reasons why you might sell -- if the price gets considerably ahead of the company's intrinsic value, if you find a more compelling investment option, or if the reason you bought in the first place no longer holds -- a fallen price alone shouldn't be one of them.

So when you're shopping for stock, look for hints of undervaluation, such as a low price-to-growth rate ratio (PEG), a P/E ratio near the low end of a stock's historic range, or a price-to-sales ratio lower than those of the company's peers. While none of those are definitive signals, they can help you figure out what stocks you might want to research further.

For example, a quick screen for firms with low P/Es, and price-to-cash-flow ratios well below industry averages, brought out the following contenders.

Data: MSN Money.

The Foolish bottom line
Don't swoon over inevitable market gyrations. Focus instead on the only two numbers that matter -- the price at which you buy, and the price at which you sell.

Recessions are often the best times to buy, as even blue chips fall to bargain levels. Don't follow the crowd and pile into a hit stock, regardless of its price. Remember the table up top, which shows you what can happen when certain stocks get way ahead of themselves (the Internet bubble) or when the overall market swoons (2008). Stay rational, especially in rocky markets.

And don't forget that even a negative interim return isn't always so bad -- provided it's better than many alternatives. A 20% drop in 2008, for example, was actually much better than the overall stock market's drop of nearly 40%.

If you'd like some pointers to a host of stocks our analysts believe are significantly undervalued, I invite you to take a free trial to our Motley Fool Inside Value service. Even in this dismal environment, our bargain-hunting team's picks are beating the market on average. A free trial will give you full access to all past issues and all our recommendations. Just click here to get started.

Here's to a happier portfolio!

Already subscribe to Inside Value? Log in here.

Longtime Fool contributor Selena Maranjian owns shares of eBay, Wal-Mart, and McDonald's. eBay is a Motley Fool Stock Advisor recommendation. eBay, Waste Management, and Wal-Mart are Inside Value picks. Waste Management is an Income Investor selection. The Motley Fool is Fools writing for Fools.