3 Easy Ways to Value the Stock Market

Ways to Value the Stock MarketHow much is a hamburger worth to you?  That’s a tough question to answer.  For most people, the decision whether or not to buy a hamburger depends on things like…

1) What’s the price of alternative options?  Maybe a chicken sandwich or some chili?

2) How much am I getting for the price?  Is this a ¾ pound angus hamburger or one of those flimsy soyburger things?

3) How much have I paid for a similar burger in the past?

If you know the answers to those 3 questions, you could probably give me a pretty good estimate of the price you would pay for a burger.  If you don’t, well… you probably don’t have much of a clue!

Just like a hamburger buyer without the aid of these 3 bits of information, the stock investor without the aid of a few valuation metrics doesn’t have much of a chance.

Unfortunately, most investors don’t give much thought to what they would be willing to pay for a stock or for the market as a whole.  They just sort of buy here and sell there because it “feels right” at the time.

Without any tools to value a company or the market, you’re going to make bad decisions. There is no other way around that fact.  Fortunately, you don’t need any statistical models or fancy formulas to value the market.

Add the following tools to your arsenal and increase your chances for success:

1. Market Cap to GDP Ratio

Warren Buffett says this ratio is the “single best measurement of market valuation at any given time.”  When the total market cap as a percentage of GDP is greater than 90%, stocks are generally overvalued.  When the ratio is below 50% stocks are incredibly cheap.  When the ratio is above 115%, stocks are getting frothy.

2. 10-Year U.S. Treasury Yields

The 10-year U.S. Treasury bond is considered to be a “risk free” investment asset.  If you can get a “risk free” return of 10% by investing in 10-year U.S. government bonds, wouldn’t you be less likely to invest in stocks?

Think of it like the price of a chicken sandwich.  When chicken sandwiches are cheap, less people buy hamburgers.  When U.S. Treasury bonds are cheap (yielding more than 4.5%), less people are willing to buy stocks.

3. Earnings Yield

Which would you pay more for… a ½ pound burger or a 1 pound burger?  All else being equal, you would pay more for the larger burger.  The earnings yield tells us how much our current investment dollar is buying in terms of company earnings.  When the yield is high (above 6-7%), we’re getting more bang for our buck.

Just knowing these three metrics can help you tremendously when valuing a stock or the market as a whole.

When the market is overvalued by these metrics, start paring back on your allocation to stocks.  When the market is undervalued, start selling everything (bonds, clothes, cars, children…) to buy more stocks.

Cheers,
Nate

How to Beat the Investing Pros in 10 Minutes or Less…

The 10-Minute Portfolios use market valuation levels to determine how much of the portfolio should be allocated to stocks vs. bonds.  Since 1976, 3 of the 4 portfolios have outperformed the S&P 500 despite significantly lower volatility.  Follow along with the 10-Minute portfolios by subscribing to the free investment newsletter.

Stop Comparing Yourself to the Market

Stop Comparing Yourself to the MarketThe rest of the world is constantly comparing their investment price performance with the S&P 500, friends, family and money managers.  If you’re thinking like a real business owner, however, you don’t really care much about what everyone else says your company is worth.  All you care about is that it remain a profitable business and generate cash for you.

Let’s say you own a private company called “Larry’s Lemonade”.  Your business is simple: it makes and bottles lemonade to be sold at local restaurants and grocery stores.  In your hometown, Larry’s Lemonade has become iconic.  Your signature ingredients and highest commitment to quality have given your lemonade a real competitive advantage compared to other lemonade brands.

Now let’s say a friend of yours wants to buy Larry’s Lemonade from you.  Every day, he comes by your office and gives you a new price.  Some days, the price is really low.  Other days, the price is really high.  The only thing you know is that your friend’s price will not be the same today as it was yesterday.

If you are the owner of this business, would you ever sell to your friend? Continue reading

How Many Stocks Do You Need For a Diversified Portfolio?

DiversificationI’m facing a difficult task today.  My goal is to try to convince you not to follow one of the most broadly accepted principles of investing: diversification.  Of course, since I’m not a widely respected academic or investment guru, I’ve got to rely on quotes from those who actually are.  Warren Buffett should suffice…

In his 1978 Berkshire Hathaway letter to shareholders, Mr. Buffett said, “We try to avoid buying a little of this or that when we are only lukewarm about the business or its price. When we are convinced as to attractiveness, we believe in buying worthwhile amounts.”

In other words, diversification doesn’t make any sense.  If the decision is between a company that we really love and one that we’re just ho-hum about, we’d rather invest 100% in the one that we really love rather than dilute our hand with mediocrity.

Warren also said, “Diversification is protection against ignorance.  It makes little sense if you know what you are doing.”  That one doesn’t need translation.  The greatest investor of all time is clearly not a fan of diversification for sake of diversification.

It doesn’t mean, however, that just anyone just go around investing their life savings in just two or three companies.  The key is the “if”.  IF you know what you are doing.  So how do you know if you know what you’re doing? Continue reading

Why Stock Market Corrections Are Irrelevant

Stock Market CorrectionSince the S&P 500 and other major stock market indices increased by 25%+ in 2013, many market prognosticators have been looking in their crystal balls and predicting that a market correction is imminent.  They cite many different reasons:

  1. Stocks are at an all-time high.  The last time they were at levels like this, we saw one of the largest market drops in most of our lifetimes (2008-09).
  2. Interest rates are so low.  When they inevitably increase, stocks and longer-duration bonds will surely take a major nosedive.
  3. The economy is still struggling to add jobs and grow fast enough to sustain the levels of earnings growth most are predicting.

I’m not here to refute or defend any of these arguments.  I’m here to throw in my two cents: WHO CARES?!

That’s right.  Who really cares about market corrections?  If you’re trying to time the market, you might.  But if you’re a smart investor, whether the market goes up, down, or sideways makes no real difference to you.   Continue reading

What Are Your Real Priorities In Life?

Priorities: What Are Yours?

I’ve been doing a lot of soul searching lately.  And I’ve realized that my priorities are way out of whack.  If you would have asked me what my priorities were a couple weeks ago, I would’ve given the “right” answers… (#1) God, (#2) family, (#3) friends… {insert more important things}… (#49) money.

If I really look deep down, however, I know my answer would have just been lip service.  If God was really my #1 priority, why was I having such difficulty finding time to study His word?  And have there been times when I’ve put my career ahead of my most important relationships?  You bet there have.

Of course, I’m human, but that excuse can only go so far.  At the end of the day, my true priorities will shine through.

A wise man once said, “If you want to see a man’s priorities, study his checkbook and his calendar.”  I believe if you looked at my bank account and calendar over the past several years, you would probably determine that my #1 priorities in life are:

(1) the accumulation of money and …

(2) learning more about how to more quickly, efficiently, and securely accomplish #1.

As vain as that probably sounds to read, imagine how extraordinarily vain I feel admitting that to you.  It’s pretty shameful, but I’m glad that God’s been helping me recognize this.

Left unchecked, our tendency to pursue success and happiness (in whatever forms we think we will find them) can lead us into misplaced priorities.  That’s where I was – chasing a fulfilling life through swelling my investment portfolio.

Sad, yeah?

To help me get my priorities in place, I decided to do a “priority audit”, which I would like to share with you today. Continue reading

Should You Always Be Fully Invested?

MythbustingIf you read around the internet, you’ll find that the vast majority of people will advise investors to have 100% of their money invested in either stocks or bonds all of the time. Should you always be fully invested?

If you are investing in individual businesses rather than a broad-market ETF, it doesn’t make sense for you to always be fully invested just for the sake of being fully invested. It is much better to sit in cash and wait patiently for an opportunity than to tie up capital earning sub-par returns.

Don’t just take my word for it. The world’s greatest investor himself advocates patience rather than action. Warren Buffet says,

“Your default position should always be short-term instruments. And whenever you see anything intelligent to do, you should do it.”

To illustrate, let’s compare the investment results of two investors. Both investors plan to invest $5,000 per year over the next 20 years. The only difference is that Investor A is fully invested in the stock market 100% of the time. Investor B, on the other hand, decides that they will only purchase companies at prices that will deliver long-term returns of 12%. Continue reading

How To Make More Money Without Working For It

No Work!There are two ways to make money in life. You can either:

#1 work for it yourself

or…

#2 let someone (or something) else do the work for you

Most people focus their attention on #1. Growing up, we’re taught that the only way to earn income is by getting a job and working. If you want more money, you have to work more hours or move into a higher-paying job.

The problem is that you only have a limited amount of hours in the day. All those extra hours on the job mean less hours doing the things you’d rather be doing and less time with the people you love.

If only there was a way to duplicate yourself…

You may not be able to send two of you to work on Monday, but you can use your money to work for you. And, no offense, but your money can work a lot harder than you can! Read more…