Buy low, sell high: we test the theory

Start early and buy and buy. Gradually those dividends exceed your outgoings and you can retire gracefully. Leave the residual value to the inheritance taxman.

You need great discipline and belief, something the average private investor might struggle with over 20 odd years. It's more likely that this sort of research all goes into the melting pot of the mind and individuals will make decisions after absorbing very many bits of information. How many shares can you monitor and manage on your own?

nice article,thanks.

I bought like a loon during 2011, particularly during the doom and gloom days we had in August to October. I upped pension contributions, moved cash from savings accounts to a new pension, maxed out ISAs and put cash into unwrapped income equities.

I'm still 12% in cash (three years essential spend as a buffer) but will probably reduce this to 10% if/when good opportunities arise during early 2012.

Whether this is wisdom or madness will only emerge over the next few years.

How many shares can you monitor and manage on your own?

A good question.

I consider the same problem with my own type of investments.

Naturally 20+ different investments are a greater diversification of risk but not so easy to manage as half that number.

There is also always the temptation to shrink the number of investments into those that have a higher yield; i.e. selling off low yielding investments (especially at a capital gain) and replacing them with higher yielding investments that give both a greater income plus have the potential to make greater capital gains.

In my case I like to think of each investment as a flowering plant that needs to be nurtured but once it has bloomed needs to be cut and re-seeded to grow anew in a mutated form.

My type of investments have a limited life span to maturity and one has to decide whether to allow each investment to live until its expected death or cull it if it has either bloomed earlier than expected (i.e. worth much more now than at maturity) or is withering and needs to be culled before the disease spreads to the whole crop (i.e. a bad plant could affect the entire crop of investments).

Yields on sovereign debt have been falling in recent weeks and investors have been piling into corporate bonds.

By sitting on my corporate bonds I bought as the market was falling last year I've made a net market gain (including one loss) of 15.156% from 3rd January 2012 to 27th January 2012 by doing very little.

Oh, if only such gains could carry on infinitum; unfortunately for me I very much doubt it though not for lack of trying!

A fascinating analysis but is it what it seems? Between beginning of January 1999 and 2012 the FTSE 100 declined by 3% so the 62% growth seen in the buy and hold case is all dividend income, and so therefore is most of the gain in the other two strategy scenarios. Is it therefore dividend income that is maximised with this strategy?

I am suspicious, as with adverts for funds, that the choice of start date may strongly impact the conclusion. Starting at any time between January 2002 and January 2007 would for example create a much less convincing graph.

Wise words , but I am still confuse with investment policy and judgement , still trying hard to understand this p/e ratio , please can any one give me a simple way to grab this p/e ratio , example Tesco . Thank you all

sgjhaghsdg

Well done!

I imagine your investments must be worth at least 528k (600k - 72k cash) if 12% in cash for three years essential spending and if I assume you just need 24k a year for 'essentials'!

Let's hope the paper profits you must be experiencing now don't evaporate when market sentiment falls again later this year; I cannot see how this rise in the markets will be sustainable with so much bad news simmering on or just below the surface.

I am not sure how much gains have been included in the cash part. Assuming that the cash is earning nothing, the buy & hold option would have made 2x62%=124% if 100% were invested in 1999 - simply the best and easiest way to go!

@Robert - Sadly my wife sees more things as essentials than I do, which includes school fees, so the numbers are somewhat larger than that, but you're in the right ballpark.

I don't expect it to be all up from here (far from it!) but I'm happy with my asset mix, and have a good 7-8 years of paying into investments left in me, so I see dips as opportunities rather than threats.

Hi Abbass,

The P/E uses 2 variables: (share) price divided by earnings (per share). Earnings (at least historically) or based upon reported company earnings whereas forecasts are based upon analysts and company guidance. Price is obviously more liquid and moves with markets and investors attitude to risk at the time.

The ratio therefore serves to act as a measure of investors/markets current attitude to risk and the "premium" that is being applied to markets and/or shares.

The higher the number the higher the premium which raises the question " how much over the odds are you willing to pay.

This is also a question re. your attitude to risk in the current time: can you afford the risk, are you optimistic/pessimistic?

The other aspect of this is that because there is an earnings variable it also serves to show how many years of profits (at the point in time) it would take for investors to get back their investment. Profits can be retained within the company or paid out as dividends but either way would "cover" the share price. Reality is different as share prices move and earnings are also expected to appreciate.

This expected appreciation also serves to add another layer to the view on whether the current P/E is cheap relative to future growth and might help to explain why some companies (perceived to have fast growth), are on P/E's of 40 or 50 which is basically saying that, if they don't grow earnings as expected, then it would take 40 or 50 years of stagnant profits to cover the original investment (share price). It also explains why they are punished if they don't hit earnings forecasts.

Specific sectors/companies also have an average (as the article suggests) based upon prospects for the industry growth/company specific prospects.

Supermarkets v Tech companies, both have their attractions, limitations, growth potential, and risks which "tends" to be reflected in their sector averages, and company specific P/E's.

The added layer to this (as the article suggests), is a macro-economic influence (majority attitude to risk) which can tend to push these numbers above or below the average.

Purely my means of understanding P/E's and apologies for length and if this is not what you were asking.

Hope this helps

MA

http://adventuresinequities.blogspot.com/2011/12/apple-cheap-at-114-times-2012-earnings.html

http://adventuresinequities.blogspot.com/2011/01/supermarket-sweep-tesco-morrisons-or.html

This article suggests what has been roughly my approach over the last couple of years. When everyone goes massively risk off, I pick up shares in those equities and markets that are usually seen as low risk. It's worked so far, but I'm all too aware that the wheels can fall off any plan at any time.

Warren Buffett Investing!

In my case it's more like Baron Fluffit at times, but I have read various books by Bernstein and Graham, so at least I know what I *should* be doing.

One does wonder what Buffett would think of my big fat gamble on Lloyds Preference Shares ((LLPC) back in the summer ...

We all have totally different needs and aspirations but I'd suggest that whatever your investment strategy saving a certain percentage of your total net income should guarantee eventual success unless you're a complete idiot or very, very unlucky.

Reinvesting 50% of total net income would be extremely hard for somebody with a small income yet obviously far easier for somebody with far more coming in than they need.

However mind-boggling hard to begin with an almost guaranteed future prosperity with an ever increasing income under almost all possible scenarios must be worth the initial sacrifice for a rational human being and is the basis of the capitalistic system we live in.

If you have zero capital apart from your determination better make a start as soon as possible converting that energy into savings you can invest and grow for the rest of your life.

Ok, so it's stating the obvious, but once your investment income equals half your total income and you can survive on 50% of your total income you must surely be making good progress towards a retirement goal (if you have one).

For those people who wish to work once they are financially independent and never have to work again then surely 'work' becomes a hobby and a joy rather than a means of mere survival?

p/e is low, but is that because profit margins are at record levels and according to Grantham, "will come down to more normal levels eventually, of course, and when they do they will bring the market down with them"

http://www.gmo.com/websitecontent/JGLetter_ShortestLetterEver_3Q11.pdf

thank you MA.

pe the number of years it would take, if u could buy the whole company and nothing changed before you received your capital back.

If we use ITV as the working example

2010 IFRS profit £286 mill divided by the number of shares issued = eps of 6.14p.

current share price 77p divided by eps 6.14 = pe of 12.54

so in 12.54 years if nothing changed and u ignore tax and everything else u would be the owner of ITV and have received all your capital back. The biggest problem u would have would to decide what to do with your £286 mill profit.

Of course the market wouldn't let u buy all of ITV at the current price and if they improve their profits the pay back time would be less.

Now if u wanted to buy ARM u would have to live for 92.6 years so may more suitable as a present for a grand child.

The current pe is last years profit, history now so next years fcasted pe is of more interest.

Chart trader

You don't have a clue when comparing stocks. Arm is growing its profits at a rate of 30% and it is the leading microprocesor designer, taking the crown from Intel. If you compound its rate of growth (without thinking of fading) you will get your money back faster than from ITV. So leave you grandchildren alone.

There are plenty of stocks with negative or zero earnings yield and plenty with zero dividend yield but they still have a price. The way to compare two stocks is to project the eps and dividend for 'x' years ahead and apply a discount rate. The stock whose NPV is more attractive versus market price is the one to go for. Long term investors will appreciate that NPV of dividends will surpass the NPV of the residual share price, therefore dividend growth is a major cumulative factor, but it does require sufficient eps. If your horizon is short dividends are a minor consideration and price will be dictated by views of the next earnings statement. The Tesco long term dcf of dividends has probably changed little and is even better value than it was, however the uncertainty of short term eps caused the sell-off by investors who care little for dividends.

Take RBS, with no chance of dividends, one could still make a case that with its highish NAV and the potential that it will become clean and make real profit, the future share price could be 85p in 3 years. Thus if a large 10% discount factor is used the NPV is 85/1.33 = 64p in round terms. If you buy this the market price of 27p/26p is a steal.

Attempting to buy low and sell high is one of the most common mistakes made by the vast majority of investors, going back as far as the early 1900s.

It may be hard to accept but buy high, sell higher and sell low, sell lower is a far more profitable strategy.

Scottino

I haven't seen a successful investor from aplying the NPV or P/E method.

First you need to undestand that the way company keep their accounts is not useful for investors but for the creditors of the company. This way of accounting was developed so long ago when very few shares were quoted on a stock exchange but firms went every month to lenders to borrow money. So all the accounting of a company is done in way to help creditors acertain if the can lend money to a company or not.

The accounts won't tell you if the factory is relatively new or old and needs replaced next year. It only show you the value it was registred 15 years ago and how much was the depreciation until now. It doesn't give you a clue how much is its replacement value. It can be a lot more or less (usualy more) but if the factory needs to be replaced it surely will afect the cashflow and your NPV.

Replacement value are very important, Eniac one if the first computers costed $3 million, its replacement value is less than $400.

Banks: if you have a method to acertain their cash flow or the value of their assets, good for you. I don't but I believe banks will struggle and there will be still a lot written down assets as they sell them. There is another problem, the yield curve started to flatten and this is not good for banking business. Bank business is borrowing on short term paying less interest rate and lending on longer term getting higher interest. The stepper the yield curve the more profit they make.

If you remember in 2006-2006 the yield became flat, so banks made not profit on lending so there was higher reliance on financial engineering done by their investment bankers in slicing and dicing NINJA mortgages and on customer buying PPI with their loan. Now they have to give the PPI back.

Valuing a company is a lot different, you need to calculate the economical profits which are different

Chart trader

By the way Arm Holdings came nicely, increasing their earnings per share with 33% comparing with last year, higher than 30% expectations.

The managers believe it can be repeated next year, the market answer was +5% . Always invest in a business you can understand. And Arm business is pretty simple. They design microprocessors which find there way in pretty everything, from tablets and smartphones to smart TV to smart cookers.

More important, producers like Apple, Samsung are happy working with them because Arm is not greedy like Intel. They don't manufacture the microprocessors themself leaving others to have a share of the profits. Producers of the same chip can even compete with each other. Licenses sold by Arm are pretty cheap (pricing power) and all the money is made on the numbers of chips sold. Good business model, I bet Intel is looking with envy.

This is all very complicated and let's make it simple. Buy when the share indices (e.g. FTSE/DOW) are low and sell when the share indices are high...