Americans have lost almost 30 years of wealth over the last 10 years.  They’ve seen a 40% drop in net worth just since 2007.  American household wealth is now below where it was in 1983.

Whose Fault Was It?

 

Was it the bankers for making credit so easy?  Was it the government for failing to supervise the bankers?  Was it corporate greed that cooked the books and pushed up stock prices to unimaginable levels?

 

Or was it something more?

 

Because not everybody lost money.  Some people sold out of their stocks at the highs… some people sold their homes at the highs… and many others simply chose to hold onto their cash and stayed out of stocks and housing.

 

What was it that these people knew that everybody else didn’t?  And how did they get so smart — or were they simply lucky?

 

Most folks will never ask these questions.  Most folks will always look for somebody else to blame for their losses, because facing the truth is difficult.

 

The truth is that 75% of ALL professional mutual fund managers cannot beat the S&P 500.  That means that your local broker has absolutely zero chance of ever growing your money for you over the long term.

 

It means that you must take responsibility for running your own money.

 

 

What Price to Pay?

 

If you are a conservative investor and willing to wait long periods of time between making stock market buys, then read on, because there is a method that you can use that will virtually guarantee that you’ll never over-pay for a stock.

 

In fact, if you had just restricted your buys to Blue Chip stocks and followed this method over the last 12 years, it would have taken exceptionally bad luck to have experienced a permanent loss of capital.  The added advantage is that you would have pulled the trigger on your biggest buys during periods when other investors would have been at their most fearful.

 

For example, August 2010 and October 2011.  Each of these recent periods were chock full of buying opportunities that fell squarely in the sweet spot of this method.  But let me warn you, this is no magic bullet, so please don’t misunderstand me.  You would have certainly experienced market volatility, but you would not have experienced permanent loss of capital like so many other folks did in the tech wreck and the financial crisis.

 

It’s a very old valuation method created by the Godfather of value investing, Benjamin Graham.  The formula looks like this:  P/E Ratio (less than) Earnings Yield + Growth Rate.  You buy into the stock when the PE ratio is lower than the combined value of the company’s earnings yield and growth rate.

 

 

What’s an Earnings Yield?

 

Let me explain with a real life example, using McDonalds (MCD).  This is a stock that I recommended in The Tycoon Report back on June 6th, 2012 at $88.

 

Today the stock is at $91.89.  Is it still a good buy?  Let’s find out…

 

First thing we do is figure out the earnings yield.  This number tells us what percentage return we would make on our investment if the company kicked out every cent of this year’s profit to the shareholders.  Here’s the formula:

 

1 divided by P/E Ratio of stock = Earnings Yield

 

McDonalds is expected to earn $5.70 per share this year, so we figure out the PE by dividing the price of MCD ($91.89) by earnings per share ($5.70) which equals 16.12 times this years earnings.

 

So our formula for earnings yield would look like this:

 

1 divided by 16.12 (P/E) = 6.2%, so if every penny of this year’s profit were sent to shareholders, and you bought the stock here at $91.89, you’d have a yield of 6.2%.  That’s the earnings yield.

 

Now we have to figure out the growth rate.  There are a couple of ways to do this:  You can take the average Wall Street estimates, or simply see what the company has done in the past.  For this example I took the McDonalds’ 17 year compounded annual earnings growth rate, which is approximately 10%.

 

Our valuation formula, once again, is P/E Ratio (less than) Earnings Yield + Growth Rate.

 

If the current P/E ratio is smaller than the combination of the earnings yield and the growth rate, then the stock is a buy.  The earnings yield is 6.2% + the growth rate which is 10%, equals 16.2.

 

So we can see that the growth rate + earnings yield combination is actually matching the current P/E.  This tells us that MCD is fairly valued here, and also lets us know that it can be bought on a pull back.

 

 

No Free Lunches

 

Let me reiterate, this is a very broad brush illustration.  There are other mitigating issues that go into making a long term investment decision that are outside the scope of this article.

 

What I wanted to do here was share with you a “quick and dirty” method for getting an idea as to whether something was cheap or expensive.

 

I find this method works best with companies that have a durable competitive advantage, a long earnings track record, and relatively low debt levels.  Things get trickier when you are in an environment like 2008, because P/E ratios and earnings yields can get out of whack as even Blue Chips can have little to no earnings during extreme recessionary periods.

 

During times like that you can use a different valuation method that is extremely good at getting you in at a terrific price while everyone else is cowering on the sidelines.  But that’s a topic for another article…

Source: 

Wednesday, July 18, 2012 | Teeka Tiwari… http://www.ifii.com/articles/531167624/wealth-withered-heres

Blue’s Comments: 

  •  

    Most folks will never ask these questions. Most folks will always look for somebody else to blame for their losses, because facing the truth is difficult.

    The truth is that 75% of ALL professional mutual fund managers cannot beat the S&P 500. That means that your local broker has absolutely zero chance of ever growing your money for you over the long term.

    It means that you must take responsibility for running your own money.

    It’s a very old valuation method created by the Godfather of value investing, Benjamin Graham. The formula looks like this: P/E Ratio (less than) Earnings Yield + Growth Rate. You buy into the stock when the PE ratio is lower than the combined value of the company’s earnings yield and growth rate.
    Our valuation formula, once again, is P/E Ratio (less than) Earnings Yield + Growth Rate…See examples above to see how this formula works..
    This is Part 1..Part 2 coming soon….Very good information here friends !!..be sure to say this in your Investment Lessons…jp/Blue
     Wall Street Lesson’s 101,Wealth Withered? Here’s The Surest Way to Restore it, Part 1.
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