"Learn all you can from the mistakes of others. You won't have time to make them all yourself" Alfred Sheinwold

If you read through my strategy one thing should become clear- the core of my approach to investing is based on sound principles of fundamental finance. I studied and passed all of my CFA exams not because I was required to do so by my employer, but rather because I was simply eager to learn how to value a standalone company, stock, bond, option or a CDO for that matter. And while my FA (fundamental analysis) background should theoretically predispose me to ignore all the TA (technical analysis) related noise as a pure nonsense, I don't necessarily do so outright. Some of the basic TA rules, help an average investor to avoid some of the most common mistakes like constantly buying companies with declining stock prices just because they seem cheap etc...

Let me make it clear- I never believed in a concept of buying stocks just because they are going up or selling them just because they are going down. Momentum investing is not my style-period. But on the other hand, I also don't buy into the concept of buying stocks just because they have a low Price to Earnings (P/E) or a Price to Sales (P/S) multiple. Making an investment decision of buying a stock A or B just because has a low P/S multiple or because it's current P/E is lower than it was last quarter, to me is just as ridiculous as some of the "super duper" TA theories...

If one simply screened the stock universe to pick stocks that have a low P/S ratio or a low P/E, it would likely result in a meaningless list dominated by retailers and financials. But how could a real "financial expert" state with a straight face that just because JCP (JC Penney's) P/S is 0.5 times and INTC (Intel's) is 3 times- the retailer's stock is a lot cheaper?? Do you really believe that a dollar of sales from JCP is worth as much or even anywhere close to a dollar of sales from Intel? How about a simple fact that one makes almost 5 times more money from each dollar of these sales than the other? And that one is virtually a monopoly in a growing industry, while the is just one of the many struggling companies in an industry that is subject to violent fashion mood swings of the American consumers?

Same thing with low P/Es... How could one say that GS (Goldman Sachs) is cheaper than BUD (Anheuser Busch) just because its P/E is three times lower?? Does one really think that a dollar of earnings from a cyclical financial company on the top of the cycle is worth as much as a dollar of earnings from a consumer company whose name is synonymous with one the core staples of an American (or even international) ways of life?

Again, let's get real here- I think the "experts" out there are making a dangerous disservice to average investors by stating, for example, that just because current P/Es of the S&P 500 are lower than historical average- means that stocks are dirt cheap. My advice to investors is very simple- ignore the noise and think for yourself. For example here is a quote from today's article in WSJ:

"Some argue stocks are attractively priced after a 17% decline in the Standard & Poor's 500-stock index since October. Based on earnings forecasts for 2008 collected by Reuters Estimates, the S&P 500 is trading at 13.2 times projected earnings, compared with an average of 16.5 times going back to 1989, according to data compiled by Morgan Stanley."

Just like the WSJ's author concludes, I don't think it is quite that simple. Let's not forget, for example, that the Price to Earnings multiple consists of two parts- price and earnings. Does one really believe that for example Citigroup or Goldman Sachs are going to earn as much in 2008 as they did in 2007, even though every reasonable person out there knows that the first two quarters of last year likely represented a multi year pick of LBO driven M&A (hence banker fees) frenzy? And that the only people believing and projecting another hockey stick earnings growth in the third and fourth quarter of 2008 are the investment banking analysts themselves. I think that as the continued spiral of newly announced write offs and fresh hedge fund collapse stories confirm- the cycle of ever expanding earnings driven by super leverage and cheap money is over.

Just as Exxon Mobile's profits are unlikely to keep growing forever, AAPL's iPhones and iPods are unlikely to be immune to the consumer slowdown and thus are unlikely to keep growing in double digits forever...

I hope you get the point here... Standalone basic fundamental ratios alone are unlikely to help you to outperform the market consistently in the long run. It is important for everyone to understand that it is not the historical earnings and sales, but rather it's the future earnings (cash flow) potential and underlying fair market (not historical book) value of companies assets, that determine how much a stock or a company are worth.

Correctly estimating whether a company has a potential to generate steady cash flows, grow its earnings and be truly shareholder (not management) friendly is not easy, but not impossible. You have to approach this valuation process with an open mind, base it on facts not popular opinions, and try to ignore quick judgments based on flawed theories like buying a stock just because it has a low P/S ratio...

I hope I did not offend anyone out there; all of the above is simply my Skeptical Capitalistic opinion...

skepticalcapitalist@gmail.com