Investors Today Just Want a Good Growth Story
Editor's note: Don't let greed ruin your hard-earned gains...
Many investors base their investment decisions on how well a stock is performing. But Retirement Millionaire editor Dr. David "Doc" Eifrig says riding a hot stock higher can get you burned more often than it can help you profit.
According to Doc, knowing when to exit a position can mean the difference between a major loss and a massive gain for your portfolio...
In today's Masters Series, originally from the July 2 issue of the free Health & Wealth Bulletin e-letter, Doc reveals the dangers of investing in stocks with major hype...
Investors Today Just Want a Good Growth Story
Call me old-fashioned, but I believe valuations still matter.
Many folks see the market hit all-time highs and want to get a little more skin in the game. It's normal to try and ride the hottest stocks higher, betting on more quick gains.
This strategy might work as a short-term trade. But the fundamental investor in me has to remind everyone that prices matter. Paying a sky-high valuation for a flashy stock will burn you in the end more often than not.
You can end up with big losses that way... even if all the hype comes true.
As an example, think of Cisco Systems (CSCO) back in the early 2000s.
Cisco reaped the benefits of the dot-com boom, even though it wasn't a literal "dot-com company." It made the routers and switches that powered the Internet.
Cisco was dominant. As of 1996, it controlled 78% of the router market. And it enjoyed strong margins and returns on capital.
By early 2000, the dot-com bubble had expanded, and telecom companies invested in a massive build-out of Internet and broadband networks. As investors got giddy about astronomical growth, Cisco's price-to-sales ratio soared to 63 times... a high valuation for any company.
Of course, the Internet bubble burst. And the wild spending on expanding the Internet ended. Cisco started losing money, and its valuation collapsed. Shares fell 86% by late 2001...
That said, all the rosy predictions about Cisco's business came true...
The company still dominates networking equipment – though not as thoroughly as it did at the time. Its operating income rebounded rapidly and has climbed for two and a half decades.
And in just the past 10 years, shares have returned 12.8% annually when you account for dividends.
This is a perfect example of what we call the "valuation life cycle"... A young, fast-growing company sports a high valuation multiple. That multiple decreases as the company matures and the excitement fades. But the rising earnings and the lower multiple can still combine to deliver positive returns for investors.
Cisco's operating income has grown to an average of more than $3 billion per quarter. And its valuation has fallen to less than 5 times sales.
If you had bought Cisco at its absurd valuations in early 2000, you'd have lost money over the past 25 years. But if you had bought into the business at almost any other time following the dot-com crash, you'd have done very well. Take a look...
You just can't win buying at 63 times sales. Over the past 12 months, though, Cisco has traded for a reasonable price. And it's returning a lot of cash to shareholders.
The message here today is to pay attention to prices...
We're seeing a lot of stocks trading for nosebleed valuations today. And it's going to be tough for many companies to grow enough in future years to deserve those valuations.
The much-hyped Palantir Technologies (PLTR), for example, is trading for around 103 times sales.
Be careful with stories like these. You can end up losing a lot of money when the hype inevitably dies down. Instead, take a long-term approach and fill your portfolio with high-quality companies you bought at decent valuations.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
Editor's note: Falling victim to buying into the hype isn't the only thing threatening your wealth. Doc says every single person is walking straight into the same three massive retirement challenges right now – without even realizing it.
That's why he recently hosted an online presentation to lay out clear-cut plans to solve each one. Click here to get the full details of his plan...