Whenever there is a selloff like we have seen this week people get worried. Seniors wonder if it is time to close their brokerage accounts and just live on CDs. Young people hesitate to put hard-earned money into stocks. Could it be 2000/2001 all over again? Could this be the equivalent of the lead up to the Big One, the 1929 free-market meltdown?
It is a good thing to think about investments before they are made. When you own an investment and it seems that others are willing to pay more for it than it is worth to you, it is good to sell.
But I see little risk in stock prices in general at this point. Few people (not even my wife) listened to me in 1997 when I said there something screwy about prices of Intenet stocks. Or in 2004 when I said housing prices cannot appreciate rapidly forever. So I am, so to speak, thinking aloud here, just clarifying my thoughts. I am much more heavily invested in California real estate than in stocks, but that was just luck, not prophecy or even planning. I bought when the market was low because I needed a home at a time that the market in my local area had hit bottom.
Today I bought Celgene (CELG) for the first time: it is a great company and the stock dropped a little bit down out of the stratesphere. With biotech companies there is always a great deal of risk involved, but I am happy to manage the kind of risk Celgene brings. (See my: 1. Celgene blog 2. Celgene analyst conference summaries page.)
Which DOW stock dropped the most, percentage-wise, today? Alcoa Aluminum, AA. It dropped
2.31% today. Is it an overpriced, substanceless high-flier? No, it has a price to earnings ratio (P/E) of 15.33. Which means trailing annual earnings are 6.5% of the stock price. Are there risks? Sure, the usual: a world-wide recession could hurt earnings, or energy costs rising faster than aluminum costs, for example. But there is an upside too. NASDAQ lists the forward P/E today as 12.25. That means the most likely, purely linear, scenario is that if you hold the stock for a year earnings will be 8.1 % of today's stock price. That is better than real estate is expected to do this year, and way better than owning a CD. Certainly safer than buying Celgene, but a bit boring.
Are there overpriced stocks? Of course, there are always overpriced and underpriced stocks, by whatever critia an individual my set. As I said Monday, I thought Dell was overpriced (See my Dell Stock Price Evaluation [June 4, 2007]). But not like Internet stocks in 2000.
I think reasonably well-informed investors can do better picking individual stocks than they would in index funds if they do their research and keep their heads. But I would have no problem recomending an index fund right now. Stocks on the whole are reasonably priced and likely to appreciate faster than U.S. real estate as a whole. Is there risk? Of course. It is good to assume that there is more risk than you think, as stock investors found out in 2001 and housing investors found out in 2006. But it is even more important to make sure that there is real value to what you buy, not just hype or an auction-fever driven pricing environment.