Profitable investing doesn't have to take up all your time. In fact, the most important decisions- buy, sell or hold, generally come down to just one key factor. Valuation.
Pay too high a price for even the best stock and you may not make a good return. Buy a so-so company at a great price and you're destined to win if you have a reasonable time horizon. Fairly valued stocks are basically toss-ups that could go either way based on how things play out after you enter the trade.
How can you know whether shares are cheap, normally priced or expensive? The simplest way is to compare their current P/E multiples to their own historical levels. Buy when you get a decent discount. Sell when the price tag is above MSRP (manufacturers' suggested retail prices) and you'll do well most of the time.
Don't be afraid to trade in and out on valuation swings which take place over months or years rather than minutes, hours, days and weeks. It takes time for markets to adjust their thinking on specific stocks as they go into and out of favor.
Here are a three examples to illustrate. I've written about each previously here on Real Money Pro. Jacobs Engineering Group (JEC) hasn't been impressive for long-term holders. Since 2010, however, it offered up five very nice entry points (green-starred below).
JEC averaged a 16.2x P/E over the past eight years. Every one of those buying opportunities launched from well below typical P/Es.
There were four "should have sold" moments on JEC (red-stared). Every one represented a significant premium to JEC's average P/E.
Letting go at those overpriced areas avoided drops of from $50.70 to $34.40 (-32%), from $55.70 to $30.70 (-45%), $66.90 to $34.80 (-48%) and from $63.40 to $49.30 (-26%).
As of Dec. 20, 2017, JEC appeared a bit pricier than normal although it was not yet up to the 20x - 22x multiples which usually saw the shares top out. Owners of JEC might wish to write covered calls which commit to selling at slightly higher prices while bringing in some extra cash and removing some risk right away.
Temporary help agency Kelly Services Cl. A (KELYA) showed similar patterns over those same years. Its EPS varied more widely than Jacob's but the general principle of buying cheap and selling dear still held true.
Kelly's average multiple (excluding an inflated number in 2014 due to reduced earnings) was 13.6x. The best buying opportunities mainly occurred when P/Es were down to the single digits. The two absolutely should have exited periods, in early 2011 and near the end of 2013, were both at premium multiples. Like JEC, KELYA is no longer in bargain territory.
I've already locked in my gains and sold.
The third teaching example is Interface TILE a manufacturer of industrial use carpet tiling. TILE normally sells for about 22.6x current year's EPS.
All four of its best entry points (green starred) came at lower than typical valuation points. Each of its three "should have sold" moments (red-starred) reflected above average P/Es. As of Nov. 24, 2017 TILE was trading for a very average P/E of 22.3x. It should be no surprise then that it fetched a bit less, about $24.40, on Dec. 21, 2017 despite the raging bull market environment.
Fairly priced stocks can go either direction. That makes them the hardest to predict. My TILE shares won't be long-term holds for another month. I've sold April and July covered calls at $25 strikes to bring in some premium while waiting for the preferred tax treatment.
None of these three stocks has been a great long-term hold. All of them presented fine trading opportunities for value-conscious investors. These swing-trading plays typically take from a few months to a year or two to mature.
The results, but not the timing, are easy to predict and well worth waiting for.
The next time you see an analyst touting a stock check to see if it's selling for more, or less, than its own average multiple. Unfortunately, most will be trading near their highs and at premium P/Es based on their histories.
If you like the ideas put the ticker on your watch list and wait for the next time it gets cheap to actually buy it. Your accountant and your spouse will both be impressed when your investment results start improving.
This commentary originally appeared on Real Money Pro on Dec. 26. Click here to learn about this dynamic market information service for active traders and get more great columns like this from Paul Price, Doug Kass and others.