It's Easy to Overlook This Basic Rule of Investing

I often show the following graphic to illustrate how much upside comes from buying stocks that have already been knocked way down in price. Media talking heads love to let people know that once a current holding has fallen 50% that it will need a 100% move higher just to break even. They rarely mention the converse, though. Putting on new positions of stock after 50% declines results in 100% gains if they merely revert back to where they used to be. Today's very painful market is providing hundreds of profitable, good quality companies at discounts even larger than that. Instead of trying to predict exactly when the bottom will be in let's re-examine what price-to-earnings ratios (P/E) really tell us. P/Es tell us how many years it would take to double your entire investment (after-tax) if you owned 100% of the shares at its current market cap. That is true even if EPS don't grow at all. Earning yield, also called owner earnings, simply uses the reciprocal of the P/E to turn the annualized return in a percentage. Low multiple stocks offer outstanding after-tax returns to patient owners of their shares. There are many ways for low P/E shares to provide great gains. P/E expansion can magnify stock prices in short periods of time. Earnings growth can easily exceed the modest expectations, which contributed to the bargain valuation in the first place. Companies priced low enough often attract leverage buyouts from management or outside investors as they have adequate cash flow and profits to support premium bids vs. their undervalued status. Catch-up moves higher can take place without buyouts simply via arbitraging away the disparity between and the market price. People are thrilled to be locking in bond yields of 2%-3% these days. They're happy they can now buy bank CDs at 1%-2% again. With true inflation between 8% - 14% they're simply guaranteeing losses of true purchasing power. Fear of even further declines in share prices have blinded them to picking up shares at single-digit multiples, which will provide outstanding total returns over time. Many fine stocks sport current yields way at much higher rates than bond and CD buyers are happily accepting while getting no possibility of capital gains. Note, too, that high earnings yields are after-tax while taxable bond and CD interest is paid pre-tax. Here are a few of my very recent buys to show you the type of stocks I'm finding irresistible lately. Each of those stocks are trading way below their historically normal P/Es. Cracker Barrel , the only one at a double-digit multiple has a 10-year median multiple and has often commanded greater than 20-times earnings. The majority of the stocks shown are down much further from their all-time highs than their trailing 52-week peaks. They are the polar opposites of the never made money darlings that traders paid absurd valuations for prior to this year's selloff. These dozen firms are highly profitable and very likely to make fortunes for those who buy in now, while valuations are dirt cheap. Print out this article and look back on it 12- to 18-months from now. I'm betting the whole group will be up from 50% to 100% or better. The Law of Asymmetric Returns is still in effect. Don't miss your chance to cash in on the coming stock price recovery. Everything in life goes to its proper value over time.

It's Easy to Overlook This Basic Rule of Investing

You can make big money via buying low. You just can't prove it until later.

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