The Single Most Important Question That Smart Investors Must Answer

Michael Price (no relation to me) died last week. He was one of my earliest heroes when I was getting started in value investing. In a recent story about him in Barron's, Price's single most relevant investing advice was highlighted. It was a question and answer on figuring out what any particular stock is worth vs. its current price. His answer, according to the column, was to evaluate businesses on merits and facts, not emotion; to subtract bad news from the company's value; to do your homework on stocks using first-hand sources; to know your rights as a shareholder and use them; to know the power of good management; and to have a process. Without that very basic information deciding on buy, hold and sell decisions becomes mainly a crapshoot. I'm always amazed at how few media personalities ever even speak about valuations in their discussions of stocks that they like or pan. Read articles on most investment websites, and you'll find actual mentions of true value very hard to find. Seeing justification for those rare price targets along with time horizons to reach them is almost never given. Why ever buy any shares that don't deliver more value than their current quotes? For me, determining normal is the first step in any valuation exercise. I rarely impose my own view of what multiple a stock should sell for, or what its yield should be. I simply use historical data on the same security to see where it typically traded over recent years. Here's an example of that process on W.W. Grainger , which was featured in this week's new Value Line. GWW is an especially good teaching stock, as it showed two separate multi-year periods of relatively stable earnings per share. EPS hovered between $11.46 and $12.26 during the five years stretching from 2013 through 2017. EPS ranged from $16.18 to $17.29 in the three years which followed (2018 - 2020). Despite those limited ranges for EPS, GWW was offered as low as $155 during 2017 after peaking as high as $276.40 in late 2013. That $121.40 per share price difference was all important in determining success or failure for investors. At the 2017 low point, GWW was offered for just 13.5-times earnings. At its 2013 peak GWW's multiple was 24-times. GWW's five best buying opportunities (green-starred below) all occurred with the stock trading for less than its typical price-to-earnings. Three of those moments also saw owners getting well above average current yields. In the 2018 - 2020 time frame the March 2020 Covid-panic low gave traders the chance to own GWEW for just 12.4-times forward earnings. At 2018's peak, it fetched 22.3-times that year's final EPS. Grainger's end of 2020 quote of $427.90 reflected a too high 26.4-times trailing P/E. For the entire period 2013 through 2020 GWW's average price-to-earnings was 19.4-times, accompanied by about 1.87% in current yield. Based on those metrics, and depending on whose 2022 estimate you believe is most accurate, GWW figures to be worth about $456 by year-end. Reverse engineering the present day dividend to 1.87% only supports about a $346.50 Dec. 31. 2022 goal. GWW on Monday was selling for over $503 per share. Anyone who worked the numbers like I did should have been wondering why people were stepping in to buy now. Value Line's three-to-five year projected total returns (shown next) were based on a $483.40 starting price as they went to press. That suggested meager returns even if profits grew nicely and the dividend expanded, too. Yahoo Finance's view of GWW appears too generous by historical standards. Yahoo did call the shares fairly valued, but gave a 12-month target of $537.33 based on a 21.9 multiple of forward earnings. It was also willing to overlook GWW's relatively puny, by historical standards, yield. Research outfit Morningstar came down a bit on the pessimistic side. It labeled GWW a 2-star, out of 5, sell. I can't argue with that, but Morningstar's $379 present-day fair value estimate was just 16.1-times this year's expected EPS. Quantitatively-based FastGraphs registered middle-ground expectations for GWW. It looked for $427.90 if GWW somehow commanded 22.7-times its 2022 EPS estimate or $282.72 if it fell to a well below average 15-times multiple. Either number, though, was far below GWW's Monday quote. No matter how you slice and dice GWW's numbers, it appears risk far outweighs potential upside for the foreseeable future. What are the key takeaways from this whole discussion? Earnings estimates can vary widely, depending on your source P/E estimates cover a wide range of possibilities, too Investor psychology can push shares prices around quite dramatically, even if EPS remain pretty flat Historically average multiples and yields are your best guide to future share prices Fight the urge to pay up for temporary good news Fight the urge to sell cheaply based on temporary bad news Having a clear idea of what a stock is worth is very valuable information If you'd don't have a good idea of what a stock is truly worth ... why bother playing it at all?

The Single Most Important Question That Smart Investors Must Answer

Value investor Michael Price recently died, but his investing advice about how to determine a stock's worth will live on forever. Here's my take on his guidance, using the stock of W.W. Grainger as an example.

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