“Every step of life shows much caution is required.”

-Johann Wolfgang von Goethe

When I’m Going to Get Back Into Stocks 

The Dow has fallen.

A reader asks: Is it time to get back into stocks?

I’m not an investment advisor. I don’t feel comfortable telling others what to do with their money. I prefer to say what I’m doing and why, and then let my readers decide if it makes sense for them.

So: Am I getting back into stocks? Not now. I’ll tell you why.

We just went through one of the longest and largest bull markets in my lifetime. From March 9, 2009 to March 11, 2020, the Dow and S&P 500 rose 351% and 400%, respectively. That was a fun ride – and I’m glad I was on it. But it became clearer and clearer as time passed that the bull I was riding was getting old.

The day the World Health Organization declared the coronavirus a pandemic, the market tumbled 6%. It has fallen since then, and is currently down about 25% from its high. (Erasing more than $8 trillion of the US market capitalization.)

When deciding to buy a stock, there are two simple ways I judge its value. The first, which I’ve been doing forever, is the price-to-earnings ratio (P/E). That is determined by dividing the stock price by the earnings per share. (If the price of stock X is $50, and the earnings per share is 5, the P/E is 10.)

There are other ways to measure share value. A popular one is the price-to-sales ratio. It is determined by dividing a company’s market cap (the total value of outstanding shares) by its revenue. This is a good quick way to compare prices of companies within a given industry, but it doesn’t make sense to value stocks across the board. Another metric is the price-to-book ratio. A business’s book value is determined by subtracting its liabilities from its assets.  You take that book value and divide it by the number of outstanding shares, which gives you the book value per share. Then you divide the share price by the book value per share. I don’t use this method because it’s just too much work for my purposes.

What I like about the P/E is that it corresponds to the way I value private businesses. I wouldn’t be interested in buying a company based on sales. And I certainly wouldn’t value it that way. I’m interested in profits. Earnings are profits. The other thing I like about the P/E is that, because it values the shares on profits, it can be used to fairly value large, established businesses in most industries – from manufacturing to agriculture to communications to energy, and so on. In other words, it’s useful for valuing the sort of stocks I want to own: large-cap, dividend-giving, industry-dominating companies that have a long history of profitability and are likely to be here far into the future.

If I traded stocks or invested in growth stocks, I’m sure I’d be interested in getting more sophisticated with my value calculations. But my strategy for stocks is based on my confidence that I do not and will not ever have the interest in or patience for beating long-term market averages. I’m happy to get 8% to 12% on my money over the long haul.

Today, the average P/E for the Dow is 16.4. That’s down two points from a year ago, and it’s getting very close to the historical average of 16. P/E ratios are not reliable predictors of short-term market moves, but over 10 years or more, they work pretty well. Thus, buying stocks with P/E ratios of 15 or less would make sense. And many value investors use that as a buy-in signal.

As an investor in private businesses, I have never paid anywhere near 15 times earnings. For newer, growing businesses, I’ve paid up to 10 times earnings. But for larger, established businesses in my industry, the range is usually a 4 to 6 times multiple of the average earnings over the prior three years.

In other words, for a business that made profits of $80,000, $100,000, and $120,000 over the prior three years (an average of $100,000 per year), I’d be willing to pay up to $600,000.

You can’t do that with larger, stable public companies. Priced at the historic P/E of 16, I’d have to pay $1.5 million for the same company.

The reason for this is supply and demand. In the public sector, there are billions of dollars of buying demand every day. The larger, institutional buyers are happy to pay 16 times earnings for the sort of stocks I prefer to buy. And they usually will. So for me, I’m motivated to buy these stocks in the 12 to 14 P/E range.

Recently, I’ve added a second tool to my valuation kit. I’m not exactly sure how I will use it, but I’m looking at it because I think it makes sense.

It’s called the Dow-to-Gold ratio. I learned about it from Bill Bonner, the founder of Agora, and Tom Dyson, who helped me assemble the core holdings of the stock portfolio I have now.

Here’s how Tom described this tool:

It’s NOT a speculation in gold. It’s a long-term buy-and-hold stock market investment strategy… with a simple market-timing element that helps us buy low and sell high.

Most of the time, we hold the stock of the world’s best dividend-raising companies. We call these “dividend aristocrats” – companies like McDonald’s, Coca-Cola, Hershey’s, P&G, J&J ,and Phillip Morris. [Note: This is basically the same core group that I have in Legacy stocks. No surprise there, since Tom helped design the Legacy Portfolio.]

Some of the time – when these stocks get too overbought and expensive – we go to the sidelines in gold.

We never cash out. And we never hold anything except gold and dividend aristocrats. We just wait for the Dow-to-Gold ratio to reach extremes… and then we rotate between stocks and gold accordingly.

As such, the Dow-to-Gold ratio is the only number that matters to us.

For Bill and Tom, the Dow-to-Gold buy-in ratio is 5. When they can buy all the Dow stocks for five times the value of an ounce of gold, they will be all in.

Right now, the ratio is well above 5. But it’s moving down with stock prices down and gold moving up. It’s likely that gold will move up considerably more if the economy doesn’t drastically improve by mid-summer. If that’s the case, we will see the Dow-to-Gold ratio moving towards 5.

But I’m not going to wait that long. As I said, this is a new metric for me. It makes the most sense in the long view. As individual stocks that I favor move towards a P/E of 12 and the Dow-to-Gold ratio continues to drop, I’ll start buying.

But on an individual basis.

In the meantime, I’ll keep my money in cash and wait to see what happens.

PS: I may put a very small portion of that cash to speculate. If I do, I’ll let you know.

“A scam is a scam. A fraud is a fraud.” – Emily Thornberry

Protect Yourself From Corona Scams (and All Scams, for That Matter) 

Those damn scammers.

On Wednesday, I listed some of the cyber scams out there aimed at people working from home. And the scammers don’t stop there. I’ve been getting government notices and reading newspaper articles about the measures we should be taking to protect ourselves from the many coronavirus-related scams that are burgeoning today.

Some give sensible advice – like this, from Medicare:

* Only share your Medicare Number with your primary and specialty care doctors, participating Medicare pharmacist, hospital, health insurer, or other trusted healthcare provider.

* Check your Medicare claims summary forms for errors.

Problem is, this applies only to Medicare scams. To defend yourself against every possible scam coming your way during the Corona Crisis, you’d need a list of do’s and don’ts a mile long. And even if you had such a list, you wouldn’t use it because the advice would be too specific – too difficult to remember.

Getting scammed sucks. I’ve probably been scammed dozens of times. I can’t say for sure, because I don’t like to carry grudges.

But there is one that I can’t forget…

His name was SS. He was recommended to me by a trusted colleague as a credit repair expert. We were creating a course on that subject, so we hired him to help us develop it. He worked for us remotely for a few months. Although I had only a few conversations with him, he seemed knowledgeable, agreeable, and friendly.

He told me that he had attended a three-day seminar I gave on entrepreneurship. He said he left early for some reason. Now I know why: He wasn’t interested in what I was teaching.

Some months into our relationship, he came to town to work with our editors. He stopped to visit me at my house one weekend morning. Within five minutes, I knew he was going to hit me up for something. I went inside to get us some coffee and told K, “This guy is going to ask me for money.”

“Don’t even think of giving it to him,” she warned.

“Don’t worry,” I said. “I know what he’s up to.”

A half-hour later, I agreed to lend him a hundred grand.

A week later, I wrote him a check. It was done as a formal loan through our legal office.

Almost immediately after we closed the deal, I felt queasy about it. I researched him on the internet. There were, as I would have expected, criticisms of his books and programs – but nothing about him and his business practices that concerned me.

I told myself not to worry, that I had a legally binding contract and collateral. But as the days passed, I couldn’t shake that uneasy feeling. Finally, I asked one of our research geniuses to do a deep search. Sure enough, he was a scammer. A charming, clever scammer.

He made his living by borrowing money from people he met through his business and welching on the loans. He would string out his creditors long enough to put a couple million in his pocket, and then he would declare bankruptcy. He had gone bankrupt something like seven times.

I remember this particular scam because (a) it was a lot of money, (b) I knew better, and worst of all (c) I had to admit my stupidity to K.

It was an immensely embarrassing mistake. And that’s why I’m still mad at myself. Ten years before it happened, when I started writing about wealth building, I had already thought and written about scams. I had ideas. I even had rules. Had I followed my own rules, I would not have made that “loan.”

Here are the rules – a simple five-part protocol for defending yourself against most scams – coronavirus scams, business scams, investment scams, telemarketing scams, whatever:

1. Never invest in (or make a loan to) any business you don’t thoroughly understand. And by understand, I mean being able to look at a P&L and balance sheets to detect any irregularities.
2. Never give money to someone or some business that you don’t have an existing, longstanding relationship with.
3. Never invest in (or make a loan to) any opportunity that is “urgent” or has any sort of deadline.
4. If you have any doubt whatsoever about the deal, say no.
5. If you decide to violate any of these four rules, don’t write a check for more than you would care to lose. Because there is a chance – maybe even a good chance – that you will lose it.