Stocks and Lottery Tickets

 

lottery ticket

I guess this week is a big one for lottery players… something about Powerball? Okay, so you can probably tell that I don’t play the lottery. In fact I never have other than buying raffle tickets at events. I have nothing against playing the lottery, I have several friends who will buy tickets, I just never got into it.

I have a friend who once said that buying stocks was the same as buying a lottery ticket. Even Efficient Market Hypothesis supports this belief. EMH states that the market is so efficient that you cannot beat the market unless you take on more risk. I have mentioned before in blog posts and videos that there is a difference between speculating and investing.

If you buy a stock purely on a whim, or because somebody told you it was a good idea, then that would be speculating and it is the equivalent of buying a lottery ticket. If you buy a stock because you have studied it and looked closely at it’s fundamentals and you believe the stock is undervalued by the market, then that would be investing.

One of the key things I look at is the company’s earning per share (EPS) and how much the experts are predicting it to grow. I use a 15% expected return (meaning that is the target return that I hope to get on the stock) and I use the company’s expected growth to calculate what the company’s EPS will be in the future. For example, if the analysts’ think a company will grow by 20% over the next 5 years, I will take 1.2 multiplied by its current EPS to the fifth power.

Ex. 20% expected growth, $3 current EPS

$3 x 1.2 x 1.2 x 1.2 x 1.2 x 1.2= $7.46

I next take the industry average PE for that company and multiply it by the projected 5 year EPS.

Ex. PE for industry is 15x

$7.46 x 15= $111.9

Now,  I need to bring this back to today’s price since this is a 5 year projection. This is where my 15% expected return comes into play. If I expect it to grow 15% annually, then mathematically that means it would double in 5 years.

So the $111.90 5 year projection would mean it should be $55.95 today ($111.90 divided by 2). 

So if the stock is significantly below $55, I know I may have found a bargain. How much below? I would like to see it be 50%-75% of that price.

Of course from here I am going to look at many more factors. I need to know this company and their story so I can know if I even think it’s possible they can grow EPS.

So as you can see, I am too busy running these numbers to stop and buy a lottery ticket, but to those of you who have, GOOD LUCK and if you win big remember to put some of that money towards your retirement 🙂

 

 

How Siberian Tigers and Diarrhea Made Me Money!

 

Man suffering from stomach pain

Siberian-Tiger-HD

 

I know this sounds crazy, but these two things made me money the past 2 years. A lot of money in fact. Okay, so maybe this is a bit of an exaggeration… but not really.

Let’s start with the Tigers. In 2013 Lumber Liquidators (LL) was fined for illegally sourcing lumber from a protected forest in eastern Russia that was home to the Siberian Tiger. Lumber Liquidator’s was fined $13 million dollars and received a lot of bad publicity over the deal.

In March of 2015, 60 Minutes ran a story on excessive formaldehyde in laminate flooring sold by Lumber Liquidators. LL had traded well over $100 at one point, but after the second story emerged, LL started dropping. As the company became embattled in legal fights and fines, investors fled.

The stock touched down somewhere around $10 per share at one point. I started buying it in January 2016 when it was around $15 per share. I sold PUT options on the stock each month and collected premium, occasionally being assigned the shares whenever the stock would dip in response to more bad headlines.

Why did I buy LL stock? Because although they had goofed up, I believed there was still a good company underneath. I believed that as time went on and LL paid their legal fines, folks would forget as they often do and move on to whatever the new hot topic was.

As Benjamin Graham once said “In the short term, the market is a voting machine. In the long-term it is a weighing machine”. Graham was stating that the market often reacts to news and events and the stock prices suffer. In the long-run, however, the fundamentals of the business drive the stock price.

LL eventually went up to $40 per share just last Fall and has since cooled down a bit. I sold my shares when they hit $27.50 so I left some money on the table,but I still made a significant profit on this company!

Okay, and now for diarrhea… I love Chipotle Mexican Grill (CMG)! I eat there a few times per month. Not only is it tasty, but they use fresh ingredients. I love the story of Chipotle and it’s founder Steve Ells. But Chipotle, just like Lumber Liquidators, has had their fair share of drama.

Over the last few years, Chipotle has been in the news for having several food-borne illness incidents with its customers. The news has driven the stock down. I started buying it last July (2017) and kept buying it up as recently as a few months ago. I own it at an average price of $288 per share. Today the stock is trading over $450 per share.

Just like in the case of LL, I believed there was still a good company underneath the broken stock price. Why did I think that? Well, one thing I noticed was that every time I went to a Chipotle the line was out the door. Obviously I did more analysis than just that, but my point is that there was still a good company there.

I could have been wrong about LL and CMG. I could have lost my entire investment. And by the way, this blog post is not recommending that you go buy stock in these companies! I am in no way your investment advisor!

The point I want you to take away from all of this is that there are some opportunities to make big gains off of beaten up companies that still have some life in them. The hard part is knowing if it’s something they can recover from or if it’s something that will ultimately lead the company to ruin. As investors you need to spend some time learning to read financial statements and company reports such as 10-K’s and 10-Q’s. These reports will be valuable tools in helping you to decide if a stock still has a good company underneath it.