In our last episode on Investing, we’re going to be talking about indicators. In other words, I’m going to tell you a few things you can use to gauge whether a company — or a market — is healthy.
I’ll start with companies, since things are pretty straight forward: all the health information, typically, is within their financials. The things you’re going to be looking out for is as follows:
- Solid EPS growth. Shows that the company’s income is growing. We use this number rather than net income, as EPS better represents the amount of money going towards your shares.
- A P/E between 1 and 25. A P/E outside of these numbers isn’t terrible, but by the value investing standards we mentioned at the beginning of this series, we typically want something in this range. All it essentially means is that the price is close enough to the actual current performance of the company (the actual ratio is stock price over EPS)
- Consistent dividends. Typically when consistent dividends start for a company, they don’t go down — in concern that it will cause the stock price to tank with it. This is more something to look for if you like the free cash that dividends provide.
- Low P/BV. Similar idea to P/E, where BV is the book value of the company.
- Low trade volume. Remember in episode one where I mentioned that risk is tied to how many people trade on a company? I mentioned that companies with a low amount of trades are typically more risky — however, if they have everything I’ve mentioned above, then they lean a lot more closely to high returns than to going bankrupt.
- Employee quality. This is a very hard indicator to measure, but I like including it because employee happiness and experience ties very well to a company’s performance. So if you are able to get the inside scoop on this, it will serve you very well!
To round off our series, we’ll move into the macro world — that is, the economy as a whole. There are a lot of economic indicators — I mean, a lot — but I’ll try to just go over the ones that are the easiest to understand and also the most meaningful.
As a general rule, if investors act as though things are all good and nothing can go wrong, act in extreme caution. On the other hand, if investors say that things are all bad and the markets are ruined, start buying. This just follows the rules of buying low and selling high, and everything else I’ll talk about follows this rule quantitatively.
The first important economic indicator to know is the yield curve. This one is a bit complicated, but it’s mentioned so often that I feel the need to mention it in this episode. Essentially you can make a map of the yields on US debt, with the X axis being the number of years (10, 15, 30…) and the Y axis being the interest rate. Typically what you’ll see is that when the number of years goes up, the interest rate goes up — this makes sense, as the farther you go into the future, the more bad things that can happen (AKA risk) and therefore the more you’ll ask for interest. However, when things are bad, the yield curve inverts — that means that the more recent years give the most interest payments. This, of course, flips the equation on its head; now the current times are seen as the most risky, and the future by comparison seems a safe haven.
Another related indicator is looking at consumer and corporate debt, as opposed to sovereign debt. For consumer and corporate debt, we’ll typically see it grow relatively rapidly in good times, whereas it will decline sharply during bad times.
Finally, we have indicators of overtrading. Overtrading serves as markers of “novice traders” entering the market. Typically when there are times of overtrading, we see things such as increased speculation, overestimation of returns, and excessive trader leverage. Typically when overtrading happens, it means we’ve hit the peak of the current cycle.
So, that finally finishes off our most length series to date! After next week’s inspiration intermission, we’ll be taking a look at some fitness tips. See you soon!