Shortsightedness is never a virtue in investing. Time and time again over the years too many investors jump into bull markets too late, stay too long, and lose their shirts. Along with the assessment of intrinsic stock value, what are the investing metrics you should pay attention to when investing in stocks today? Here are a few thoughts on the subject. Our treatment of this is in no way complete but rather intended to point investors in the right direction during a time of market uncertainty.
What Are Investing Metrics and Why Should You Care?
As noted by Investopedia, investing metrics are quantitative measures used to assess current performance and predict future performance. The key to using metrics is choosing the right ones to watch and then learning how to read them. For example, the P/E ratio is generally considered one of the best ways for value investors to assess the value of one stock compared to others. Unfortunately, stock prices can be manipulated on a short term basis with stock buybacks. And, financial statements can be manipulated to make earnings appear greater than they really are. This does not mean that you should throw out the P/E ratio as a useful metric. Rather, it means that you should use more than one metric to assess your investments.
Investing Metrics You Should Pay Attention To
We write again and again on this site about using intrinsic value as a guide. This approach seeks to determine the forward-looking income stream of a company. Smart long term investors only invest in companies that have products and services they understand and a clear way that their business plan will make money for years to come. Success depends on the company, its products and services, and management. And, it depends on the economy. No matter how great a widget a company makes, it won’t make any profits if no one has the money to buy those widgets.
The Global Macro Monitor blog has some interesting comments in this regard in their post, How Far Can the Stock Market Run?
Our predisposition to the market is always anchored in time tested valuation metrics, which are hard to manipulate. That is why we like market capitalization deflated by some macro variables, such as nominal GDP or wages.
Micro measures, such as Price-to-Earnings are way too distorted by buybacks and can be easily manipulated by CFOs, who play around with variables such as depreciation or loss reserves.
Our two favorite are 1) market cap-to-GDP, which, according to Warren Buffet is, “the best single measure of where valuations stand at any given moment.” Take a look at the following chart and you will understand why the Oracle of Omaha is sitting on a record $122 billion stockpile of cash, 2) the number of hours of work needed to buy the S&P500, not a perfect valuation measure but does track our other favorite quite well. The average person, making the average salary is not a big holder of stocks but the metric does give a heads up when the stock market becomes divorced from the underlying economic trend.
This is the first chart he refers to.
The commonly used micro investing metrics are these.
- Price to Earnings Ratio
- Price to Book Ratio
- Debt to Equity
- PEG Ratio
- Free Cash Flow
The commonly used macro investing metrics are these.
- Market Cap to GDP Ratio
- Average Number of Work Hours Needed to Buy the S&P 500
- Bonds yields (e.g. inverted yield curve)
Using Investment Metrics
Micro metrics are useful in evaluating individual stocks. Macro metrics are useful when deciding when it is time to pull your investments out of the stock market and hold cash. Depending on the status of your macro investing metrics, you will choose to stay with your current investments or consider how to invest without losing any money by sticking with investments that will not crash when the market does.