Retirement Income Strategy: How to Invest in Stocks for a Secure Retirement

Casey Weade: You're thinking about buying some stock, but you want to know, is it a good price? What's the value of the stock? Maybe you're wondering about investing in the stock market. Is now the right time? That's what we're going to talk about and more in today's video.

Hey, I'm Casey Weade, CEO and Founder here at Howard Bailey Financial, also a certified financial planner practitioner. Today we're here to talk about stock prices. Can we get a good buy in the stock market? How do you know if you're getting a good price? Do you know if now is the right time to invest in the stock market? A famous saying was once said by Warren Buffett, and that is, "Price is what you pay. Value is what you get." You see the price of a stock, but is it a good buy? That's what we're going to be focusing on.

We're going to talk about a couple of different stocks. We're going to be talking about AEP. We're going to be talking about NVIDIA stock. We're also going to better understand a key ratio that provides you a number that you can use to better understand the value of a stock. We're going to look at some different ratios, and other ways that we can look at an individual stock to better understand whether you're getting a good buy. Then we're also going to be looking at the stock market as a whole, and some of the analysis that we do here at Howard Bailey Financial. Now let's start by looking at a couple of different individual stocks that I'm sure you've heard of before.

If you're over on Google Finance, which I bet you've done, you've probably typed in a stock ticker. When you type in that stock ticker on Google Finance, something pops up with some line graphs and a number of different things at the bottom here. One of which we're going to be focusing in on is the P/E ratio, that price-to-earnings ratio.

Now, we're looking at AEP stock here, American Electric Power, and they have a P/E ratio of 16.38. Is that good? Is it low? Is it high? Let's look at a different one. A very popular name today is NVIDIA, and NVIDIA's P/E ratio is a 78.64. Which one is cheaper? Which one is more expensive? If we just stopped there, that 78 would say that is a much more expensive stock on NVIDIA than what we see on that AEP stock at 18. It is more expensive. The price is much higher relative to the earnings of the company over the last 12 months. We can't stop there, because there's more for us to understand in order to really uncover which one is actually going to be more valuable for your portfolio in the long run.

Now, in order to understand this ratio and how you can apply it to your portfolio, I want to walk you through a fun and general example, and that is none other than ice cream, of course. I love ice cream. I'm sure you love ice cream. My kids love ice cream. Who doesn't love ice cream? Let's say that we wanted to go out and invest in our dream company and own an ice cream shop of our own. If we wanted to go out and shop around for an ice cream company, we want to know if we're getting a good deal. We always look at two numbers. What is the price and how much is it earning? That is the P/E ratio, the price of the company we want to buy and the earnings of this ice cream shop in this particular example.

In this example, let's say that we found an ice cream parlor to buy that had a price of $800,000 and earnings over the last 12 months were $100,000. Is that a good deal? Would you pay 8 multiple? That is an 8 P/E ratio or an 8 multiple in this particular example. That is something we might consider relatively cheap. It's going to take us eight years to make back that principal. We're back in the green considering there is no earnings growth.

Now if we look at an ice cream parlor that's $2.5 million in price and has $100,000 in earnings over the last 12 months, that's a P/E ratio of 25. We might consider that to be more expensive, but we want to know some more about the company. What are the fundamentals? What are the earnings growth? We want to take a look at a number of different ratios, because what if these earnings, for instance, are growing at 25% a year, but these earnings are flat? We might find that this is a better buy over the long haul. We want to take a deeper dive into these numbers. What you're going to find today is the S&P 500 is running about a 25 on a trailing 12-month P/E ratio today as we're recording this video. That's going to be interesting for us as we dive deeper into the stock market value as a whole today.

Now let's look at how it's calculated. If you're looking at a stock on the New York Stock Exchange or over on Google Finance, you see a number of different things. How is that P/E ratio being calculated? Let's take, for instance, a stock that has 1 million shares outstanding, $30 is their price per share. Their price per share is $30, they have 1 million in shares outstanding, and they have $2 million in net income over the trailing 12 months. That gives us a price of 1 million shares outstanding times our $30 price per share. That's $30 million. If we want to buy the whole company today, we have to pay $30 million, and it has earnings of 2 million. That shows us that we have a 15 times multiple. That is how that number is derived.

We wouldn't want to stop there. One, we looked at P/E ratios, but there's a number of different ratios, and considerations, and facts and figures for us to look at. If we're analyzing your portfolio, we always provide you with a snapshot of that overall portfolio. We're going to be looking at standard deviations, we're going to be looking at Sharpe ratios, alphas, betas, R-squared, and a number of different things, including additional valuation multiples. That is not just the price per earnings number, the price book value, the price over shares, price over cash flow. We want to look at all of these different things to really determine if you have a strong portfolio as a whole, and if we have a strong individual position within that portfolio.

A couple of other things for us to consider, in addition to all of these other numbers, are trends and comparisons to other companies. If we look at some of these trends we might be paying attention to, we might want to look at forward P/E ratio, for instance. If we're looking at trailing 12 months, many would say, well, that's not really helpful because the past doesn't predict the future. What are they going to earn over the next 12 months? We might be looking at forward earnings that are substantially higher than what we've seen in the trailing earnings. There may be some trends that we're finding historically.

If historically the price has been going down while earnings have been increasing, that shows us that the investors are not quite valuing those earnings like they used to. On the other hand, if price is going up in that stock and earnings are going down, that shows us that investors are highly valuing those earnings today and continue to value them at a greater pace. Why is that? Maybe they expect long-term growth of those earnings to be better or there's something within the fundamentals of the company.

We may also find situations where the price is increasing but earnings are staying the same. There's also something else that's going on there, and we want to dig in deeper. That might be the growth rate of those earnings historically and moving forward, or maybe something with the fundamentals. Let's take, for instance, the ice cream parlor, and let's say that came in at a 15 times multiple today but we said, well, historically, it was a 20 multiple. Is that a good deal? We might say we have a temporary depression in prices. We have a temporary opportunity to buy at a great price.

If we look across all of the different ice cream companies, maybe we find it's still a relatively high P/E ratio, or maybe we're seeing some bad press, for instance. Maybe they've uncovered that ice cream is bad for our health. Maybe they've uncovered that ice cream causes cancer. That might be really bad for the industry over the long haul, and earnings are going to continue to tumble. We want to look at the fundamentals. We want to look across the industry. We want to look at the historicals and trends.

Maybe now you're saying, Casey, get to the stock market. Is the stock market a good buy today? Let's take a look at a ratio that is known as P/E 10. That is an earnings history over the last 10 years. This is a ratio that won Robert Shiller a Nobel Prize because it's been one of the best predictors of future performance in the stock market. If you Google P/E 10, you're going to find probably this chart as your top result. This is the Shiller P/E 10. What we find is that P/E 10 today is running at about 35, 35.68 as we record this video. We can also see that it's historically quite high.

If we go back throughout history and we average the beginning of every bull market, the beginning of every bear market, we would find that on average, the beginning of every bull market, we're going to have a P/E ratio somewhere around 8 or 10. At the beginning of every bear market, we're going to find P/E ratios that hover around 25, 30 on a P/E 10 basis. If we go back, for instance, to the roaring '20s, we had a P/E 10 of about 5. The market took off until we saw valuations get too high, Great Depression kicks in, and we find ourselves again with a good buying opportunity when we're entering a new bull market.

If we fast forward, we can look at the tech bubble. During that tech bubble period, we saw record high P/E 10s, and that was followed by what? The 2000 to 2003 tech bubble bursting. Then we entered another period after the financial crisis of another major bull market. Now, does that tell us that today markets are valued very high, they're very expensive, we shouldn't be buying in today?

We have to exercise some caution with that because you could have looked at the market back around 2018, and said, we need to get out of the market, the market's overvalued, just look at the P/E 10, and you would have missed out on the last several years of really strong returns in the stock market. This is why I hope, today, what we've uncovered for you is a different way to look at your portfolio to value stocks, and some recognition that we want to dive a little bit deeper to make sure that we're buying in at the right time and we're holding the right assets in that portfolio.

If you'd like us to provide you an analysis, a free portfolio analysis of your portfolio, all you have to do is call the number on your screen to visit virtually or in person with one of our fiduciary financial planners and provide you that free analysis to better understand your retirement assets.

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