The Real News About CP Rail

Q: Pat, here’s a very interesting question. You advise downplaying stocks in the broker/media limelight, but CP is your number one stock pick of the year and it is front and center in the media. What is your reaction to that?

Pat McKeough: Well I saw that comment come in and I was very happy to see it because I think it’s a very good function of our site that you can write in and ask questions like that, where I obviously didn’t explain our rule as well as I could have.

I tell people to avoid stocks that are in the broker/media limelight, because that can raise investor expectations. But when I say stocks in the limelight, I am talking about stocks that the brokers and the media are very hot on. This intense broker/media interest generates high expectations. I would say in CP’s case it’s the reverse; all they talk about is how poorly managed CP is and how it’s lagged behind and how this is indicative of how poorly Canadian managers run their companies.

Up to a point that is true with CP. But CP also has a lot of underused assets. Since CP started breaking itself up, I guess a decade and a half ago, we’ve had incredible profits just because we’ve bought things that were part of the old CP empire and somebody new got their hands on them and suddenly they were worth a lot more money. I guess the biggest one example would be Fording Coal, but we’ll have to leave that for another time.

Anyway, back to CP. It has drawn a lot of attention, it’s in the focus of attention, but it’s not in the "limelight," because remember the limelight is something that gets shined on stars. And the media do not see CP as a star, at least of all for its management.

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COMMENTS PLEASE

How do you feel about it when a company from the U.S. or some other foreign country takes control of or buys out a major Canadian company, such as Canadian Pacific? Do you feel foreign takeovers present an economic risk to Canada? Or do you feel that Canadian investors should have a right to sell their stocks to the highest bidder? Let us know what you think in the comments section below. Click here.

Dividends are in fashion with investors right now, and that’s always a good thing. Creative accounting can produce false impressions of prosperity and hide embarrassing financial problems. But accounting can’t create cash for this year’s dividend, let alone conjure up a history of past dividends. If you restrict your stock market picks to dividend payers, you’ll avoid most of the market’s greatest disasters.

It’s odd that while investors periodically crave cash dividends, they rarely get excited about stock buybacks. But in some ways, stock buybacks are better than dividends. In particular, they give you a tax-deferral option that you don’t get with cash dividends.

Stock buybacks raise the value of a given stock holding in two ways:

First, stock buybacks raise a company’s earnings per share. Buybacks reduce the number of shares outstanding. To get earnings per share, you divide total earnings by the number of shares outstanding. With fewer shares, the calculation naturally gives you a higher number for earnings per share. On the whole, buyers are willing to pay slightly more for a stock with slightly higher earnings per share.

Second, when the company buys back its own stock in the market, it bids up the price of the stock.

When you hold a stock in your personal, taxable account and it pays a cash dividend, you have to pay tax on the dividend in the year in which you receive it. If the company instead devotes the cash to a stock buyback, you have two options:

• If you need cash, you can sell part of your holding in the stock, presumably at a higher price than you’d get in the absence of a buyback. If you do that, you’ll only pay taxes on the sale if the stock has moved up since you bought. If the stock has moved sideways or down, the proceeds of your sale are tax-free.
• Of course, you’ll always have the option of holding on to your stock until it suits your purposes to sell.

This added opportunity for tax deferral may not seem like much of an advantage in any single year. However, the magic of compound interest applies to that tax deferral. It can add up to a huge advantage over a decade or two.

The advantage expands all the more if you hold off on selling until you need the money. That holding period may last until you retire, when your income tax rate is likely to be lower.

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Overestimating the value of dividend reinvestment plans

The funny thing is that, just as investors tend to underestimate the value of a buyback, they overestimate the value of a dividend reinvestment program (or DRIP). They put a high value on the fact that they can reinvest their dividends automatically, without paying brokerage commissions.

They fail to recognize that brokerage commissions are now at historic lows. They also overlook the fact that they have to pay taxes on the full dividend, even if they reinvest it. That tax hit and the loss of an opportunity for tax-deferred compounding greatly outweigh what they save on brokerage commissions.

Don’t get me wrong—cash dividends are a definite plus. But you still need to follow the three key guidelines in our Successful Investor approach to sound investing:

Invest mainly in well-established companies, since they are the companies most likely to keep making, if not increasing, those dividend payments each year.

Spread your portfolio out across the five main economic sectors: Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities.

You also need to limit your exposure to stocks that are in the broker/media limelight, which bloats investor expectations. When stocks fail to live up to those expectations, big downturns often follow, regardless of a company’s dividend history.

COMMENTS PLEASE

Are you more likely to buy a stock if it offers shareholder “rewards” like dividends, share buybacks or a dividend reinvestment plan? Which of the three has the greatest appeal for you? Let us know what you think in the comments section below. Click here.

When the market is as turbulent as it has been lately, investors can easily panic and make mistakes. Our investment advice is to avoid three common mistakes we have seen over the years:

1. Overanalyzing: During this week’s market turmoil, the media has been focusing on the uncertainty in Europe. The election of a socialist president in France and electoral confusion in Greece is fuelling further fears about the ongoing European debt crisis.
   
   Turmoil is inevitably accompanied by a flood of economic statistics and analyses of government economic policies and how they may affect markets. You may feel tempted to try to figure out what the economy will do next, and invest accordingly. But economic forecasting is hard enough. When you try to forecast market trends based on economic forecasts, you are virtually certain to fail. As Peter Lynch (the world’s top mutual-fund manager from the 1970s through the early 1990s) wrote, if you spend 12 minutes a year worrying about the economy, you’ve wasted 10 minutes.
   
   Investors should resist the urge to overanalyze and try to predict the future. If the situation continues to rapidly change, or if market turmoil increases, you could find yourself stuck with costly and unprofitable investments in your portfolio.

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2. Refusing to make changes: The second easy mistake to make during times of market upheaval is to throw up your hands and refuse to consider changes in your portfolio. Although you can’t predict the market or economy with any consistency, you can definitely choose which stocks are best suited to your portfolio, regardless of how the market is performing.
   
   You can also update your choices as new information becomes available. Even if we recommend all your stocks as buys in our investment newsletters, you still need to consider how appropriate your choices are for you as an individual and to your portfolio as a whole.
   
   On the other hand, if your portfolio consists of too many stocks we see as “holds” or, worse, stocks that are merely “okay to hold,” you run the risk of suffering steep losses, especially during periods of market turbulence.
3. Taking on heavy risk: Many investors do this in hopes of quickly reversing the losses they experience during market downturns. It’s a natural temptation in troubled times.
   
   You may have noticed a lot of ads for courses in online, short-term stock trading or foreign-exchange trading. The promoters are aiming their pitch at inexperienced investors who have suffered losses due to market volatility. These investors may be inclined to follow the example of desperate gamblers who bet their last few dollars on a handful of lottery tickets, or a long shot at the track or the casino. That’s a wasteful example to follow.

COMMENTS PLEASE:

Have you made any moves during a market sell-off that you later regretted? Has this helped you act differently in other market crises? Let us know what you think in the comments section below. Click here.

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific investment advice. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Technical analysis can help you, but it can’t tell you everything you need to know about a stock.”

Some investors rely on technical analysis (basically, chart reading) when they’re picking stocks. Relying on charts seems much simpler than delving into and weighing a company’s fundamentals.

There are successful investors who find that it helps to know a little about charts. But if you rely on charts at all, you should view them as just one of many things to consider when you make investment decisions.

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Small successes can precede big mistakes

The main problem with technical analysis is that it focuses too narrowly on a stock’s past price movements in an attempt to determine its future price. It doesn’t really tell you anything about other crucial parts of a company’s business, such as financial statements or management. Rather, it just zeroes in on how stock prices have behaved in the past, and the clues that may offer about future price movements.

In fact, an investor who relies solely only charts might buy and sell a stock while knowing little or nothing about the underlying company.

The appeal of reading charts is that this approach often seems to work, at least in small ways. But this may be an illusion. You may only remember your successful chart interpretations. More important, this kind of analysis tends to work in spurts. There’s a distinct risk that while it might lead you to make five or even 10 small wins, it could very well steer you wrong at the worst possible moment. That next mistaken trade may cost you much more than your winnings to date.

Our investment advice: Use technical analysis to support—not determine—your view of a company. A far better approach is to look at chart reading as one tool among many. But don’t look at the chart for a prediction of what’s going to happen. Look to see if the pattern on the chart seems to support your view of the stock, based on its finances and other fundamentals. But remember that the stock market follows a multitude of factors to varying extents, and the most important or influential factors continually change.

It’s encouraging if your analysis and the chart seem to match. But sometimes they don’t. If a company looks promising, but its chart shows a lengthy falling trend, insiders may know something you don’t. That’s when you know you have to dig deeper, and perhaps wait until the situation clarifies itself.

We judge the leading Canadian stocks on a multitude of factors, with consistently successful results, as you can see when you take a risk-free introductory subscription to The Successful Investor. As a new subscriber, you can save $50.00— and get all the details on “My #1 Stock Pick for 2012.” Click here to take advantage of this special subscription offer.

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific advice on investment topics like stock market research. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “As a measure of volatility, beta ratings can be useful with the right investment strategy.”

Beta ratings are used to measure stock-market volatility. Stocks with a beta of 1.0 have exactly the same degree of volatility as the market they trade in, based on a comparison of the fluctuations in the stock and the market index over a period of time, usually five years.

If a stock’s beta is below 1.0, the stock is less volatile than the market. High-beta stocks above 1.0 are typically more volatile than the market. (If a stock has a negative beta, it has an inverse relationship with the market; it tends to fall when the market goes up, and vice versa.)

Stock market research: The right balance between profit potential and stability

In a rising market, high-beta stocks tend to jump ahead of the market indexes. However, when the market declines sharply, high-beta stocks can fall more quickly than the market, and be slower to recover. Low-beta stocks may not move up as quickly as the market indexes, but they’re unlikely to fall as far during market declines.

A sound investment strategy can help this relative volatility work in your favour. That’s what we aim to achieve with our 3-part approach: invest mainly in well-established, dividend-paying companies; spread your stock market investments across the five main economic sectors (Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities); and avoid stocks in the broker/media limelight.

With this approach, we naturally diversify into high- and low-beta stocks. That adds potential for strong gains when the market is rising, but it also adds stability that helps protect your portfolio in market declines.

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This balanced strategy contrasts with that of advisors and portfolio managers load up on high-beta stocks. Of course they can show bursts of high performance when the market is rising. But the market declines sharply, these portfolio managers can lose far more than the market, and be far slower to recover — if they recover at all.

Stock market research: Don’t be led into a trap by high-beta stocks

It’s difficult, if not impossible, to predict when the market will jump. It’s even more difficult to predict when a rising market will reverse course and plunge. This simple fact of investment life causes an extraordinary amount of loss and investor bewilderment. That’s because it’s too easy to give yourself credit for a gain you owe to buying a high-beta stock just before the market rises, or when it has just begun to rise.

If you mistakenly give yourself credit for a gain like this, you may then go on to fill your portfolio with more of the same kind of stock. That can keep on paying off for a time. But inevitably the market quits soaring and stumbles. When that happens, high-beta stocks are the worst ones to hold. When the market is falling, they tend to fall even faster.

If stocks like these make up a big part of your portfolio, even a mild market downturn can leave you with horrendous losses.

All in all, a stock’s beta rating makes a broad statement about its history of volatility. Unfortunately, it tells you nothing about its inherent safety or future prospects. For that, we rely on the key factors that yield our TSI Network ratings for stocks: Highest Quality, Above Average, Average, Extra Risk, Speculative and Start-up.

If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific investment advice, including how to use financial ratios and other information in your stock research. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Use the price-to-sales ratio correctly and you can uncover stocks with strong growth potential.”

We display a price-to-sales or p/s ratio with every stock we cover in our Wall Street Stock Forecaster newsletter. It lets you see how the stock is doing relative to the company’s sales.

You get the price-to-sales ratio when you divide a stock’s price by its sales per share (you arrive at sales per share by dividing total annual sales by the number of outstanding shares).

Financial ratios like price-to-sales are just one way to measure a stock

The basic rule is that a lower price-to-sales ratio means that a stock is cheap. A higher p/s tends to indicate that a stock is expensive. Still, many individual stocks seem to run counter to this rule. Stocks with deservedly high p/s ratios can rise for lengthy periods, and stocks with deservedly low p/s ratios can fall.

That’s why it’s important to keep price-to-sales ratios in perspective. They tend to provide hints rather than clear answers. They are only one among many tools in your stock research.

Price-to-sales ratios can signal future gains

Sales is the raw material of earnings; that is, sales minus expenses equals earnings, so earnings are always less than sales.

So, if a stock has a very high p/s ratio — 20, say —its price-to-earnings (or p/e) ratio has to exceed 20, since “e” is always less than “s”. In that case, its rate of sales growth will have to be very high if it is ever to earn enough profit to justify its current stock price, let alone go higher.

On the other hand, you might uncover a company with an extraordinarily low price-to-sales ratio, such as .01 (for example, a $1 stock with $100 a share in sales). That can indicate a lot of capital-gains potential, if the company can improve its profit margin.

However, a low p/s is an advantage only if a company can make money on its sales. If the company can’t make a profit, its low p/s may signal danger, rather than a bargain. The low p/s may reflect the fact that well-informed investors are selling the stock (and driving down the ‘p’). Money-losing companies eventually go out of business.

Using financial ratios to your best advantage in the search for fast-growing stocks

In the latest issue of Wall Street Stock Forecaster, we looked at Apple Inc. (symbol AAPL on Nasdaq). The computer giant continues to pump up its earnings thanks mainly to strong sales of its iPhone smartphones and iPad tablet computers.

Apple’s price-to-sales ratio is somewhat on the high side, at just over 4, yet that’s reasonable for a fast-growing tech stock. What’s more, the stock is trading at just 14 times its likely earnings for 2012. That’s pretty low considering the company’s brisk growth.

The two ratios give you a picture of a stock that is still growing rapidly. It’s smart to use more than just one financial ratio, so that you’re not getting only part of the story.

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Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific advice, in this case showing you how we judge winning stock picks. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Use our TSI Network ratings system to pick the right stocks: Part 2”

Last week in the Investor Toolkit, we looked at 4 of the 9 factors that we use to establish our TSI Network ratings: Highest Quality, Above Average, Average, Extra Risk, Speculative and Start-up. (View the post: How our ratings system finds the best stocks: Part 1.) These ratings appear next to every stock we recommend in our investment newsletters.

We use a point system to award our ratings, as I mentioned last week. This week, we’ll look at the 5 remaining factors we use to assess risk and build a profile of winning stock picks.

5. One point for a long-term record of profit. A company that makes money just about every year will survive a lot longer than one that makes money sporadically, if at all.

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6. One point for a long-term record of dividends. A steady or rising dividend provides a sign of safety. Dividends, after all, are impossible to fake — either the company has the cash to pay dividends, or it doesn’t. Failing or fraudulent companies hardly ever pay dividends.
   
   Two examples of companies with a long history of raising their dividends are Fortis Inc. (symbol FTS on Toronto), a stock we analyze in our flagship advisory, The Successful Investor, and McGraw-Hill (symbol MHP on New York), which we analyze in our newsletter on U.S. stocks for Canadian investors, Wall Street Stock Forecaster.
   
   Fortis is the main supplier of electrical power in Newfoundland and Prince Edward Island. It also operates power plants in the U.S., Belize and the Cayman Islands, and has other businesses across Canada.
   
   McGraw-Hill announced in September 2011 it will split into two separate companies: McGraw-Hill Markets, which will sell a variety of financial-information products and McGraw-Hill Education, which will publish textbooks for schools and colleges.
   
   Both companies have raised their dividends for 39 consecutive years. Fortis’ annual rate of $1.20 a share yields 3.6%. McGraw-Hill’s annual rate of $1.02 yields 2.2%.
7. One point for an attractive balance sheet, with adequate equity and manageable debt. When bad times hit, debt-heavy companies go broke first.
8. One point for being able to serve all shareholders. The best stocks in this area are free of heavy-handed government regulation, free of too much dependence on a single supplier and free from abuse by insiders.
9. One point for Canada-wide operations, or two points for multinational operations. Companies that are confined to one geographical area are inherently more speculative than those whose operations are more spread out.

If you’d like me to personally apply my time-tested investment advice to your portfolio, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific investment advice, including the best use of financial ratios in your stock research. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Assessing a company’s debt is important, but you can be misled by the numbers.”

The issue of debt appears regularly in the media these days—whether it’s the debt of governments or the indebtedness of the population at large. Deciding whether a company has too much debt is certainly an important factor for investors.

Many experienced investors begin their stock research by looking at ratios such as a company’s debt-to-equity ratio. This ratio comes in several variations, but the basic idea is that you measure a company’s financial leverage by comparing its debt with its shareholders’ equity.

A high ratio of debt to equity increases the risk that the company (that is, the shareholders’ equity in the company) won’t survive a business slump. However, this ratio can mislead, because it compares a hard number with a soft one.

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Debt is usually a hard number. Bonds and other loans generally come with fixed interest rates, fixed terms of repayment and so on. Equity numbers are fuzzier. They mostly reflect asset values as they appear on the balance sheet (minus debt, of course).

But figures on a balance sheet may be misleading. They may be too high, if the company’s assets have depreciated since it acquired them (that is, depreciated more than the company’s accounting shows). In that case, the company will eventually have to correct the balance-sheet figures by trimming them back or “taking a writedown.”

Or, the equity value may be too low if the company’s assets have gained value since the company acquired them. This can happen with real estate and other investments.

Stock research: The debt-to-market-cap ratio can say more about a company’s long-term prospects

Instead of overemphasizing the debt-to-equity ratio, we recommend that you expand your stock research to look at the ratio between a company’s debt and its market capitalization or “market cap” (the value of all shares the company has outstanding).

Like shareholders’ equity, market cap may differ widely from the net value of a company’s assets. However, a moderate debt-to-market-cap ratio will tend to provide a conservative starting point for analyzing a company’s chances of survival.

A great example that we like to cite is Coca-Cola Co. (symbol KO on New York). The company has long-term debt of $13.7 billion, which represents a moderately high 41% of its $33.4-billion shareholders’ equity. But that debt is just 8.5% of its market cap.

The difference reflects the fact that the company’s balance sheet doesn’t show the true value of its most valuable asset — its so-called intellectual property. In Coke’s case, one key asset is the secret formula for Coca-Cola, which is reputedly carried on the company’s books at one dollar (and was recently moved with great fanfare to a new vault in Atlanta). More important, the Coke brand name carries no value on the company’s balance sheet. However, these are reflected in its huge market cap of $160.6 billion. So, put into perspective, the company’s debt is very low.

In contrast, penny mines often have low debt-to-equity ratios. But their shareholders’ equity reflects a lot of investments in mineral properties that will almost certainly never result in any significant revenue. And one good reason that their debt is low is simply that no one wants to lend them money.

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Recently, one of our Inner Circle members asked about a stock certificate for Consolidated Denison Mines, a company that no longer trades on any stock exchange. Our research showed that Consolidated Denison had merged in 1960 with Can-Met Explorations and was renamed Denison Mines Limited. That company now trades in Toronto under the symbol DML. We gave him the number of the transfer agent for Denison Mines Limited to see if he could exchange his shares for those of the existing company.

Perhaps you have an old stock certificate like this in your files. The certificate may be registered in your name, or in the name of an earlier owner—a friend or relation who left it to you, or a total stranger. Is it worth something?

One way to find out whether the certificate has any value is to try and deposit it in an account with a discount broker. If the issuing company’s corporate charter has been cancelled, the broker will reject the certificate and return it to you. If the stock has been taken over by another company, the broker may try to collect the securities or cash that the buying company paid for it.

Stock market advice: You don’t find pearls at the bottom of a junk drawer

Still, certificates like these almost always turn out to be worthless (although they may have some value in the field of scripophily—the study and collection of stock and bond certificates). People take care of items that have some value. For stock certificates, that means keeping them in a safe deposit box, or with a brokerage account. Certificates of defunct stocks are more likely to be deposited at the bottom of a file drawer, “just in case they ever come back to life.” They don’t.

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Another reason why most old stock certificates are worthless is simple arithmetic: It’s much easier to launch a company and sell stock to the public than to launch a business and make a success of it. That was truer decades ago than it is today—it’s now much harder and more expensive to launch a new public company. But it’s still easier than starting a profitable new business.

This highlights important stock market advice that can keep your buys from winding up at the bottom of an old file drawer:

1. It’s essential to invest mainly in well-established stocks with a history of sales and earnings, if not profits. If you break this rule and invest in, say, junior mines or Internet startups, you should only do so if you have a high opinion of the value of the junior’s assets and/or business plan. And you should buy the stock with money you can afford to lose. You could be mistaken about its value. Someone might eventually find your low-quality buys gathering dust at the back of a drawer and wonder if they were ever worth anything.
2. “Holding for the long term” only pays off with investments in high-quality, well-established companies. If you buy low-quality or speculative stocks, time tends to work against you. The longer you hold them, the likelier you are to lose money.

You can follow our safety-conscious advice in the Canadian Wealth Advisor. We help you discover stocks whose built-in value limits losses during downturns—and produces superior gains over time as the markets rebound.

You can get a special risk-free introductory subscription to Canadian Wealth Advisor at a savings of $80.00 off the regular rate. Best of all, your subscription contains 5 in-depth Special Reports, and much more. Click here start your introductory trial subscription to Canadian Wealth Advisor now.

P/e ratios (the ratio of a stock’s price to its per-share earnings) are published regularly in newspapers and on the Internet. These financial ratios are widely followed, and are an important part of many investors’ decision making.

Typically, you calculate p/e’s using a stock’s current price and its earnings for the previous 12 months. The general rule is that the lower a stock’s p/e, the better. And a p/e of less than, say, 10, represents excellent value. A low p/e implies more profit for every dollar you invest.

P/e financial ratios are just a starting point when you research stocks

P/e financial ratios are a good starting point for researching a stock you’re considering buying (or selling). But relying too heavily on these financial ratios can expose you to serious risk.

Successful investors treat p/e’s as just one of many tools, and not a deciding factor. This is the approach we follow when we use these financial ratios to evaluate stocks for our newsletters and investment services.

Here are 3 risks of relying too heavily on p/e ratios. All can seriously hurt your portfolio’s long-term returns:

1. One-time gains can artificially inflate a company’s p/e: Make sure you factor out low p/e’s that arise if a company sells off assets or subsidiaries and records a large one-time gain. That inflates the p/e, and is not representative of the company’s true ongoing operating earnings. Similarly, you should add back any one-time write-offs so you don’t miss any stocks that have low p/e’s on an ongoing basis.

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2. A low p/e ratio can be a danger sign: It pays to be wary of stocks that trade at suspiciously low p/e’s. Low p/e’s may come about because well-informed investors are selling the stock and pushing the price down, regardless of earnings. In other words, unusually low p/e’s can be a sign of danger rather than a clue to a bargain.
   
   Some companies, especially in the cyclical manufacturing and resources sectors, go through periodic booms and busts that can balloon their earnings in the space of a few quarters, then deflate them overnight. If earnings are high and p/e’s are low on a company or industry, it usually means investors expect a profit setback. These stocks could easily plunge when growth turns down. Often the riskiest time to buy stocks in these industries is when p/e’s are at their lowest.
3. Don’t discount stocks with high p/e’s: You should expect to pay high p/e’s for stocks with lots of growth potential. As well, you may want to buy shares of high-p/e firms that report earnings even in bad times. This shows a high-quality company. This is true even if a company stays marginally profitable, or avoids eye-catching losses, in bad times.
   
   You’ll also pay more for companies with a long-term earnings pattern. However, few are worth more than 20 to 25 times normal earnings in the midst of an economic cycle. So you should avoid loading your portfolio up with high-p/e stocks. Should the market go into a broad setback, these stocks are particularly vulnerable.

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