Do It for your Foreigner Blonde Girlfriend

"I actually did call my brother yesterday—he's not a trader, he's an investor—and told him to start buying," Iuorio said.

I read this particular line in an article on CNBC site that was named “Why long-term investors should buy this sell-off”, and I found it pretty smartly witty. Anyway, I will begin my rambling now.. I had wanted to write an article on Alpha (No wonder they already got a popular site named on it; seekingalpha.com) and HOW TO CHOOSE THE RIGHT STOCK.. So, I am going to do both in the same post.

I don’t want to go too back in the past, so I'll take an example of the late 90’s.

Imagine you woke up one fine day in 1997 and decided to invest in Amazon.com and bought a hundred of it’s shares for $2.5, ($250 spent)… What do you get today???

A hot blonde girlfriend – preferably one who doesn't even speak your language, so 0 phone call bills, a convertible and don’t forget - The Good Life!

Haha no, you got $31,700. And if I go ahead and convert it into my currency, you have Rs 19 lakhs (using current USD/INR Rs. 60) from Rs 15K. That shit cray! This is Value Investing. You pick your blue chips well, you invest in them, you stay updated with what’s going on with the company, competitors  catalysts and other factors affecting. Lets figure out how to find one such blue chip (or as I call them Love).

   1)   P/E Ratio

P/E Ratio is share price divided by the Earning per share, The denominator (EPS) is based on an accounting measure of earnings, and is highly susceptible to forms of manipulation. For example, a stock’s P/E Ratio is 20, that means investors are willing to pay $20 for every $1.

Now, if the P/E Ratio is very high (or just rose), it means that investors are willing to pay more because they are expecting the stock to outperform in the future (they are expecting firm’s Earning per Share to rise). But if its low, then there are no expectations from it, or market expects it to fall, or no one has invested enough time to find this particular stock. Warren Buffet found these stocks that were undervalued and made his fortune.

   2)  Catalysts:

This is where you analyze on a macro-level, then industry-level, company-level etc. You have to do your research and field work better than others. This is where you can score marks, as ratios are all out there on internet for almost all stocks these days. You have to pick reasons as to why a certain stock’s price will fall or rise and why it should be invested in. When picking your catalysts, don’t pick one that’s too far in the future. Stock Market has a short-term span; anything from one year to less is a good catalyst.

Don’t pick too generic a catalyst either. Anything that affects the economy as a whole should not be the reason behind you picking or rejecting a particular stock. For example, Recession.. NO! that will affect other stocks too. Pick something more specific. Keep your ears and eyes open!

Look at what happened to MH370, of all the people I know I was the (OMG Im boasting!) only one who went online and checked if Boeing and Malaysian Airline were listed on Stock Exchange, and if yes, did the plane's disappearance affect their share prices? Yes, and Yes. MAS that had been trading nowhere less than a consistent 0.31MYR is still unable to rise above its current 0.21MYR.

    3)  PEG Ratio:

Formula is P-E Ratio/EPS Growth. This tells a more complete story than P/E Ratio alone. Don’t be confused when you see different Annual Growth Rate on consulting sites; as this varies. They could be using trailing growth or future growth  for the next 5 years, like I have.

Now, Imagine you want to invest in either of these two companies – Facebook or Netflix. How do you know which one to pick? Share prices could change their direction anyday!

	P/E RATIO ‘14	EPS ‘14	EPS ‘15	EPS ‘16	EPS ‘17	Average EPS
FACEBOOK	58.57	67.69%	41.44%	45.81%	42.05%	31.46%
NETFLIX	80.85	96.35%	80.71%	57.92%	32.71%	24.08%

 (I have made a table so it’s easier to decipher the numeric I will vomit next.)

Facebook has P/E Ratio of 58.57 (2014); and annual growth is 31.46%. (via http://www.nasdaq.com/symbol/fb/earnings-growth )

Therefore, PEG Ratio of Facebook, for 2014, is (58.57/31.46) = 1.86

Netflix has P/E Ratio of 80.85 (2014); and Annual Growth of 24.08%.

Therefore, PEG Ratio of Netflix is (80.85/24.08)= 3.35

So, one would pick Facebook trading at $59.7 than Netflix that is trading at a whooping $332.40.

This means that Netflix stock price is higher than it's earnings growth; and if the company doesnt grow at a faster pace, it's Stock price will fall.

   4)    SEEKING ALPHA

So, what is Alpha? I’ll save you the technical blah blah; Alpha is the *little extra* you receive from a stock that you (or the market) didn’t see coming! It means the stock outperformed market’s expectations and generated abnormal returns. It is in comparison with the risk taken to get the said results. So, a positive alpha means the fund got better than expected returns based on how risky/volatile it was. It measures risk premiums in terms of Beta (β).

Once you know this, you don’t judge a portfolio plainly by the returns it gives. You want to know if the risk you underwent was justifiable by comparing them to the returns received.

It’s like you could be delighted that your blonde girlfriend has finally found someone she can use her foreign language with whilst she chats with some little kid off the streets; but you are failing to see that he could be more than just *a little kid* to her. 
Of course, You are relieved the kid is not around her age, but you are missing the possible risk here, he could be "her" kid. The risk this happiness of seeing her play hopscotch with a toddler would definitely cost you MUCH more than just seeing her flirt with a cute biker off the streets!

Therefore, Knowing Alpha and being able to use it is highly necessary. I will not further explain Alpha or you would be mentally exhausted.

Be a Top Dog! :)