If you look at a chart of the Dow’s activity over the past five trading days, it looks like a roller coaster. The index has shed nearly 2% since last Thursday. So, when I was out on the golf course yesterday with some brokers, the mood was gloomy. After the volatility we saw in February, there’s a lot of fear that we’re in for a bumpy ride this May.
For some, those fears could be justified. Specifically, those who are invested in overvalued stocks may experience more of this roller coaster action this earnings season.
Yesterday, shares of Priceline Inc. (PCLN) gapped down after the travel booking website guided below the Street view for the second quarter. Given the stock’s relatively high price to earnings (P/E) ratio of 25, Wall Street couldn’t tolerate its lackluster outlook. Chipotle Mexican Grill (CMG), Coca-Cola (KO), Microsoft (MSFT), Netflix Inc. (NFLX) are also examples of high P/E stocks that have fallen after disappointing earnings.
So, if you’d prefer to avoid any heartburn over the next several weeks, I recommend that you pay close attention to your holdings’ P/E ratios and Forward P/E ratios. Sometimes, if a stock has excellent forecasted sales and earnings, and a good track record of beating estimates, I’ll be willing to overlook a higher P/E ratio. Facebook Inc. (FB), which is one of my rare “Triple-A” stocks, is a good example of this. Last week, FB rallied after the social media network trounced analyst expectations. So, while the broader market has fallen, FB has bucked the trend.
However, if one of your stocks is overvalued, and it doesn’t have the fundamentals to back it up, I’d tread very carefully. There are many ways to look up your stocks’ P/E ratios; my Portfolio Grader stock report pages have them listed towards the bottom. This heat map is also a helpful resource for checking the valuations of S&P 500 companies.
If you want to have the best of both worlds, look for companies with reasonable P/E ratios and excellent sales and earnings prospects. And, whenever possible, it’s nice to have a solid dividend yield to help smooth out any near-term volatility.
For example, I’m currently recommending four such stocks in CNBC’s Platinum Portfolio stock picking contest: Acuity Brands Inc. (AYI), Constellation Brands Inc. (STZ), Public Storage (PSA) and Total System Services (TSS). Three of these four companies have posted solid gains in the past week. And while the broader market is just about flat year to date, my portfolio of these four stocks is up over 6% during that time. That has put me neck and neck for first place in CBNC’s contest.
To summarize, my strategy focuses on four criteria: 1) Low to moderate P/E and forward P/E ratios. 2) Earnings growth. 3) Sales growth. 4) Dividend growth, when applicable. I must also add that I have been avoiding the energy sector, because it is still being whipped around by the strong U.S. dollar and the global glut of crude oil.
The market is becoming very narrow, so these four criteria should be a minimum benchmark for any new buys. In this daily blog, and in my premium newsletters, I’ll continue to point you to buying opportunities that satisfy these benchmarks.