Stock Valuation and Toyota
Stock valuation is one of those really important basics if you're trying to invest safely. And this applies not only to stocks, but also to index funds and, well, everything else. You don't want to buy stuff that's overpriced. Duh.
Most people aren't willing to put the work into figuring out if their stock is for sale at a good price. Last week, I used the example of Toyota's problems to illustrate the problem of making unrealistic assumptions in your personal financial planning. Now let's use Toyota's problems to help us understand the importance of stock valuation. We'll start with a simple ratio that's been a pretty good indicator of whether a stock is overpriced or underpriced: P/E ratios.
You can find a stock's P/E ratio on the internet at Yahoo Finance. Just put in the stock symbol and then click on "key statistics." You'll see "Trailing P/E" under the heading "Valuation Measures." You want the "trailing" P/E that Yahoo provides, not the "forward P/E." The reason is that "trailing" is based on last year's actual numbers, whereas "forward" is based on an estimate - sometimes not much more than a guess.
Historically, when a P/E is less than 15, the stock's on the cheap side. When it's over 15, it's more expensive. You wouldn't necessarily make your decision to buy or sell a stock based just on the P/E, but I consider it an important input when I'm making such decisions.
The thing about these sorts of ratios is you've got to do some number crunching - a real necessity when it comes to stock evaluation and essential if you want to invest safely. If you don't like crunching numbers, get someone to do it for you. The bottom line is the number crunching pays off because sometimes number crunching is the only way to get at the truth.
Which brings us to Toyota and its recent problems. Toyota's definitely in the hot seat. The media and those Congressional hearings saw to that. They got there because of accusations that they have "sticking accelerator" problems. But it wasn't just the sticking accelerator problems that created the real problem - it was the 34 people who've died in accidents allegedly caused by sticking accelerator problems.
People dying certainly - and understandably - focused everyone's attention. But hold on a minute. I just looked at some interesting number crunching that's questioning whether all the hoopla has any merit.
Basically, an analyst I use did some number crunching and concluded that your Toyota is just fine. While he admitted 34 deaths would normally be cause for concern, he noticed that you have to go all the way back to 2000 to come up with the number. That got him thinking.
Based on those 8.5 million cars recalled in the U.S., and assuming the owners drive an average of 10,000 miles per year (a low estimate), you get those Toyotas logging about 85 billion miles per year. Over ten years, you're at 850 billion miles. That makes the chance of one of those Toyota owners having one of those accidents about 1 in 2.5 million - which statistically makes it a random event.
Of course, this doesn't minimize the fact that people died in an accident. But if the accident was a random occurrence, you can question all the time and effort being put into dealing with something whose occurrence is less than your chances of being hit by lightning. In fact, you have a lot better chance of shooting a hole in one in golf.
But while the number crunching seems to call into question the whole basis of the Toyota investigation, Toyota's going to suffer nonetheless - both its sales and its stock price - at least in the short run.
So what can our Toyota story teach us about stock valuation? In spite of the best due diligence, stocks will sometimes head down in the face of all the evidence. There's nothing more frustrating than spending time doing your due diligence, finding a stock that's cheap, and has great prospects for the future, then watching it go down - in spite of all your diligent number crunching. It's one of the things that can make managing your investments frustrating.
So can we conclude anything from all this? Sure. Don't rely strictly on stock valuation when making your buy and sell decisions. And if you own a Toyota (as I do), I'm guessing the cars are just fine in spite of all the hub-bub. In spite of that, make sure you take the thing in to get fixed if you do get a recall notice so that you don't invalidate your warranty.
Most people aren't willing to put the work into figuring out if their stock is for sale at a good price. Last week, I used the example of Toyota's problems to illustrate the problem of making unrealistic assumptions in your personal financial planning. Now let's use Toyota's problems to help us understand the importance of stock valuation. We'll start with a simple ratio that's been a pretty good indicator of whether a stock is overpriced or underpriced: P/E ratios.
You can find a stock's P/E ratio on the internet at Yahoo Finance. Just put in the stock symbol and then click on "key statistics." You'll see "Trailing P/E" under the heading "Valuation Measures." You want the "trailing" P/E that Yahoo provides, not the "forward P/E." The reason is that "trailing" is based on last year's actual numbers, whereas "forward" is based on an estimate - sometimes not much more than a guess.
Historically, when a P/E is less than 15, the stock's on the cheap side. When it's over 15, it's more expensive. You wouldn't necessarily make your decision to buy or sell a stock based just on the P/E, but I consider it an important input when I'm making such decisions.
The thing about these sorts of ratios is you've got to do some number crunching - a real necessity when it comes to stock evaluation and essential if you want to invest safely. If you don't like crunching numbers, get someone to do it for you. The bottom line is the number crunching pays off because sometimes number crunching is the only way to get at the truth.
Which brings us to Toyota and its recent problems. Toyota's definitely in the hot seat. The media and those Congressional hearings saw to that. They got there because of accusations that they have "sticking accelerator" problems. But it wasn't just the sticking accelerator problems that created the real problem - it was the 34 people who've died in accidents allegedly caused by sticking accelerator problems.
People dying certainly - and understandably - focused everyone's attention. But hold on a minute. I just looked at some interesting number crunching that's questioning whether all the hoopla has any merit.
Basically, an analyst I use did some number crunching and concluded that your Toyota is just fine. While he admitted 34 deaths would normally be cause for concern, he noticed that you have to go all the way back to 2000 to come up with the number. That got him thinking.
Based on those 8.5 million cars recalled in the U.S., and assuming the owners drive an average of 10,000 miles per year (a low estimate), you get those Toyotas logging about 85 billion miles per year. Over ten years, you're at 850 billion miles. That makes the chance of one of those Toyota owners having one of those accidents about 1 in 2.5 million - which statistically makes it a random event.
Of course, this doesn't minimize the fact that people died in an accident. But if the accident was a random occurrence, you can question all the time and effort being put into dealing with something whose occurrence is less than your chances of being hit by lightning. In fact, you have a lot better chance of shooting a hole in one in golf.
But while the number crunching seems to call into question the whole basis of the Toyota investigation, Toyota's going to suffer nonetheless - both its sales and its stock price - at least in the short run.
So what can our Toyota story teach us about stock valuation? In spite of the best due diligence, stocks will sometimes head down in the face of all the evidence. There's nothing more frustrating than spending time doing your due diligence, finding a stock that's cheap, and has great prospects for the future, then watching it go down - in spite of all your diligent number crunching. It's one of the things that can make managing your investments frustrating.
So can we conclude anything from all this? Sure. Don't rely strictly on stock valuation when making your buy and sell decisions. And if you own a Toyota (as I do), I'm guessing the cars are just fine in spite of all the hub-bub. In spite of that, make sure you take the thing in to get fixed if you do get a recall notice so that you don't invalidate your warranty.
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