Are You Patient Enough to Invest?
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Patience is virtue. It is a state of being that is developed over time. Being a good investor is about more than finding a great company at a great price. If you don't have enough patience, your chance of earning a reasonable return is very small. Understanding a company's valuation and its prospects is important, but you need to be able to wait years for time to work its magic.
Valuation Analysis 101
The price to earnings (P/E) is one of the most commonly used metrics to value a company. Beginning and advanced investors use this number to help understand if a company is a good deal. What is commonly left out of the discussion is the fact that the predictive power of the P/E ratio over short time frames is limited. Studies have shown that a P/E ratio is much better at predicting the next 10-year returns than the next year's return.
The longer the investment horizon, the better
The S&P Depository Receipts (NYSEMKT: SPY) is one of the most popular exchange traded funds (ETFs). It offers a simple way for investors to invest in the global economy while paying a net expense ratio of just 0.0945%. It is important to remember that investing with a 20-year investment horizon is better than a 10-year investment horizon. If the S&P 500 follows the trend it set from 2000 to 2010, its future return will be negative. If you add another 10 years to the period and start at 1990, suddenly it has a positive outlook.
You cannot predict the future, but you can use the future to your advantage. Right now, you can buy this ETF at around a one year forward P/E ratio of 15, a current P/E ratio around 17, and a price to book ratio around 2.4. This places the ETF in the middle of its valuation range. It is not terribly cheap, but it is not terribly expensive. If you have the patience to wait 20 years, then there is a good chance you will be sitting upon a positive return in your investment account.
Cheap companies in the S&P 500
With a P/E ratio around 6, Valero Energy (NYSE: VLO) is one of the best deals in the S&P 500. There is a good reason for this discount. Wall Street loves to look a few months ahead, and Valero is becoming a more volatile stock with thinner margins. The company takes hydrocarbons and refines them to make gasoline, diesel fuel, jet fuel, and other products.
In the past couple of years, Valero has made a killing by buying cheap U.S. oil and selling expensive gasoline and diesel fuel overseas. Now, the spread between international gasoline prices and domestic crude oil is falling, and Valero is facing falling margins.
Valero is still a good company to consider. Its debt load of 0.37 is manageable, its return on investment (ROI) of 12.8% is reasonable, and it is trading close to book value with a price to book ratio just over 1. Going forward, Valero will be heavily exposed to gyrations in the energy markets, but it is still a strong U.S. refiner trading at a low valuation.
CF Industries (NYSE: CF) is a major producer of nitrogen fertilizer. The world population keeps on growing, and this company helps to boost crop yields to ensure that the world's food supply remains strong.
It is not hard to see why the market is pricing CF Industries at a P/E ratio of around 6. Natural gas is its main cost and driver of its margins. The price of natural gas has fallen, sending CF Industries' earnings and stock price through the roof. Now, the number of rigs drilling for natural gas is down, and there are number of analysts saying that rosy numbers are creating a natural gas bubble.
Financially, CF Industries is on good footing. Its total debt to equity ratio of 0.28 and ROI of 26.2% are very strong. Even if natural gas prices rise substantially and its 32.5% profit margin takes a hit, the company will keep on producing fertilizer. The company is a value play; it just is not a necessarily stable value play.
Value investing works, but you need to have a long-term perspective. If you can invest for two or three decades, you have a great chance of making a positive return. A general investment like the S&P 500 depository receipts ETF is as close to a set-and-forget investment as is possible.
Taking value investing one step further offers a greater potential return with greater volatility. Valero and CF Industries are two energy companies trading at low valuations. Both of these companies might face difficulties in the future, but that doesn't mean that they will stop being profitable.
Joshua Bondy has no position in any stocks mentioned. The Motley Fool owns shares of CF Industries Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!