Don’t Be a P/E Fool
Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One of my worst investment decisions was not a purchase, but rather a sell. It happened to be one of my favorite businesses. And like all great stock success stories, valuation got a little ahead of itself. Savvy investors know when to hang on to a stock that is overvalued; others incorrectly stick to their little book of P/E investing and often miss the great run in a stock. This is an example of when I was a P/E fool.
Flash back to October 2008. One of my favorite stocks, Chipotle Mexican Grill (NYSE: CMG), traded at $55. I thought the stock market had a lot of downside potential, so I sold hoping to get back in at a better price. I was concerned about higher food costs and that they wouldn’t be able to pass those on to customers in the form of higher prices. I also thought they would slash new store expansion in the face of recession and cause massive sell-side earnings revisions. Oh, and I was a P/E donkey thinking 23x was overvalued, especially in the heart of a bear market.
Was I right? Absolutely! The company reported same store sales growth in 2009 of 2.2% versus double-digits prior to the Global Financial Crisis. The stock went from $55 to $44 in short order (not because of SSS as that happened later).
Was I wrong? Absolutely! New store growth in 2009 was 18%. Combine that with 2% comps and you have 20% sales growth when everyone else is struggling to stay flat. Before I could stop patting myself on the back, the stock was at $80, then $180, then $280, and now $347. What a missed opportunity! I tried to get too cute on a business I knew was going to be a long-term winner.
- The number one lesson is to not get too cute on the few stocks you think have home run potential. Chipotle fit the bill to me at the time. Currently, Textron falls into this category and I have to remember my Chipotle experience before foolishly selling.
- Take the P/E ratio and stuff it! Itis a garbage indicator for identifying home run stocks. The indicator may be useful if you want to be a singles hitter, but fails miserably at indentifying the great stocks each year. Great companies and consequently great stocks ALWAYS have a moment where the P/E ratio is egregious. That creates a negative story and some bearish news for the stock to overcome and continue to push higher. Remember, stocks climb the wall of worry and slide the slope of hope.
- Own the only growth company in an industry. When Chipotle was growing it was one of the few in the consumer discretionary space, expect to a lesser extent, Panera Bread Company and The Cheesecake Factory. (PNRA has also been a home run stock) With all the long only mutual funds out there needing some stocks to own in the consumer discretionary sector, the few growing companies were a magnet for their cash.
If you have a stock or two you absolutely love, don’t get too cute. You should more than be willing to settle for a little volatility and high valuation if it gets you that home run by the end of the decade, or sooner if you are lucky enough. Of course you want to make sure not to fall in love with them all!
Motley Fool newsletter services recommend Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. market8 owns shares of Textron. 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.