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Earlier, I spoke about the earning estimates of the “experts” and that, at least in the case of Target [stckqut]TGT[/stckqut], the numbers didn’t make sense for a 5-year projection of their earnings growth.

Let’s dig in a bit deeper. We will stay with MSN Money (I am not beating up MSN Money – it is simply reporting data supplied by others – you can find the same numbers at Morningstar or probably your favorite broker’s website). A few items below Earnings Estimates, you will see Financial Results and then Statements will appear and it will show a page that includes a tab for 10 Year Summary.

Let’s compare Sales over the last 10 years to Earning before Interest and Taxes (EBIT). We can quickly calculate that Earnings has varied from about 5.5% to 7.5% and averages about 6.3%. We can also see that for the last couple years, Target has been a bit below average on its Earnings compared to Sales (5.92% for last year).

Earlier, we saw that the analysts are saying the company is going to increase earning 12% per year for the next five years. That would mean that either Sales are going to increase at 12% (something that when you look at the Sales column hasn’t happened in the last 3 years) OR the earnings/sales would have to increase very dramatically – something that also has not happened in the past.

My prediction is that Target will not grow earnings at greater than 12% per year for the next 5 years. The evidence of the company to pull off that level of performance is simply not available.

A quick side note – why do I care about earnings growth? Simple, earnings growth should result in a higher stock price meaning my investment in the company will continue to appreciate. The growth of one company compared to another company is a major factor in my decision to invest my hard-earned capital in any given company. I want to maximize my rate of growth of my investment – don’t you?

P.S. Tomorrow, I will post my analysis on Target Corporation. Sorry to use them as my whipping boy for this commentary.

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I spend a lot of time helping people figure out how to make money in the stock market.  Most people don’t truly make money:

  1. They put their money into mutual funds which pretty much follow the market or perhaps do a bit worse.
  2. They put their money into big companies that they have heard about and then leave that money in there for a long time. The stock moves up and down but really doesn’t increase their wealth.

Or, they follow my advice and find great companies to invest in (see the Watch List to the right) and then have automated indicators tell them when the stock is moving up or moving down. They react accordingly and build up a large equity position.

But how do you find the money to invest in the stock market? It is getting tougher and tougher to make ends meet and many people are living beyond their means.  If you are in that boat, I found a great article that you should read: How To Afford Anything.  Here are some highlights:

Cheap means buying something obvious crappy, and only stupid people do that since they usually cost themselves more in the long run. For instance, a cheap person hires the wrong person to do a job, and winds up paying more to have a competent person have to fix the damage done by the first workman. Cheap means giving your girlfriend flowers picked out of a funeral home dumpster, and leaving the wrong sympathy card attached to them, That’s going to cost you a lot more than you just saved!

Frugality is entirely different. Being frugal means using your money well and not wasting. Being frugal often involves spending large sums on the right things, like hiring competent professionals to do a job, or buying a more durable, quality product that lasts far longer than a regular one.

The people who want to sell you a new car do everything they can to make it easy to take your money. It takes a great deal of self control to resist. Let’s face it: everyone deserves a new car every couple of years, and if you can afford it, why not? Simple: because it costs you tens of thousands of dollars that you could spend on more fun, or even on better cars if you do your homework and buy used.

Let’s look at fast numbers. The shortest reasonable commute is 10 miles (16 km) each way. (Anything shorter is bad for your car, since it won’t heat up all the way and boil off the water that condenses from the exhaust in your cold engine. This water dilutes your oil and rusts your exhaust. Engine wear is far, far greater in the few miles during engine warm up, too.)

10 miles each way is 20 miles a day. There are 250 work days a year, or 5,000 miles a year for commuting. At 50¢ a mile, the latest averages for running a car, that’s $2,500 a year.

I’m really cheap. I always order the least expensive thing, and skip beverages and extras. This sounds silly, but if you eat out often, simply skipping these high-profit extras can buy you an expensive camera in a few years.

I eat off the dollar menu at fast food. I don’t get suckered into buying a drink or fries. I love the $1 double cheeseburger at McDonalds, but if I ordered a drink or fries, I just padded the bill up to triple what it might have been.

Only buy what you can afford. Don’t buy anything until you have the cash to pay for it.

Half of America doesn’t get that, and spends all its money barely making the minimum monthly interest payments on their credit cards each month. GAG!

Americans are the only people on the planet who walk into a store and pay the price on the sign.

My wife and I always ask for the deal. I’ve gotten price concessions even at Sears! I love my wife because she is such a deal-getter. I couldn’t afford not to have her, for instance, last week she haggled a mattress store down to half of their bottom-basement posted sales price on a floor sample! She paid about one-third the new sales price of the item. Few Americans have the mettle to haggle as well as she does.

If you save $5 a day by skipping a latte, you’ll feel better, make more money, have more fun and save almost $2,000 every year. I don’t know how much Starbucks actually charges for each dose, but give it up for a couple of years and you again just paid for a free new exotic camera.

When I bought my own health insurance, I had a plan that was inexpensive, but had a $5,000 annual deductible. If I had a serious problem, I could find $5,000. I saved about $3,600 in annual premium (I paid $300 a month less for this insurance) by not having a small deductible, and always came out ahead. Never ask an insurance company to pay something you could afford to pay for yourself. You pay heavily for that privilege, if they pay out at all.

Ken has more suggestions on his site, so take a look.  He is obviously talking about saving up to buy expensive photography gear but the principle still remains the same – just replace the expensive photography gear with great investments.

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If you sit on Twitter long enough (especially Stocktwits) you will see a message like this: “I think XXXX company is great because their new widget is awesome and it is going to shake up the industry.” So the question is out there, should you invest in the company based on this amazing new product?

Probably not!

  1. One cool product does not make a great company. It takes many products over a series of years to make a company that you can be confident will be a long-term hold. Great companies consistently offer good products to their customers and create ways to keep and attract customers over a long cycle.
  2. While there is some bounce on new good news, typically this is just a bounce. It doesn’t last. If you are a day-trader then you may want to take advantage of these “news bounces” but if you want to hold a security for some time, you need more than just a single new cool product.
  3. You are probably late.  Most companies have the majority of their stock held by institutional investors. If this new product was that significant then they have already factored this news into their holdings. Major investment firms do not wake up in the morning, read Engadget, and then decide to buy a company. If this new product was that significant then they were slowly accumulating the stock in advance of the introduction and they were doing it by listening to the company’s statements of direction in their annual meetings, quarterly calls, and analyst updates.
  4. You are swimming against the tide. As I pointed out in 3, most of the stock of many companies is with institutional investors. They aren’t going to buy the inflated price from a product bubble, they will wait until the excitement is over to continue to accumulate. That means the only people you are going to sell your stock to are the fools that also listened to the new product fervor and are late to the game (so they have made a 2nd mistake by being late).
  5. You may be wrong! How many great products have been introduced that simply didn’t live up to the hype? Even great companies will sometimes release a dud product.

Let me give you a great example.  Arguably, the iPhone from Apple is the most significant cell phone ever released to the market. It only operates on the AT&T [stckqut]ATT[/stckqut] network so a few weeks before the introduction of the iPhone in June of 2007, you could have surmised that AT&T stock was going to boom.  Didn’t happen, on May 31, 2007 the stock closed at $24.82. Yesterday, the stock closed at $26.26 – not even 10% growth. Yes, I know that AT&T put out some dividends in that time but those didn’t increase in size either – on April 27, 2007 AT&T gave out a dividend of $.412 and on April 28, 2010 they did a dividend of $.398 (all prices per Yahoo Finance).

On the flip side, Apple [stckqut]AAPL[/stckqut] had a significant rise in stock price but Apple makes a lot of great products and their customers love the company. Apple is a Good Company on my ranking scale, AT&T is not.

Market timing is fine for buying stocks but you should limit yourself to momentum indicators and overbought indicators on Good Companies (see the Watch List on the right side of this site). Don’t try to market time based on product introduction hype.

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BusinessInsider.com has an interesting analysis that says that we would could be in for a correction.  I am not sure that I agree but it is hard to argue with the metrics.

If you continue to follow the practice of investing in solid companies and making sure that you are sitting on the sidelines when the market turns against your stock pick, you should be fine.  In fact you may thrive!

90 Years Of History Suggests A Move Like This One Is Followed By A Market Bust

Based on data going back 90 years, whenever the 12-month rate of change (ROC) in the Dow Jones Industrials Average has exceeded 40 percent, it has generally signaled trouble ahead.

In three cases, a 12-month ROC above that level has only marked a short-term pause, after which the market traded higher.

But on 11 other occasions, similarly rapid advances have been followed by notable corrections, including the collapses that followed the 1929 and dot-com era peaks, as well as the 1987 crash.

Given those odds, increasingly exuberant bulls might want to have a rethink.

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To be honest, I never considered this approach before.

I typically do not like paying fees to fund managers. I am especially skeptical of standard mutual funds when their track record can be worse than the market almost as frequently as above the market.  According to that great champion of individual investors, Motley Fool:

The average actively managed stock mutual fund returns approximately 2% less per year to its shareholders than the stock market returns in general.

Most of my advice is to pick great companies and invest in them with caution, taking profits when the market moves against the company’s stock. I do suggest that a certain portion of your portfolio reside in index funds – I typically tell people to pick their favorite broker and buy a DOW index fund, a S&P index fund, and at least one international index fund.  I rarely care about the brand since we are just trying to match whatever the market is doing.

Crossing Wall Street just did a great post describing a fairly mathematically correct method of creating your own S&P Index fund.  This would allow you to avoid any fees leveraged by the index fund management company.  Not a bad idea.  Note though that not all of these companies are Good Companies (in fact at least one of them is a Poor Company) but that is okay since you are only investing in these companies because they are your own home-grown index fund.

Looking to build a quick-and-easy index fund? Of all the stocks in the Dow, United Technologies [stckqut]UTX[/stckqut] has had the strongest daily correlation with the S&P 500 going back to the beginning of 2005. Each day’s UTX gain or loss has a 69.7% correlation with the S&P 500.

If add in Dupont [stckqut]DD[/stckqut], the correlation jumps to 80.5%. (Note this is average daily change, so it assumes you invest equal amounts each day.)

If you add is Disney [stckqut]DIS[/stckqut], the correlation rises to 85.4%.

Now the extra correlation really is hard to come by. If you add ExxonMobil [stckqut]XOM[/stckqut], the correlation rises to 88.9%.

Still more?

If we add American Express [stckqut]AXP[/stckqut] the daily correlations rises to 90.6%.

Verizon [stckqut]VZ[/stckqut] brings it up to 92.6%.

If you want to go for seven stocks, IBM [stckqut]IBM[/stckqut] will bring you up to 94%.

Now we’re almost out of room. Wal-Mart [stckqut]WMT[/stckqut] will bring our eight stock index fund up to a 95% daily correlation with the S&P 500. This is, of course, an equally weighted fund.

Obviously, you will spend $15-$20 per stock as you buy and eventually sell each stock (I assume you know where to buy or sell a stock for $7-$10). this may make this strategy not work for you depending on the amount that you invest in your “fund” so do the math before you get online with your favorite broker.