Three Steps to Protect Your Portfolio from the Next Bear Market

Three Steps to Protect Your Portfolio from the Next Bear Market

ALEXANDER GREEN, CHIEF INVESTMENT STRATEGIST, THE OXFORD CLUB

In one of my recent columns, I noted that investment analysis has gotten far trickier over the last few years. 

We have entered a period of “administrative markets,” in which equity returns are affected as much by government policies as they are by economic growth and corporate profits. 

In the last few years, we’ve seen large-scale bailouts; trillions in fiscal stimulus; massive quantitative easing; nearly seven years of zero short-term rates; heavy-handed regulation; and sharply higher taxes on income, dividends, and capital gains. 

Our corporate tax rate is the highest in the developed world, driving even iconic American companies like Burger King to move their headquarters to Canada. 

These policies distort markets... and lately equity investors have been paying the price. 

A Shot Across the Bow

The S&P 500 recently plunged more than 10% in four days. 

Don’t shrug this off. According to Bianco Research, this has happened only eight other times in the last 80 years. 

Yes, the markets took a significant bounce. But I still view this as a shot across the bow, a warning. 

Here’s what makes the smart money nervous right now... 

In the past, when the economy (and the stock market) went into the tank, the traditional policy response was to stimulate the economy with lower interest rates and deficit spending. 

But interest rates are already at zero. And under the Obama administration, the national debt has soared from $7.4 trillion to $18.4 trillion. 

What’s next? Are we moving to negative interest rates (like Europe), creating a situation in which you have to pay to leave your money in the bank and even more stupendous deficits? That policy prescription didn’t work well for Greece. 

Don’t put me in the gloom-and-doom camp. I’m not a pessimist. But I’m no Pollyanna either. 

I consider myself a skeptical realist who looks at both the positives and negatives. Despite the many government policy missteps over the last decade, there are factors to appreciate as well. 

For instance, the U.S. economy posted a much bigger rebound in growth during the spring than previously reported… (The Commerce Department adjusted the annual expansion rate in the April-June quarter sharply higher to 3.7%.) 

Plunging energy prices are a huge plus for everyone outside the oil and gas industry… 

Inflation is negligible… 

Housing is roaring back… 

Unemployment is falling… 

The dollar is strong... And the outlook for corporate profits is improving...

Three Essential Steps

Given the mixed outlook, what should you do with your portfolio now? Start with these three essential steps: 

1. Check your asset allocation. The roaring bull market of the last six and a half years has almost certainly increased – and perhaps more than doubled – your exposure to equities. If it’s now larger than you’re comfortable with, pare back to the point at which you’ll be able to sleep at night. How much in stocks is enough (or too much)? Investment great Benjamin Graham used to say that no one should have more than 80% of their portfolio in stocks – or less than 20%. Look at your age, time horizon, and risk tolerance, and adjust accordingly. 2. Move those trailing stops. Make sure they are no more than 25% below your holdings’ recent highs. And if you’re using “mental stops” – no actual stop orders entered – be sure to maintain your sell discipline when your stocks trade through your predetermined price. 3. Adopt a late-stage bull market strategy. That doesn’t mean move to cash. (This bull market could last five more weeks, five more months, or five more years.) History shows that as a bull market ages, the safest and best-performing stocks tend to be recession-resistant, mega-cap value stocks, preferably ones with growing dividends. (Those dividends both support your shares and provide income during the bad times.)

All this government meddling with the market makes this a challenging time for investors. We can only wait and see what policymakers dream up next, whether it’s higher rates or QE4 or something entirely new. 

Investment legend John Templeton used to point out that no matter how strange things look, economic and market cycles are all essentially the same. 

He famously noted that “this time is different” is the most expensive phrase in the annals of investing. That statement is generally true. 

But check your history. When was the last time the national debt was bigger than our GDP and the Fed held rates at zero for nearly seven years? 

This time really is different. Govern your portfolio accordingly. 

Good investing, 

Alex Green 
Chief Investment Strategist, The Oxford Club 

Source: Bonner and Partners

Follow us on Twitter: @blacklioncm

Investment Advice TO a World Champ

Investment Advice TO a World Champ By Dr. Steve Sjuggerud Tuesday, January 13, 2015

I met a legend over the weekend… He's a now-retired international sports hero. I don't want to share his name today, because he told me quietly that he could use some financial help, and he probably wouldn't want that word out in public. I didn't really answer him when we were together. But as I thought about it later, the right advice for him is the same advice that I would give to you… This is serious stuff. I urge you to take it seriously, and commit these ideas to memory. Let's get started:  1. Nobody will care more about your finances than you.  This is critical for you to embrace, immediately. Nobody is going to care more about your finances than you. You simply can't just find somebody smart and hand your money responsibilities off to them.  You can't just hand off your life and hope it goes okay – this is your life we're talking about! How many rock stars and sports stars have you read about that are broke today because they handed off this responsibility? Don't do it.  The quicker you take control and ultimate responsibility with your money, the quicker you will start building your legitimate fortune. And you can't ever give up that responsibility.  Let me be clear… It is alright – even smart – to work with smart people, and to delegate some of your money responsibilities to carefully chosen people. The important part is, you just can't "check out." You have to be the team captain here… the captain of your money ship.  2. There is no magic bullet, or shortcut.  You didn't become a sports legend by taking shortcuts. You had to work harder than the next guy, learn more than him, and focus with more intensity than the next guy to achieve your goals.  If you want to invest successfully, you have to do the same thing. You can't get by on one hot tip after another. The shortcuts don't work. This leads us to the third idea…  3. If you don't understand it, don't buy it.  It's easy to get dazzled by promises of big profits… It's even easier to get sucked in when the promises are accompanied by slick brochures and fast talk with a lot of words that you don't understand.  You'll save yourself a lot of loss (and time) if you remember this: If you don't understand it, don't buy it. Don't ever cheat on this one. It will cost you.  4. Buy investments that are 1) cheap, 2) hated, AND 3) in an uptrend.  I've built my wealth and reputation on this philosophy. In short, you can't buy what's already incredibly popular – because if you do, chances are you've already missed it. Instead, you have to buy what people are skeptical of.  Separately, waiting for an uptrend is a crucial part of this strategy as well… It helps take the risk out of the idea, and it helps "confirm" that your investment thesis is "right."  If you want my opinion today, property is probably your best bet. Here's why:  It's surprisingly affordable (when you factor in today's record-low interest rates). I say "surprisingly" because most people look at house prices versus incomes, and they wrongly assume that house prices are expensive. The correct way to look at it is relative to monthly payments (interest rates). And based on that, house prices are plenty affordable after all.  Also, investors are skeptical about property now, wrongly thinking that it is overpriced. (So it is hated – or at least not loved). AND property is in an uptrend. PERFECT.  Best of all, you can understand it. You hold the keys, you paint the walls… with YOUR property, you control your destiny.  My money is where my mouth is with this one… Back in 2010, I owned no property outside of my home. Today, property makes up the biggest percentage of my own financial assets – by far.  Property is what I'm doing with my own money.  You will always hear about ways to make higher returns, or faster ways to make a buck, than property. But chances are today you'd be risking much more than you can imagine, relative to the potential reward. It's simply not worth it.  Again, right now, property is affordable, unloved, in an uptrend, and understandable. You control your destiny, to a better degree than with other investments. Particularly if you are not an expert in investing, and don't intend to be, then property makes sense for you.  I could go on and on about "do's" and "don'ts" when it comes to your money… But I won't.  Instead, let's leave it at these simple-but-absolutely-critical points…  1. Nobody will care more about your situation than you, so don't hand off your finances. 2. There is no magic bullet or shortcut. (The "hot tip" doesn't exist.) 3. If you don't understand it, don't buy it. (If it sounds too good to be true, it probably is.) 4. Buy investments that are cheap, hated, and that have started their uptrend. That's it. Commit these points to memory.  Again, property, right now, ticks a lot of these boxes. That's where I'd suggest you start…  Good investing,  Steve Source: Daily Wealth Follow us on Twitter: @blacklioncm

The Most Important Wealth Secret You'll Ever Learn

The Most Important Wealth Secret You'll Ever Learn 
By Chris Hunter,

What you are about to read flies in the face of everything your stockbroker or Wall Street adviser will tell you. 

It's about the closest thing to heresy you can get in the investing world... and the newsletter business. It's also a key insight if you want to stay wealthy over time. 

It is simply this: Stock picking alone won't help you hold on to wealth. 

Unless you are very lucky... or very, very talented... you will struggle to pick the right stocks at the right time ALL the time. You will make mistakes. You will mess things up. 

And unless you have the right discipline in place, sooner or later you will lose money. 

That discipline is called "asset allocation." That sounds technical. But it's really just about how you spread your wealth over different types of investments. 

This is backed by hard data. 

For instance, a well-known study in 2000 by Yale professor of finance Roger Ibbotson and Paul Kaplan of Morningstar showed that differences in asset allocation among mutual funds explained virtually all of the variance in their returns. 

Differences in stock picks made virtually no difference to the variance in portfolio returns. 

Common Sense Decisions
It's common sense, but you don't put 100% of your wealth in stocks in a savage bear market. 

And you don't invest 100% of your wealth in bonds in times of runaway inflation. 

This seems straightforward. But you'd be surprised how many investors skip over these fundamental decisions in the rush for the latest "hot stock." 

This is nearly always a bad idea. 

Before you even think about picking which individual stocks to own, you have three decisions to make. These are the three most important decisions you make as an investor. 

1) Which assets to hold in your portfolio 

2) In what proportions to hold them 

3) When to change those proportions 

Get these three decisions right, and long-term wealth creation and preservation will follow. Get them wrong, and you are unlikely to hold on to what you've worked hard to earn and save. 

So what makes for a good asset allocation? 

Today, I'd like to share with you what we've learned so far at Bill's family wealth advisory service, Bonner & Partners Family Office... where our goal is long-term wealth preservation. 

7 Rules of Successful Asset Allocation
1) It will have a cash buffer – Having cash on board makes it easier to deal with a major downturn and the losses that come with it. Remember, you want to make sure you are not forced into dumping your investments in times of market stress. 

The more cash you hold, the more of a buffer you have. Having cash on board also allows you to go bargain hunting when investments go on sale. In times of crisis, having enough cash to buy beaten-down assets is essential. 

2) It will be an inflation beater – Your asset allocation must allow you to stay ahead of consumer price inflation. There is little use in putting together a portfolio that gets eaten away by inflation. 

This is especially important given the sky-high deficits most advanced economies are running and the widespread money printing central banks are engaging in. We may not see a lot of inflation show up now. But that doesn't mean it won't show up in the future. 

3) It will be able to withstand currency depreciation – This is particularly important if you are internationally mobile, as many Bonner & Partners Family Office members are. 

There is no point in making big portfolio gains in a currency that is losing value. Or for that matter, leaving a portfolio vulnerable to the collapse of a currency (something that is now being talked about openly in the case of the euro). 

4) It will be properly diversified – A prudent long-term portfolio will contain a mix of asset classes that reduce risk. It will also be well diversified within asset classes. 

For example, the money you have in stocks should be diversified across sectors and geographies. Having all your stock market investments in Japanese nuclear stocks, for example, is a bad idea, even if you have only 10% of your total wealth invested in stocks. 

5) It will take advantage of the "bargain counter" – The individual assets you own should only be bought when they are selling at what we like to call the "bargain counter." 

If you buy when an asset is expensive you expose your portfolio to the risk of a large capital loss. Buying assets when they are selling at a discount to their estimated fair value increases your margin of safety. 

6) It will follow sensible "position sizing" rules – Position sizing answers the question "How much should I own?" 

The answer to this question varies. But as a general rule, never put more than 3% of your overall capital at risk on one stock position. This is one of the most effective ways of reducing the risk of a ruinous loss to your portfolio. 

7) It will contain plenty of "off market" assets – "Off market" assets are assets that don't trade on a public exchange... things such as real estate, gems and stakes in private business ventures. 

Putting all your money at risk in the financial markets (whether in stock markets, commodity markets, bond markets or currency markets) is too much of a risk. 

For instance, owning a quality house... bought at a good value and soundly financed... is an excellent way of reducing overall portfolio risk. If you go about it right, you should own the home outright by retirement. 

Owning a home debt free is one of the best protectors against financial crisis that there is. Owning a private business or investing in one is another great way to earn high returns on your capital. 

The Icing and the Cake
Asset allocation is how serious investors think about investing. 

At Bonner & Partners Family Office we call the returns you get from your asset allocation decisions "beta." 

Beta is the result you get from getting the big trend right. 

Once you've got your beta right, it's time to look at boosting those returns. We call this "alpha." Alpha is what you get by choosing the individual investments (stocks, bonds, etc.) best positioned to profit from the big trends. 

Beta is the cake. Alpha is the icing on the cake. 

The most important wealth secret you'll ever learn is understanding this relationship... and always starting with the cake first. 

Most investors get this backward. And they suffer as a result. 

Source: Early To Rise

Follow us on Twitter: @blacklioncm

One of the All-Time Great Investment Secrets

One of the All-Time Great Investment Secrets An Interview with Brian Hunt Wednesday, July 9, 2014

Today's DailyWealth covers one of the greatest investment secrets in the world. You won't hear about it in the mainstream media… and very few people want to publicize this idea… but it's one of the safest, easiest ways to make great investments. In the interview below, S&A Editor in Chief Brian Hunt reveals all the details behind this powerful investment secret… including the reason nobody wants to talk about it… Stansberry & Associates: You often say one of the great investment secrets – a source of giant investment returns – comes down to "investing in habits."  What's the story here? How can it lead people to great investments?  Brian Hunt: One of the truly great investment secrets is the idea of owning companies that sell habit-forming, or even addictive, products. I'm talking about things like soda, fast food, candy, cigarettes, and alcohol.  I often tell people that if they only knew this secret of investing, they could ignore just about everything else. It's that powerful.  Although it can lead to gigantic investment returns, it's not a popular idea. The Wall Street Journal isn't going to run a regular column about this idea. Mainstream magazines aren't going to run monthly features on it. Many folks are just not comfortable with owning businesses that sell habit-forming products. And if they are comfortable owning them, they are often very uneasy about publicizing it. It's not a popular topic at dinner parties or cocktail receptions.  S&A: Let's talk about some real life examples.  Hunt: Sure.  If you look at the list of the 20 best-performing S&P 500 stocks from 1957 through 2003 that kept their general corporate structure intact, you'll note many of them sold habit-forming products. It jumps right out at you.  For example, Phillip Morris is at the top of the list. It was the top-performing S&P 500 stock from 1957 to 2003. It sold cigarettes, which contain addictive nicotine.  Coca-Cola and Pepsi Co. are on the list. They sold soda… which is a sugar delivery vehicle. Hershey Foods and Tootsie Roll are on the list. They sold chocolate and sugar. Wrigley is on the list. It sold sugary gum, like Big Red and Juicy Fruit. People love to get a little sugar rush. It's habit forming… even addictive.  Many drug companies are on the list. These names include Abbott Labs, Bristol-Myers Squibb, Merck, Wyeth, Schering-Plough, and Pfizer. People get accustomed to taking certain drugs. Much of the time, those drugs are useful, although sometimes they are not. I'm not saying they are good or bad… I'm simply pointing out that people get extremely accustomed, even addicted, to taking them.  Fortune Brands, which was called American Brands for a while, is on the list. It sold cigarettes and alcohol.  You can make the case that certain fast foods are addictive as well. Food chemists load fast food with stuff that makes people want more. This is part of the reason McDonald's has been such a corporate success. McDonald's returned an average of 13% a year for three decades. Few businesses can achieve that kind of sustained performance.  The businesses I just mentioned produced more than 13% annual gains for decades. Those returns are extraordinarily rare in the stock market. You won't find anything better. Most companies can't sustain 13% annual returns for more than five years. The businesses I just mentioned sustained those returns for decades. And the reason why they did so well is simple.  When people form a habit around a product, it goes a long way toward ensuring repeat business. People get used to certain brands and they grow resistant to switching. Also, when people get used to a product and the brand surrounding it, they are more likely to continue buying the product even if the price increases a little. Both of these habits help companies sustain sales growth and healthy profit margins. That's good for shareholders.  It's also important to know that when these companies hit upon the right recipes or the right mix of whatever it takes to make good products, they don't have to make large, ongoing investments in the business. They don't have to spend tons of money on further research and development. Once Coca-Cola hit upon Coke, it didn't have to change it. The same goes for Budweiser and Hershey and Tootsie Roll.  When you develop a product that people love and develop habits around, you don't tinker with it. You don't have to spend a lot of money on new research and development. You don't have to buy expensive high-tech equipment. This means a larger percentage of revenues can be sent to shareholders. This leads to big dividends and share price gains. When a business get into that position, my friend Porter Stansberry says it is "capital efficient."  These sellers of branded, habit-forming consumer goods, by the way, are the kinds Warren Buffett, the greatest investor in history, always looks to buy.  S&A: How about a few recent examples of this idea working?  Hunt: The coffee chain Starbucks is a great one. It's one of the great success stories of American business.  Starbucks coffee was traditionally higher in caffeine than other brands. This helped it become more addictive. From 1995 to 2006, Starbucks advanced more than 2,000%. Starbucks was very good at selling a habit-forming product, and shareholders made a fortune.  Sam Adams is another good modern-day example. The makers of Sam Adams did a great job of producing quality beers associated with a strong brand. The name "Sam Adams" is associated with quality beer all over America.  From 2003 to 2013, shares in the maker of Sam Adams, Boston Beer, gained more than 1,000%. It's been a tremendous stock market winner. And the driver of those gains is a habit-forming product.  S&A: What are some of the other benefits of this strategy?  Hunt: The idea of owning businesses that sell simple, habit-forming products is great for folks who don't follow changing technologies.  It shows you don't have to try to pick winners from the complicated world of high-tech. You can make a fortune in "low tech" companies. It's very unlikely that enjoying a beer after work will become obsolete.  I like the predictability of owning robust, reliable businesses like McDonald's and Coca-Cola. I know it's very likely that folks will keep eating burgers and drinking soda.  I don't like the idea of buying a stock only to see it fall 30% in a few days because its fad product is going out of style… or because the cancer drug it bet the company on got rejected by government regulators.  Owning quality businesses that sell habit-forming products is a safe, sleep-at-night way to build wealth in common stocks.  S&A: How about another benefit?  Hunt: This strategy is also ideal for investing in high-growth emerging markets like China and India.  Combined, China and India have about 10 times the population of the United States. Many of those people are at the level of economic development of 1950s America… and they are getting a little richer every year. It's an incredible trend.  To invest in the trend, I don't want to try and guess what websites will become popular… or what retailer will become fashionable. That's a very difficult game. Those business landscapes will shift and change rapidly.  On the other hand, I'm very confident those folks in India and China who are getting a little richer every year will want to enjoy the same habit-forming products Americans have enjoyed for decades. They will want to consume more branded soda, cigarettes, beer, liquor, and processed foods. So, owning international businesses that serve those growing markets makes a lot of sense.  S&A: Can you provide some guidance on the right time to buy these companies?  Hunt: One way is to buy the biggest and best companies, like Coca-Cola or Hershey.  In order to buy them at a bargain price, it's best to buy them after a bear market or a major market correction. For example, many good sellers of habit-forming products fell 25%-50% during the 2008 market crash. After the crash was a great time to buy them.  You can also get bargain prices when a good company gets hit by what Warren Buffett calls a "one-time huge, but solvable, problem."  What Buffett means here is that even great companies make mistakes along their way to greatness. When these mistakes occur, investors often overreact and dump their shares. When you see a great company like Hershey or Coke suffer a major share-price selloff, I recommend viewing it as a potential buying opportunity.  Another option is to try and pick the next big success story. Who's the next Boston Beer or Starbucks? If you can get in early, the gains can be extraordinary.  But remember, that's a much riskier path. When Boston Beer began nationwide distribution, there was no guarantee enough Americans – accustomed to mass-produced lager like Miller Lite – would pay premium prices for a higher-quality "craft" brew.  And remember in 1997, a year after it went public at $30 a share, Boston Beer was trading for $9 a share. Probably not a lot of shareholders held on through the darkest days to enjoy the big gains.  If you want to try to profit from the next big success story, my advice is to keep your position sizes small so you can withstand the big swings in share price. Also, if your stock doesn't become the next big success story, at least you won't lose much.  S&A: Any final thoughts?  Hunt: It's worth addressing something that always comes up when this idea is discussed. People like to talk about whether it's right or wrong.  I'm not making a statement on whether owning these companies is right or wrong or socially responsible. Deciding to own businesses like these is up to the individual.  I'm just pointing out what works. I'm pointing out that selling habit-forming products often makes for a great business. It has been a proven strategy for decades… and it will continue to be for decades more. Human nature is what it is.  There are two basic keys to successful long-term investing in common stocks. One is to learn how to identify great businesses that you can own for years and years. The other is to make sure you pay good prices for your ownership stakes in those businesses. Knowing the powerful secret of "investing in habits" is a great help with the first part of the strategy.  If investors know this secret, they can make sure to monitor these types of stocks, look to buy them at good prices, and hold them for long periods of time. It's a proven wealth-generating idea that's rooted in common sense.  S&A: Thanks for your time.  Hunt: My pleasure. Source: Daily Wealth Follow us on Twitter: @blacklioncm

The Most Important Aspect of Any Investment

The Most Important Aspect of Any Investment

From the S&A Interview Series

Wednesday, June 4, 2014 If you want to be successful in stocks, there's one simple thing you have to do – focus on the price you pay. Buy at bargain prices.  It sounds simple. But most people can't bring themselves to do it.  Below, Stansberry & Associates Editor in Chief Brian Hunt explains this vital idea… and how you can use it to make winning investments. Stansberry & Associates: Brian, at Stansberry & Associates, we urge people to focus on the price they pay for investments. Could you explain why this is so important?  Brian Hunt: Sure.  This whole idea comes down to treating your investments like you treat almost anything else you buy. The idea is that you should focus on finding good values… and not overpaying for things.  When you buy a pair of shoes, you want to pay a good price. When you buy a computer, you want to pay a good price. When you buy a house, you want to pay a good price. You don't want to overpay. You don't want to embarrass yourself by getting ripped off.  Yet… when people invest, the idea of paying a good price is often cast aside. They get excited about a story they read in a magazine… or how much their brother-in-law is making in a stock, and they just buy it. They don't pay any attention to the price they're paying… or the value they're getting for their investment dollar.  Warren Buffett often repeats a valuable quote from investment legend Ben Graham: "Price is what you pay, value is what you get."  I think that's a great way to put it.  S&A: How about an example of how this works?  Hunt: Like many investment concepts, it's helpful to think of it in terms of real estate…  Let's say there's a great house in your neighborhood. It's an attractive house with solid, modern construction and new appliances. It could bring in $30,000 per year in rent. This is the "gross" rental income… or the income you have before subtracting expenses.  If you could buy this house for just $120,000, it would be a good deal. Since $30,000 goes into $120,000 four times, you could get back your purchase price in gross rental income in just four years. In this example, we'd say you're paying "four times gross rental income."  Now… let's say you pay $600,000 for that house. Since $30,000 goes into $600,000 20 times, you would get back your purchase price in gross rental income in 20 years. In this example, we'd say you're paying "20 times gross rental income." Paying $600,000 is obviously not as good a deal as paying just $120,000.  Remember, in this example, we're talking about buying the same house. We're talking about the same amount of rental income.  In one case, you're paying a good price. You're getting a good deal. You'll recoup your investment in gross rental income in just four years.  In the other case, you're paying a lot more. You're not getting a good deal. It will take you 20 years just to recoup your investment. And it's all a factor of the price you pay.  S&A: Let's move on to a stock market example.  Hunt: Sure. It works the same way.  Let's say Company ABC generated $1 million in annual profit last year.  If you buy ABC at a market value of $6 million, you're paying six times earnings. If you buy ABC at a market value of $20 million, you're paying 20 times earnings. If you buy ABC for a market value of $50 million, you're paying 50 times earnings.  The market is made up of people. And people tend to act crazy from time to time. One month, the market might set the price of ABC at $6 million. The next month, it might set the price of ABC at $8 million or $10 million.  I know that sounds like a wide range of prices, but you see these ranges in the stock market all the time. People are willing to pay different prices for different businesses at different times.  The amount people are willing to pay for a company's earnings is often called the "price-to-earnings multiple," or simply "the multiple."  In this example, it's a much, much better deal to buy shares of ABC when the market is valuing it at $6 million – or at a price-to-earnings multiple of six – instead of buying shares when it is valued at $50 million – or a price-to-earnings multiple of 50. You get more value for your investment dollar. You're buying shares in a cash-producing enterprise for a lot less.  The job of the investor is to make sure to buy assets at reasonable prices… and avoid buying assets at bloated, expensive prices.  S&A: If you're buying a great business, does it really matter if you pay too much?  Hunt: It's vitally important to know that buying shares in a great business can turn out to be a terrible investment if you pay the wrong price.  Let's go back to ABC. Let's say it's a great company. It has a good brand and good profit margins. It's steadily growing. And remember, it does $1 million in annual profit.  If you purchase ABC shares at a market value of $100 million, that's paying 100 times earnings for ABC. This is an extremely expensive price. Your only shot at making money in this example is if someone else comes along and is willing to pay an even crazier price than you did.  While this "waiting for a greater fool" can work occasionally, it's generally a losing strategy. The regular investor will never be able to make it work.  What often happens is that the company keeps doing well, but the multiple people are willing to pay returns to more normal levels. In a case like this, the company can keep increasing its profits, but the share price will plummet. It can fall 50% or 75%.  I know this sounds extreme, but it's exactly what happened during and after the 1999 and 2000 market peak.  Back then, good companies with solid future prospects – like Wal-Mart and Microsoft – traded for 50, 60, even 90 times earnings. People who purchased shares back then paid stupid prices. They had speculative fever. They didn't focus on getting good value for their investment dollars.  Because many stocks with good business models were so overvalued, their share prices crashed and went nowhere for many years.  Keep in mind, the underlying businesses were still very sound. Those businesses were still growing. But the stock prices got so out of whack that investors who overpaid suffered horribly. It took a long time for the stocks to "work off" their extremely overvalued state.  For example, in 1999, Wal-Mart traded for more than 50 times earnings. It spent more than a decade working off that overvaluation. Folks who bought Wal-Mart back in 1999 didn't make any money for more than a decade. The company did fine… but shareholders who bought the stock at stupid prices suffered for a long time.  If you can buy a great business for 10 times earnings, it's a good deal. But if you pay 30 or 50 times earnings for it, you're bound to be disappointed.  I have to state it again: If you overpay, you can make a horrible investment in a great company.  S&A: One the other hand, you can make money in a poor business if you pay a bargain price, right?  Hunt: Yes. Let's look at another example…  Let's say Company XYZ is barely profitable with a market value of $2 million. It makes just $250,000 a year. And a competitor is doing a better job of serving customers… so sales are declining.  But let's also say that the company sits on a valuable piece of real estate, which it owns free and clear. You know the piece of property could easily sell for $3 million… maybe even $4 million.  You could buy up shares, knowing full well the business is in decline and could even stop being a profitable enterprise. But if you buy shares while the market values the company at $2 million, you could make a great profit if they close the business and sell the assets for at least $3 million.  In this example, you could make money in a bad business… by paying a bargain price. Again, it all comes down to the price you pay.  S&A: What if you're buying a stock to collect dividends? How do you know what a good price is?  Hunt: The price you pay for a dividend-producing stock is a huge deal.  Let's say Company ABC is a great business that pays a very stable dividend. It has raised its dividend every year for 29 consecutive years. Its current annual dividend is $1 per share.  If you bought ABC at $20 per share, your dividend yield would be 5%. If you bought ABC at $30 per share, your dividend yield would be 3.3%. If you bought ABC at $36 per share, your dividend yield would be 2.8%. If you bought ABC at $100 per share, your dividend yield would be just 1%.  As the price you pay goes up, the yield on your original investment goes down.  Obviously, you want to pay lower prices and earn higher yields.  It's a similar story with bonds. Bonds pay fixed-income payments. But like stocks, the price of bonds can fluctuate.  For example, let's say we have a bond that is issued at a price of $1,000. Let's say it pays a 5% interest rate. That's $50 in annual interest.  If investors lose faith in the company that issues the bond, the bond price could fall to $700. But the annual interest payment would remain $50.  In this case, the buyer of the bond who pays $700 would earn about 7% in annual interest. The difference in how much income you earn is all a function of the price you pay.  S&A: Any parting thoughts?  Hunt: The big takeaway here is that investors need to view their stock, bond, real estate, and commodity purchases just like they would view buying a house or a car or a phone or their groceries. Don't be a sucker and overpay. Make sure you get good value for your investment dollar. Hunt for bargains.  You wouldn't pay $50 for a gallon of milk, would you? So why would you pay absurd prices for stocks?  Before you buy an asset, study its valuation history. See what levels represent "good prices" and see what levels represent "stupid" prices. These prices vary from stock to stock and asset class to asset class. Make sure you buy at levels that represent historical bargains.  S&A: Great points. Thank you.  Hunt: You're welcome.  Summary: Investors need to view their stock, bond, real estate, and commodities purchases just like they would view buying a house, car, phone, or groceries – don't overpay. Even buying a great company at a "stupid" price can make for a terrible investment. Make sure you're getting a good value for your investment dollar by buying an asset at a good historical valuation. Source: Daily Wealth Follow us on Twitter: @blacklioncm