Yeah, I know four is a weird num­ber. But, I hear this stuff so often when I tell peo­ple about the Elephant’s Paycheck that I had to share.

Stock Price

“I love Apple, but at $500 a share it’s expensive.”

Yeah, pret­ty much the price does­n’t have any­thing to do with any­thing. It’s just like split­ting the stock does­n’t have any­thing to do with things. After a split, you just have twice as much at half the val­ue. Stock price does­n’t mat­ter except in the con­text of earn­ings. That’s why the PE ratio met­ric (price:earnings ratio) is impor­tant. That gives a con­text for the price that lets you com­pare dif­fer­ent com­pa­nies to each oth­er.

Thinking about cheap or expen­sive, the ques­tion to real­ly ask is how much “earn­ings” does the stock at a giv­en price buy me? The PE ratio tells you that. A low­er PE buys you more earn­ings per share for each share pur­chased.

Knowing Some Trick

“Don’t buy Apple, buy it’s supply chain.”

Brilliant, I’m not sure why this piece of wis­dom has elud­ed all the pro­fes­sion­als.

Seriously, that last sen­tence was sar­cas­tic. Maybe buy­ing the sup­ply chain is a good idea, but I won­der why this seems to be a response that peo­ple use to imply they know some deep trad­ing secret.

I’d buy the com­pa­ny mak­ing the mon­ey.

Timing

“I’ll sell if it gets too high, then buy it back when it drops.”

Buy low, sell high is a great strat­e­gy. But if you’re a per­son of reg­u­lar means (not a trad­er) you’re like­ly giv­ing a ton of your gains to the IRS on each trade, which means you take all the risk, and they get half the reward. You’re real­ly just bet­ting on the volatil­i­ty, hop­ing it goes back down enough to cov­er what you’ve giv­en to the IRS and then some, so when it goes back you get to put some mon­ey in your pock­et. A good idea, but as a strat­e­gy…  “hope” is not such a great strat­e­gy.

The Elephant’s Paycheck is less like bet­ting, and shares less of your earn­ings with the IRS.

Reverse Gravity

“It hasn’t gone anywhere in a while, so it should jump.”

There’s no reverse law of grav­i­ty that says if a stock has­n’t gone up in a while, it’s build­ing up some kinet­ic poten­tial that can beat mar­ket iner­tia. I like to think of this as “wish­ful think­ing”, and when you invest this way, it’s “wish­ful bet­ting”.

Some com­pa­nies have a rea­son to not go any­where for a while. Usually it’s due to some uncer­tain­ty, like when Duke Energy had some CEO dra­ma after recent­ly com­plet­ing a merg­er with Progress Energy. The Progress Energy was sup­posed to become CEO after the merg­er, but at the last minute Jim Rogers took his place. The con­tro­ver­sy depressed the stock until it was resolved. However, when a com­pa­ny’s mar­ket posi­tion is unclear, pos­si­bly due to per­ma­nent changes in the mar­ket (and the economies of that mar­ket), just because the stock­’s down for a while does­n’t mean it has to come back. Think Microsoft. It’s been most­ly flat for 10 years. Does that mean it bounces? Surprisingly, some peo­ple think so sim­ply because it’s been flat for so long.