Expert: Paul Henneman - 5/24/2006

Question
Hey, I'm a beginning investor (just 18) and I'm trying to get my feet wet in investing so I'll have experience later on when my investing decisions will really affect me.  As my first purchase, I bought a few shares of Getty Images (GYI) at around 80.  It was holding steady there for awhile, then plummeted to 60 before rebounding to about 65 where it is now.  I checked the news when it started dropping, and it looks like the only bad news around the time it started dropping was that it missed earnings estimates by a penny a share, which doesn't seem significant enough to warrant a 20 point drop to me, especially since the fundamentals of the company still seem strong.  Can you tell me if I should have sold when the stock started dropping, or is my current plan of holding on and trusting that because the company is still fundamentally strong, it'll rebound a valid one?
Also, what do you when a stock starts dropping and you don't know why?  (Ie, there's no real bad news that you can see, but it's dropping day after day quite a bit).
I've heard it's a good idea to set a limit of a certain % that you'll let a stock drop before you'll sell it, or a certain % that you'll let it climb before you sell--is this a good idea, and if so, can you offer any guidelines?
And one last question, though if you're not interesting in doing my research for me, that'd be ok.  What do you think of American Standard (ASD)?  I've checked the reports and it's got good earnings, a reasonable P/E and no red flags, so I think that'll be my next investment, but there might be something there that a more seasoned investor would spot that I would miss (Like with GYI, I noticed that the fundamentals were good when I bought it but I didn't realize that the P/E was dangerously high).  If scouring through info on ASD is not so fun, then could you tell me a few things I should watch out for that I might not realize?  Thanks :)
-Dan Wendler

Answer
Dan,
  Thank you for your questions! First, congratulations on your analysis, and approach to investing at such a young age. I can tell you that I approve of the way you are doing your research, with a stress on earnings and fundamentals. I believe you are going about it correctly, and will get better the more you practice. I also agree with you completely that the more practice you can do before actually investing, the better.
   Now on to your examples. Unfortunately I cannot offer much guidance here. You appear to be doing what you should be in your analysis. Sometimes things just do not go your way, no real way to explain it. Even the best of analysts and wall street professionals are not right more than 60 or 70 percent of the time. I would suggest looking at a slightly larger number of stocks, even if this means your analysis may not be quite as complete. If you find 10 stocks for example, and over a one year period the majority make money, you are doing great.
   Also, rather than measuring your performance in the short term for individual stocks, instead look at your cumulative performance for the year. The S&P500 index is a good benchmark to measure yourself against, the idea being that you want to beat overall market average performance for the year. For example, you may be up 20% for the year and be happy with that, but if the market is up 30%, then you would have been better off simply in an index mutual fund.
   You won't beat the index every year. And it also depends upon how agressive an investor you are. When tracking 10 or 20 stocks, you can really diversify: some can be more agressive investments, some more conservative. I believe in spreading out into different sectors as well, make sure that no more than 25% of the stocks you are tracking are in one sector.
  You may be working with a very small sum of money at first I realize. You could still invest in just a few stocks, but track a larger portfolio until your funds warrant holding 10 or 20 stocks. There are some services online like www.FOLIOfn.com that make trading small portfolios very effective. I would suggest looking at that service closely, for $19.95 a month you can have a portfolio of up to 50 stocks, and essentially trade them whenever you want. (there are some restrictions, but they are not all that bad). It makes it economical to hold 10 or 20 stocks with just a few thousand dollars.
   My final suggestion would be to always place the earnings and other fundamental data within a context. For example, what is a 'high' P/E ratio? It is different for each industry. It is important to compare the P/E to the main competitors, and to the industry as a whole. If better than average, you are on track. You will at times be suprised to see that what may look like a good P/E is actually average or even below average for a particular industry.
  I cut and pasted a table of data below for ASD as an example. The formatting will almost certianly be messed up when you receive this through All Experts, I hope that you can make sense of it. The idea is that for each data point there is the data value itself, then a 'rank' for that data point. The Rank is roughly a percentage, so a rank of 50 would be perfectly average for that data point. A rank of 99  would be in the top percentile, and a rank of 1 would be the worst percentile. The ranks in the below data are for all stocks that my company covers, 4,500. So it is not industry based, but overall market based. I hope that makes sense.


Valuation     1.21% overvalued     Valuation Rank      57
1-M Forecast Return   0.58%    1-M Forecast Return Rank    45
12-M Return    -2.21%    Momentum Rank    31
Sharpe Ratio    0.60    Sharpe Ratio Rank    78
5-Y Avg Annual Return    13.82%    5-Y Avg Annual Rtn Rank    68
Volatility    23.06%    Volatility Rank    84
Expected EPS Growth    15.03%    EPS Growth Rank    43
Market Cap (billions)    8.56    Size Rank    94
Trailing P/E Ratio    16.60    Trailing P/E Rank    77
Forward P/E Ratio   14.43    Forward P/E Ratio Rank    66
PEG Ratio   1.10    PEG Ratio Rank    49
Price/Sales    0.82    Price/Sales Rank    74
Market/Book    9.95    Market/Book Rank    8
Beta   0.84    Beta Rank    56
Alpha   -0.08    Alpha Rank    32
Dividend (Yield)   0.72 (1.71%)     

I hope that that this is of some help to you. If I have simply confused matters, or if you have a follow up question on any of the above, please do not hesitate to follow up with me!

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com
www.ValuEngineView.com
www.VEReports.com
www.VEInstitutional.com