General Stock Investment Strategies/RE: Luxotica

Advertisement


Question
Hello Tad,

I had a disagreement with my friend concerning purchasing the company stocks of Luxotica.

Luxotica is the parent company of Lenscrafters and trades in the US stock exchange as lux.

Although the company has good fundamentals, I argued the stock wasn't worth buying because of the high price earnings ratio. On top of that, given current market highs, I think we're due for a correction. If the stock price does correct, I may buy it if the p/e ratio is just right. I also told my friend that he's better off buying another stock that is going for cheap, providing the fundamentals are in place.

My friend, in turn, argued that what is going on in the stock markets doesn't matter. Although he recognizes that the P/E ratio for Luxotica is high, the stock price will go up regardless. If the stock price corrects, he'll just be happy to buy more shares.

I wondered what is the point in that since a low P/E is a good entry point to buy a stock with good and consistant fundamentals.

With regards to the two school's of thought, who is correct?
Is Luxotica worth considering a look at?

Answer
This isn't specific to Luxotica...the P/E ratio is just one factor to look at, and it can't be the only one. Usually the P/E reported is the "trailing" one based on the earnings over the prior 12 months, and the current stock price. What gives a stock value is its future earnings, not its past earnings. And of course, the future earnings are unknowable. The historical earnings are just an indicator of what they might be, and may not be a good indicator depending on the company's specific situation. If earnings are expected to grow a lot in the future, a high "trailing" P/E could be associated with a "cheap" stock.

So it isn't as easy as just buying stocks with the lowest P/Es. That can be a starting point, but if you pick only the lowest-P/E stocks you'll end up with many that have low P/Es because their earnings are expected to decline, justifying lower stock prices in the future...and you'll exclude high-P/E stocks that are arguably "cheap" because the earnings were low recently for only temporary reasons.

In your question you mentioned a couple times buying a stock if the fundamentals are in place. Really that's the question...are the fundamentals actually in place? All companies are subject to a variety of risks specific to their industry, plus risks related to financing, the global economy, regulations, bad management, etc. The ones that have minimal risks often have minimal growth potential, so sell at low P/Es because they're unlikely to grow earnings much. It just isn't easy to say that a company's fundamentals look good for the long haul. I've been well served by assuming that just about any company's prospects can look completely different after even just 5 years, and looking out 10+ years it's very likely some major change will happen along the way (there are very few "buy and hold forever" investments).

Regarding the timing question, a portion of most stocks' price movement is tied to how the overall stock market is doing. If the stock market goes down 5%, it's likely that most stocks will be affected by that and will also drop. So yes there is an argument for not buying in when the overall stock market is high. There are two decisions to make though. First, is the market so high that it's likely to drop significantly, justifying avoiding purchases entirely? And second, will company-specific factors be more important - to the point where you should buy a stock no matter what the overall market is doing? These aren't easy questions. Even just judging whether the stock market is "too high" is difficult and it can be costly to get that wrong. Waiting for a specific stock to get cheap can mean never getting a chance to buy it. Long-term, investors need to play a balancing act, trying to avoid buying into bubbles while also not being so cynical as to sit in cash forever.

Good questions though, they go to the heart of why you buy stocks - hard to answer in a quick post, but hope that's helpful.

-Tad

General Stock Investment Strategies

All Answers


Answers by Expert:


Ask Experts

Volunteer


Tad Borek

Expertise

I am a San Francisco-based investment adviser and attorney.

Experience

I opened my investment advisory practice, Borek Financial Management, in 1999, and have been a licensed attorney since 1993.

I received my B.S from Cornell University, and a J.D. from George Washington University Law School.

©2016 About.com. All rights reserved.