Considering valuations when investing

[YoungFlyingSaver]

To start with: I am NOT a proposer of market timing neither stock picking. I completely understand the benefits of index investing, as well as the buy and hold strategy.

My question is: do you guys consider at all valuations when you invest? What I mean is, do you look at PE/PB ratios, underperformance and other indicators when you buy securities? Or do you just have your asset allocation picked beforehand and just stick to it?

I am asking, since I have been investing for almost 2 years now and tend to change my asset allocation somewhat based on valuations. (There are also some ETFs that follow this strategy, the RAFIs for example) What do you think about this topic? Would appreciate any insight from the long-lived investors here

 

[Whisper66]

I pick a range of asset allocation I am happy with. For us that is 65% equities through 90% equities.

If the market is highly valued, I tend to sell my "winners" and lower the asset allocation toward the lower end (65%). If the market is very low valued, I will look for buys and move toward the upper end (90%). So it's a very muted market buying type thinking I suppose. But one I'm comfortable with. Most anything I buy will have taken a 20% hit before I buy it. The exceptions are good dividend paying companies which I might buy with only a 10% hit (being retired, I like income).

 

[donheff]

I think we all think about it and I have seen threads here where people agonize over whether to immediately invest a windfall at their chosen AA or dollar cost average it in. I got a chance to face that choice last year when I sold my weekend house and had a large amount to invest. Looking at the PE/10 it was clear the market was historically high and due for a correction eventually, just as it is now. Ultimately I decided to invest it at my AA immediately. I ended up satisfied that I did although I would have been a bit irritated had we had a major correction right after. For me it was just easier to get it done at once and I would have been just as irritated if I dribbled the funds into equities and missed a some big gains. Thinking back I can't even remember whether say a six month dribble in period would have made a material difference.

 

[marko]

Thinking back I can't even remember whether say a six month dribble in period would have made a material difference.

Agreed. In life in general, I don't like jumping through hoops, analyzing something to death only to make a gain of a few bucks. Work vs reward calculation.

 

[audreyh1]

I intend to move to a valuation sensitive allocation model when I add a new lump sum to my retirement portfolio this year - this lump is currently in cash. It will only range from 50% to 60% equities though, I'm not comfortable going above or below that range.

With current CAPE10 > 25, that would have me changing from 51.5% to 50% equities, so it's not a huge move. But I will feel more comfortable about investing the new money which is what brought me to this new model in the first place.

My other bound is for CAPE10 < 18, allocation would be 60% equities, and a linear slope between the two. So 55% equities at CAPE10 = 21.5.

 

[OldShooter]

Here is something to consider: Whether you are buying or selling, the strong odds (I have read 95%) are that your counterparty is a professional. He/she knows far more about the stock than you do and has vastly more resources and information. If you're buying, this professional believes that the stock's upside potential is not as good as other investment options that he/she has. If you're selling the professional believes that the stock has upside and hence he/she is a buyer.

There is also the efficient market theory which, though certainly debatable, argues that the market price is the consensus stock valuation by all the [professional] traders and investors. Hence, you are left with a random walk and any decision to buy or sell is simply a roll of the dice short-term. Long-term may be different as some factors (small size, value pricing) have been shown to be better investments than others (growth). So that is probably the place to focus if you're looking to invest in a specific stock for the long haul. For short term trading, have a nice random walk!

 

[samclem]

I am asking, since I have been investing for almost 2 years now and tend to change my asset allocation somewhat based on valuations. (There are also some ETFs that follow this strategy, the RAFIs for example) What do you think about this topic? Would appreciate any insight from the long-lived investors here

I believe there's merit in the approach, but I would not pay any extra in costs for an ETF or mutual fund to execute the strategy for me. If you vary from a fixed allocation in order to take into account valuations, you have to be prepared to be "wrong" for a long time (i.e. a decade or so). Also, I do not believe CAPE-based strategies are powerful enough to merit "all in or aall out" investing: like Audrey, I will vary my stock allocations based on allocations (about +/- 10% in my case). This appears to improve return while reducing risk. Folks who get entirely out of equities just based on high valuations can take a beating over time, they miss out on dividends and sometimes the alternatives also don't do so well.
You'll find lots of discussion about this topic here, try a search using "CAPE" "PE10" Schiller, etc.

 

[Proteus126]

Would making use of a single mixed fund like Wellington/Wellesley be a decent way to sidestep the issue?

Say for instance you inherit a decent chunk of change and you already have a 70% equities 30% bonds asset allocation. Would the action of dumping all of the new cash into Wellington (2/3 equities 1/3 bonds) be both consistent with your asset allocation and also somewhat shielded from the need to sweat market valuation?

 

[photoguy]

Although I'm a big believer in valuations being predictive (in a statistical sense) of future returns, I don't actually use this information much. Why? because regular rebalancing with set percentages already trims highly valued assets and increases investments in "cheap" assets.

The only times I have actively considered valuations are: (1) when I started investing and I didn't have enough money for the all asset classes I wanted, I prioritized putting new money into those assets with the lowest valuations. (2) Recently I trimmed my REIT allocation percentage due to valuations being higher than I like. Yes I consider this market timing.

 

[Totoro]

My question is: do you guys consider at all valuations when you invest? What I mean is, do you look at PE/PB ratios, underperformance and other indicators when you buy securities?

Disclaimer: I may not qualify as long-lived.

In my individual portfolio valuation is a strong component, mostly as a disqualifier: Great companies at silly high valuations are kicked off my buy list, or become sold. P/FCF and P/E averaged out over the last ten years tends to be the first thing I look at. P/B is mostly used for financial firms (Banks, funds, insurance, real estate).

For the index: I want to be overall at 80% equities, but given the current valuations I'm sitting on a significant cash portion. I did allocate some to non-US stocks end of last year, also driven by valuation. Plan on never going below 35% total equities.

 

[Nature Lover]

To start with: I am NOT a proposer of market timing neither stock picking. I completely understand the benefits of index investing, as well as the buy and hold strategy.

My question is: do you guys consider at all valuations when you invest? What I mean is, do you look at PE/PB ratios, underperformance and other indicators when you buy securities? Or do you just have your asset allocation picked beforehand and just stick to it?

I am asking, since I have been investing for almost 2 years now and tend to change my asset allocation somewhat based on valuations. (There are also some ETFs that follow this strategy, the RAFIs for example) What do you think about this topic? Would appreciate any insight from the long-lived investors here

When I was younger, I traded a portion of my portfolio (shorter-term speculations)...and valuations were an important consideration for the trades. However, for the majority of my investments (the long-term portfolio - and where I invested and made much more $$$)...my approach was mostly a "buy and build" approach (investing and building the portfolio every month).

To the extent my portfolio included different asset classes, I wanted to keep the asset allocation near to my then preferred AA. Naturally, to accomplish this, each new investment was used to purchase shares of the asset class(es) that moved me more towards that state. Since overextended markets tend to result in those markets/asset classes becoming overweighted in the portfolio's AA, this approach over time continually pushed my new investments into buying lower valuation, underweighted asset classes. So, yes, valuations played a role - but it was buried in my approach to keeping to my AA; and I didn't have to spend any time/energy trying to guess which, if any, of the markets were overvalued. I almost always needed to invest in those asset classes that were undervalued at the moment (or at least relatively undervalued).

As for changing my preferred AA....I did make changes in my AA over the years, but these changes were the result of my progressing through life, experiencing changes in life circumstances, approaching retirement, and finally retiring. They weren't driven by valuations.

NL

 

[CyclingInvestor]

Relative valuations are important to me. I have kept nearly 100% in individual stocks since 1993, and retired in 2006 at 48.

I track 20-25 high quality (IMO) large cap dividend stocks at any given moment, and usually own about a dozen. The only valuation I use is their current PE/historic PE. Whenever one of the stocks I own has a ratio far enough above one of the stocks I do not own in my group, I sell it and buy the second stock. Turnover is low - I made no trades in 2016 or so far in 2017. It takes about 5 minutes per week to update my database.

The last 8 years of my career were spent working with 'stock market professionals', and I have no problem being on the other side of their trades.

 

[Blue Collar Guy]

the year 2000 cured me of valuations

i bought individual stocks up till the year 2000, my stock picker was another blue collar genius like myself, we took such a beating with the tech stocks, that i never looked at valuations p/e's again. i just buy the total market and small caps . i can give u the symbols of the lemons i bought hahah .

 

[UnrealizedPotential]

I strictly just buy mutual funds and ETF's these days. Ten or Fifteen years ago when I bought individual stocks I didn't pay attention to valuations. It showed. I did terrible. Luckily I didn't make big stock purchases. Valuations are important along with earnings in individual stock selection. But I have no talent for it. It is much easier to buy a fund and let the professional money manager do it for you. There are some who are good at picking stocks. But most investors are not that good. There is a reason why index funds are so popular. Nowadays I dollar cost average so I do not worry about valuations in either a good stock market or bad one.

 

[LOL!]

I definitely make market timing trades using index funds and index ETFs. While I don't look at PE nor PB, I do look at asset allocation percentages and very recent price actions. All this is chronicled in the thread I started: http://www.early-retirement.org/forums/f44/lol-s-market-timing-newsletter-57042-73.html which is the most viewed thread in this subforum.

So far in 2017, I have traded an almost 7-figure dollar amount of securities in a tax-efficient way and I am beating my benchmarks handily. But there is still the rest of the year to go and my portfolio could easily end up worse than the benchmarks by year-end.

A 3-part posting of my philosophy is found starting at: http://www.early-retirement.org/forums/f44/lol-s-market-timing-newsletter-57042-65.html#post1787189