Unless you work in the finance industry, most stock market news is heaped in with other headlines. The White House launches Space Force, the Mets are having the worst season of all time and Bayer’s stock is down 10%. But some finance news is tough to ignore — like when Facebook tumbled 20% in a day recently, causing CEO and founder Mark Zuckerberg to lose $17.6 billion in his net worth.
It sucks to be Zuckerberg (just this once), but it does raise the question: Should I go out and buy some Facebook stock right now? And what about other companies grabbing headlines for landing in the toilet, like Papa John’s or CBS? Yes, there are financiers around the world who spend their lives observing every in and out of the market, but what about the rest of us, who just notice the news and want to make a buck?
If there’s any investment advice that neophytes do know, it’s to buy low and sell high. Is that the case with a blockbuster stock like Facebook and the ongoing public relations nightmare that is Papa John’s?
“It’s a nice and noble goal in theory to say, yes, you should buy low and sell high,” Amanda Agati the co-chief investment strategist at PNC Financial Services Group, said in a phone interview. “But almost always nobody ends up doing that, right? When things fall precipitously, whether it’s a stock or index or the market, fear and uncertainty creeps in pretty quickly. What’s causing this decline, and how do I know what this is the bottom? It’s not a black-and-white decision.”
The question is simple but, indeed, the answer is not black and white. Here are some things to consider when looking at these suffering stocks.
How quickly are you looking for returns?
The problem with buying low is you need a lot of patience. “It’s always very important to know where this investment fits in your overall plan,” Ken Hevert, senior vice president at Fidelity Investments, said in a phone interview. “If it’s money you need, or money you have earmarked for something in the near term, then you should consider a much more conservative approach. Start at that fundamental level: What is this money for, and what’s my time horizon?”
If the money is actually discretionary, and you won’t need to cash out in the next few years, then you can take a bigger risk, Hevert said.
Is the company’s fall only temporary?
“When you’re talking about a stock taking a sharp fall, we can’t sort of blindly buy the dip,” Agati said. “We have to understand why the stock has fallen. There’s potentially real value when the stock price has fallen because of temporary factors. It becomes a bargain because it’s trading below its ‘real’ or intrinsic value that we assign to particular stock. The challenge is that stock prices fall for all sorts of reasons. It might not necessarily be something temporary in nature — it may be something that’s more structural causing it. Investing is not for the faint of heart.”
After all, even when it seems like a company can’t go lower, it can. “When you buy the stock you thought was cheap but it continues to get cheaper, and cheaper and cheaper, that’s what a value trap looks like,” she said. “Even the most astute, experienced investors can find themselves from time to time in value traps. The financial crisis is a perfect example of how really seasoned investment professionals continued to buy a number of companies that ultimately went down to trading at a couple of dollars or even zero.”
Does the company still have earning potential?
Agati recommended examining the real or intrinsic value of the company, and Hevert recommended just the right jargon to help determine that value: the P/E ratio. “The P/E ratio [or price-earnings ratio] is the stock price divided by the projected earnings of the company,” he said, noting that in the S&P 500, an average P/E ratio is in the low- to mid-20s. “By understanding some of the measures of valuation, you’ll get a better sense of whether you’re going to achieve your investment objective.”
Anyone can determine a company’s P/E ratio by googling it, but it’s not like a credit score, where a company has a good one or a bad one. It’s just a helpful tool to determine if you’re making a solid choice — you could compare it to companies you know are solid. Facebook’s P/E ratio went as high as 109 in 2015, indicating that shares were very expensive compared to their earnings but investors anticipated the company would do well in the future. Now, in 2018, it’s relaxed to 28.26.
“P/E ratios vary by industry, by sector, by maturity of the company, whether it’s at IPO versus a company that’s been around for generations,” Hevert said, which is why he wouldn’t advise one specific number or range to look for.
Do you have a good feeling?
When considering two companies making news, like Facebook and Papa John’s, it’s not difficult to theorize which company can bounce back; you don’t have to be an investment banker to stumble upon that analysis. “Facebook is a very unique business model, differentiated from basically all others,” Agati said. “There absolutely is a sustainable business model and edge there. They’re also a disrupter, in the tech world.” Whereas with Papa John’s, “What is the competitive landscape for pizza?” she said. “Anyone can open a pizza shop. It doesn’t mean Papa John’s can’t do well, but they need to be able to demonstrate a solid business plan, solid fundamentals, growth above expectations, a proven returns profile — all of those components of an investment thesis.”
If your instinct tells you that Facebook is amazing and important and will grow for year to come, that could be reason enough to buy their stock. “There’s the speculative gut feeling, like ’Oh yeah, I love this company, I get it, I understand it,” Hevert said. That’s a part of the speculative approach to investing. But I do think that it’s about doing a gut check by using some very commonly used price ratios and measures.”
“That’s really my answer when I talk to my sons,” Hevert continued. “They say, ‘Should I buy it?’ I tell them what I told you: Maybe you should, maybe you shouldn’t, but at a minimum, you should know what you’re buying, whether the price you’re buying is a reasonable value.”
It’s not the sexiest advice, but such is the stock market. If the choices were obvious or easy, then there’d be no risk — but also, no reward.