In the first article about 4 of the big players of the computer manufacturing industry, I looked at how these computer stocks performed since 2007.
By looking at growth histories spanning back to 1997, I sought out to determine whether such a long viewpoint could be a better indicator on stocks likely to outperform moving forward. You can read those conclusions in this article.
With this article here, I want to postulate whether an investor could combine the findings from the first article with some standard value investing metrics to improve results.
Recall that the first article showed that the two big computer stocks winners, AAPL and NICE, had high valuations in 2007. This is to be expected from companies growing and performing well during the peak of a bull market. The other interesting result was that the one company with favorable valuations in 2007, HPQ, ended up being the big loser. But upon further research, I’ve discovered a couple more interesting developments.
What if we had put a simple criterion on these 4 computer stocks? Such as only buy their stock when the P/E is below 35…
A P/E below 25 is a general screen used by many investors as a starting point. I tend to be a little more flexible than the public when it comes to any one single metric, and I’ve been known to buy above 25 in the right situation.
Now IBM and HPQ would’ve qualified at all times because their P/E was never above this (neither have ever really been considered growth stocks).
Looking at AAPL’s chart above, the P/E below 35 criteria would have you buying after the bull craze of expensive stocks—right around mid to late 2008. Depending on your timing, you’d hit right during the crash or immediately after. Obviously after the crash would be more ideal for ROI, but today we have the benefit of hindsight. So, while this criterion could’ve been helpful had you gotten timing perfect, I don’t see it as particularly useful for AAPL.
Here’s where investors would be pickier, having to hold off on NICE until mid-2009 and mid-2013.
Buying in 2009 would’ve added to the overall performance, resulting in an over 200% return vs. 81%.
Buying in 2013 would have put the return at around 81% as well since the price had recovered to its 2007 high by then, but it also could’ve potentially saved buying in 2007 to put the capital elsewhere.
While this simple P/E criterion is nice, what gets especially interesting is when we combine it with net income growth.
Generally, you’d think a falling P/E is better because it signals a stock getting cheaper. But when you combine it with falling net income, as shown with HPQ above, you can see that it becomes like trying to catch a falling knife.
I mean sure the P/E eventually bottoms out, but at point you’re playing the timing game. Lower valuations hurt performance here. Compare this to AAPL’s chart.
You can see that falling P/E with rising net income signals better buying opportunities. The P/E would rise as the stock price did, as is only natural, but the best buy points presented themselves as P/E was falling or in the lower range. The rising net income is the key component here differentiating HPQ from AAPL, and it’s even more clear that both the net income and price rose exponentially nearly simultaneously.
IBM confirms this thesis even further so. In the years that the company had rising net income, falling P/E ratios signaled good buy points. In the years to follow with falling net income, the opposite was true. Valuations matter and have proven to be able to boost investors’ performance. But don’t discount the influence of growth in the equation, as this case study of the computer stocks industry has “NICE-ly” showed us here.