One common occurrence that I have seen many investors make, including myself, is placing a position in a stock at the wrong time. My last article detailed the importance of timing, while this article will concentrate on the importance of staying focused and emotionally stable when things don’t work out as expected. In the past, I would study a stock’s chart, the fundamentals, the general market health and everything else that I felt necessary before placing a large sum of cash behind my beliefs. When things went wrong and I was forced to sell for a small loss, I would drop the stock from my watch lists and remove it from my memory. This was one of the biggest mistakes that I was making during my earlier years of investing. The greatest investors study their mistakes and learn why they were wrong. If you don’t learn from your mistakes, you will continue to repeat them and never move to the next level.

I was usually correct with my analysis on the particular stock but many times I was too early with my entry point during a new up-trend. Months later, I would come across the same stock in my screens but it was now up 25%, 50% or more from my initial buy point and stop loss. I would be frustrated for selling my stock too soon and was getting tired of using rules and missing big winners that I sold for a loss. I knew money could be made in Wall Street by using the law of averages to my advantage and employing strong money management skills but I needed to employ the rules more consistently. I started to practice what I was taught by selling my losers quickly and allowing my stronger stocks to ride their trends. Over time, I was experiencing a few more losers than winners but my stake was growing because these losers were smaller in size than the winners. The words written in the books were true; Jesse Livermore, Gerald Loeb and William O’Neil were all accurate with their lessons about cutting losses quickly.

I kept using my system of trial and error and started to record every thought and transaction I made. With my revised philosophy in place; I continued to study the stocks that I was forced to sell and tried my best to re-purchase, even at higher prices than my original position if the time was right. Even now I have these issues, the greatest traders of all time always had these issues and every fund manager must decide if the time is right. My latest example, which can relate to almost everyone in the community is Paincare Holdings, a stock that was purchased solely as a “test buy” that I was forced to sell. If things turn around and the general market starts to rally, I would have no problem buying the stock at a higher price than my original position if the opportunity presents itself.

LaBarge is another example, first showing up on the screens at $9.35 but during a down-trending market. The new pivot point and buy area was $14, over 50% higher than the original price but a solid entry point regardless of past gains or prices. Mentally it is always the toughest to buy a stock at a higher price than you were watching it at an earlier date but it can be the most rewarding strategy. Never look at a chart and toss away a candidate because it has moved up 50% or even doubled in recent months, the real move may just be beginning.

The moral of this article is to make you understand that timing may be your only issue when buying stocks so never throw away a possible superstar because you bought too soon. Keep it on your watch list and be prepared to initiate another position, even if it will cost you an extra point or two. If you buy again and it doesn’t work out, re-peat the process, there is always a chance that the stock was not meant to be or your analysis was slightly faulty. In either case, learn what you are doing right and wrong so you can be prepared to use those lessons with the next stock.

About the Author

Chris Perruna is the founder and president of MarketStockWatch.com, an internet community that teaches you how to invest your money with solid rules. We don’t stop at just showing you our daily and weekly screens, we teach you how to make you own screens through education. Through our philosophy, you will be able to create your own methods and styles to become successful.

Many value investors will pass on a growth stock that has a P/E ratio higher than a predetermined level. For example, they may discard all stocks that have a ratio of 15 or higher, no matter what industry group they come from. Some investors will discard any stocks that have P/E ratios above the industry group averages, concluding that they are grossly overvalued. I am not saying that this method doesn’t work, because it does but it will not work when you focus on buying young innovative small cap stocks that are growing at tremendous rates, rates that “big caps” can no longer sustain.

I have never passed on buying a stock due to its P/E ratio being too high. What is too high? Too high to one investor may be low to another investor. This is the same logic that I use when speaking of stock’s prices. One problem that have with some value investors is their lack of understanding of the movement of the P/E ratio line on a chart. As a stock begins to move 100% or 200% from its pivot point, the P/E ratio will also move higher over the course of time. Plotting the P/E ratio on a chart will show you how much of a gain the ratio has made as the stock continues its up-trend.

Value investors that pass on buying stocks with P/E ratio’s above a certain threshold have missed some of the biggest winners of all time (the 10-baggers as Peter Lynch would say). Analysts frequently downgrade stocks when their P/E ratios cross what they believe to be fully valued thresholds.

The P-E ratio uses a stock’s current price and divides it by total earnings per share over the past four quarters. For example, currently GDP has a P/E ratio 51.06 with a share price of $24.00. Its last four quarters of EPS add up to $0.47. Its P-E ratio is $24.00 divided by $0.47, or 51.06. MSN Money Central has the P/E ratio listed at 51.30.

Growth stocks usually sport higher P/E ratios than the rest of the general market, even at the start of up-trends. A high P/E ratio typically means that the stock is enjoying strong demand. If a stock climbs in price from 40 to 60, its P/E ratio also gains 50%. Even though the P/E ratio may be high according to some analysts and value investors, the stock may be about to breakout from a cup-with-handle and go on to double from this point. Would you want to miss out on a possible 100% gain because the P/E ratio is too high?

Investor’s Business Daily conducted an excellent case study in 1996-97: “The 95 best small- and mid-cap stocks of 1996-97 had an average P-E of 39 at their pivot and 87 at the peak of their run-ups. The 25 best large caps of those years began with an average P-E of 20 and rose to 37. To get a piece of these big winners, you had to pay a premium.”

When I purchase a stock, I note the current P/E ratio and chart it along with the price. Historically, P/E’s that move up 100%-200% or more while the stock is advancing, usually become vulnerable stocks and can start to become extended and flash sell signals. It holds true for a stock with a P/E starting at 15 and going to 40 or a stock with a P/E of 50 and going to 115. Don’t skip over EXCELLENT companies that are growing at amazing clips because of a high P/E ratio. What may seem high now, may be low later on! Earnings and Sales are much more important. Price and volume are the most important. The P/E ratio is just a secondary indicator that can be used to further analyze the stocks in your portfolio.

Always use price and volume as your first line of offense and defense. From this point, turn to some dependable secondary indicators to confirm your original analysis and then make a decision. I would never throw out a stock because its P/E ratio is too high. Take GOOG for example, every value investor missed the 100% gain that this stock boasted after the release of its IPO. Growth stocks are expensive for a reason, don’t forget the analogy to a Mercedes.

About the Author

Chris Perruna is the Founder and President of MarketStockWatch.com, an internet community that teaches you how to invest your money with solid rules. We don’t stop at just showing you our daily and weekly screens, we teach you how to make your own screens through education. Through our philosophy, you will be able to create your own methods and styles to become successful.