Patience is virtue. It is a state of being that is developed over time. Being a good investor is about more than finding a great company at a great price. If you don’t have enough patience, your chance of earning a reasonable return is very small. Understanding a company’s valuation and its prospects is important, but you need to be able to wait years for time to work its magic.
Valuation Analysis 101
The price to earnings (P/E) is one of the most commonly used metrics to value a company. Beginning and advanced investors use this number to help understand if a company is a good deal. What is commonly left out of the discussion is the fact that the predictive power of the P/E ratio over short time frames is limited. Studies have shown that a P/E ratio is much better at predicting the next 10-year returns than the next year’s return.
The longer the investment horizon, the better
The SPDR S&P 500 ETF Trust (NYSEMKT:SPY) is one of the most popular exchange traded funds (ETFs). It offers a simple way for investors to invest in the global economy while paying a net expense ratio of just 0.0945%. It is important to remember that investing with a 20-year investment horizon is better than a 10-year investment horizon. If the S&P 500 follows the trend it set from 2000 to 2010, its future return will be negative. If you add another 10 years to the period and start at 1990, suddenly it has a positive outlook.
You cannot predict the future, but you can use the future to your advantage. Right now, you can buy this ETF at around a one year forward P/E ratio of 15, a current P/E ratio around 17, and a price to book ratio around 2.4. This places the ETF in the middle of its valuation range. It is not terribly cheap, but it is not terribly expensive. If you have the patience to wait 20 years, then there is a good chance you will be sitting upon a positive return in your investment account.
Cheap companies in the S&P 500
VLO Total Return Price data by YCharts
With a P/E ratio around 6, Valero Energy Corporation (NYSE:VLO) is one of the best deals in the S&P 500. There is a good reason for this discount. Wall Street loves to look a few months ahead, and Valero Energy Corporation (NYSE:VLO) is becoming a more volatile stock with thinner margins. The company takes hydrocarbons and refines them to make gasoline, diesel fuel, jet fuel, and other products.
In the past couple of years, Valero Energy Corporation (NYSE:VLO) has made a killing by buying cheap U.S. oil and selling expensive gasoline and diesel fuel overseas. Now, the spread between international gasoline prices and domestic crude oil is falling, and Valero Energy Corporation (NYSE:VLO) is facing falling margins.