The Only Three Questions That Still Count: Investing By Knowing What Others Don't, 2nd Edition

Always Look at It Differently

Investors fall prey to myth because they’re used to seeing investing truisms in accepted and normal ways—as they were taught. Once you start thinking even a bit differently—not in a complicated way, just differently, like graphing a bell curve or looking for the same phenomenon overseas—myths tend to fall apart. Whenever you’re confirming an investing belief, try it from a fresh angle. Go crazy. Be creative. Flip things on their heads, backward and inside out. Hack them up and go over their guts. Instead of trying to be intuitive, think counterintuitively—which may turn out to be much more intuitive.

For fun, let’s look at why, intuitively, high P/Es don’t spell disaster for stocks. Most investors look at stocks with high P/Es and assume their prices are too high relative to the companies’ earnings. If a price is proportionately much greater than earnings (so goes the thinking), the stock must be overpriced; what goes up must come down. What investors forget is the P isn’t the only moving variable in the P/E.

In years following high-P/E markets, earnings often rose faster than share prices. And often after low-P/E years, we ran into unexpected rough economies where earnings vanished. In fact, in 1929, the most famous market peak of all time, P/Es were low, not high, because the soon-to-disappear earnings were too high in 1929, making the P/E low.

When we buy stocks, we’re buying future earnings. At some times we’re willing to pay more than at others. ...