You’ve probably heard a lot of people talk about the P/E ratio. It’s one of the most popular fundamental analysis numbers out there. Moreover, it has earned a reputation as one of the key ways we value stocks. And in my book, it’s one you simply can’t avoid.

In a nutshell, the P/E ratio gives us a clue into the real value of a stock. It does so by taking the price of the stock and dividing it by the company’s earnings over the last 12 months. Spelled out:

P/E Ratio = Stock Price / Yearly Earnings

Let’s say XYZ is selling for $20 a share. Over the last 12 months, the company has earned $2. As a result…

XYZ P/E Ratio = $20 / $2 = 10

Since XYZ stock is currently selling for $20 and over the past 12 months the company has earned $2 a share, XYZ’s P/E ratio is 10.

So getting the P/E number is pretty straightforward. But by itself, figuring that XYZ has a P/E of 10 doesn’t really do much for us. It’s just the starting place that makes valuing a company easier. Without it, we’re sort of left in the dark about whether a stock’s price is really worth what people are paying for it. So now we need to dig deeper.

Using the P/E Ratio Makes Valuations Easier

Think about it a second. In our example above, XYZ is selling for $20 a share. But how do we know that $20 a share is a fair price for XYZ?

First off, we take XYZ’s P/E and compare it with other companies in XYZ’s industry. If other companies in the same industry carry P/Es lower than XYZ’s, then we say the XYZ is “overvalued.” Let’s look at a real-life example…

As you can see from this graph, IBM carries a P/E ratio of 12.8. That means its share price is valued at nearly 13 times its last 12 months of earnings. The average P/E for companies in IBM’s sector is just 10.7. As a result, we can figure that IBM is slightly overvalued.

In other words, compared with other companies in its marketplace, you’re going to pay a little bit more for IBM than other players. And the P/E ratio helped us get to this determination very quickly and with very little fuss.

Since IBM is slightly overvalued, does that mean we shouldn’t buy the stock? Not at all. While the P/E ratio tells us something about IBM’s value, it’s not the whole story.

IBM is an industry leader. So just as with any big-name brand, you’re going to pay a little bit more for it. And in my book, the slight difference between IBM’s P/E of 12.8 and the sector’s 10.7 is well worth the premium.

Now, if you are looking to invest in a company with lots of solid growth prospects, you’re quickly going to see that the company’s P/E ratio could easily be much higher than IBM’s 12.8. And the reason that’s so is pretty simple…

Companies with high growth prospects command a higher P/E ratio because investors believe the growth rate is going to translate into higher stock prices down the road. And since stock prices reflect what investors think is going to happen to a company, these high-growth companies usually carry higher P/Es.

Should these higher P/Es drive us away? Not necessarily. Companies with higher growth rates are going to deserve higher P/Es. But the higher P/Es have to be justified by other solid fundamental factors, like exciting new products, top management and good financial operations.

Look at Both the “P” and “E” for Historical Comparisons

In addition to comparing a company’s P/E with its sector, I also like comparing its current P/E with what’s happened in the past. Let’s take another look at XYZ…

Currently, the company carries a P/E ratio of 10. But let’s say that a year ago, XYZ’s P/E was 8. So what does this tell us about the value of XYZ?

Looking just at these numbers, I would conclude that XYZ is becoming higher valued. In other words, investors like the growth prospects for XYZ and are bidding up the stock’s price to prove it.

But before we pop open the champagne, it’s a good idea to take a look at what’s happened to both parts of XYZ’s P/E over the last year.

If the “P” – the price – of XYZ has gone up and XYZ’s “E” – earnings – have gone up, then we’re looking at a growth company that’s commanding a higher stock price. In my book, that’s a positive.

But if the “P” of XYZ has gone up and the “E” has remained the same – or, worse, gone down – then investors are piling into XYZ without much care for earnings. While that’s not always a bad thing, a lower “E” with a higher “P” is certainly cause for concern in my book.

P/E for the Broader Market

No matter what kind of company you’re looking at, it’s always a good idea to have an idea of where its P/E stacks up against the stock market as a whole. And a good way of doing that is to look at historical P/Es for the S&P 500. Take a look at the next graph.

As you can see from this graph, the P/E ratio for the broader U.S. stock market fluctuated between 17 and 25 from March 2005 to September 2008. In fact, the average P/E for the S&P 500 was 19.5 during this period.

In December 2008, the S&P 500′s P/E ballooned to 61. With my data going back to 1936, this is by far the highest P/E on record. And with the mess the market and the economy were in, it goes without saying that this astronomical P/E wasn’t driven by high growth and excellent earnings.

So what’s the takeaway? Simply, that when looking at P/Es for the broader market, it’s important to pay attention to long-term trends with exceptions – like last December’s quarter – taken into consideration.

Drawbacks to the P/E Ratio

Just like every indicator in the book, the P/E has drawbacks. And you need to keep these in mind when you use this popular ratio.

First off, the bottom of the equation – the earnings part – is calculated by the company based on accounting rules. And while many of these rules are in place to protect investors, there’s little doubt that figuring out how a company arrives at its “E” is a monumental task.

Companies can also massage numbers to make their “E” more attractive. And I don’t have to tell you that the unscrupulous ones aren’t above just plain falsifying their books.

But that’s not all…

The P/E ratio can also be calculated using different time frames for the earnings part. The one we’ve used here – the trailing 12-month historical P/E – is the most common, but sometimes the P/E is based on projections that haven’t happened yet. As a result, projected P/Es are less reliable to me than historical P/Es. And you have to know which kind of P/E you’re dealing with.

Best wishes,
Wayne Burritt

September 9, 2009

The Secret of Wall Street’s Most Powerful Number was originally featured in the Penny Sleuth.

Super-investor Warren Buffet once said that his investment philosophy was to buy stocks when others were fearful, and to be fearful when others were buying. Right now isn’t the time to be fearful along with the herd; it’s time to stock up on stocks.

As I predicted earlier in the year, right now the market is zooming higher like there’s no tomorrow.

Let’s begin with this chart of the S&P 500, a good proxy for the broader U.S. stock market…

As you can see, shares of U.S. companies have been soaring. In fact, from a low of 667 on March 6 to a recent high of 1033, the market is up a mind-boggling 366 points.

Translation: U.S. stocks have improved a whopping 54.9% in just a matter of months.

The fact is the market made positive moves long before the economy was showing a ton of life. And if you don’t jump in early, you’re likely to miss the best moves.

And now, with the 960 level for the S&P 500 — the top of the resistance range — clearly out of the way, U.S. stocks are now setting their sights on the next big resistance level of 1313, set way back in August of last year.

Now, getting there won’t be a straight line: 300-plus point moves don’t usually happen like that. So there will likely be the occasional, healthy pullback along the way.

But there’s no doubt: From a technical perspective, the 1313 level on the S&P 500 is the next order of business.

And don’t forget: When we make it back to this level, we’re getting very close to the pre-recession highs of 1500-plus. While that’s by no means a done deal, there’s little doubt we’re headed in the right direction at a solid pace.

But it’s not just the market’s technical factors that have me jazzed. The fundamentals are on the right track, too…

Fundamentals Improving Big Time!

For a while now, I’ve said that the housing market got us into this mess and the housing market will get us out.

Well, the facts are in: Housing is beginning to show consistent signs of life.

Sales of existing single-family homes jumped 7.2% in July compared to the month earlier. That’s the largest increase since the National Association of Realtors began tracking data way back in 1999. Plus, it marked the fourth monthly increase in a row.

In other words, the improvement in the real estate market isn’t just a flash in the pan. It’s here to stay.

But that’s not all. Compared to July 2008, home sales were up a solid 5%. That’s the first year-over-year gain since November 2005. And that means the real estate market is showing significant legs, even when dealing with tough year-ago comparisons.

Another positive: The improvement in home sales is geographically broad-based. Take a look at this chart…

As you can see, home sales improved across the board during July. In fact, they’re up 13% in the Northeast, 11% in the Midwest and 7% in the South. Only the West region showed a small 2% decrease.

And it’s not just the real estate market that’s showing solid fundamental action. The broader economy is looking good, too. According to Federal Reserve Chairman Ben Bernanke…

“Fears of financial collapse have receded substantially… After contracting sharply over the past year, economic activity appears to be leveling out, both in the U.S. and abroad, and the prospects for a return to growth in the next year appear good.”

And he’s not alone. According a survey of economists by the Wall Street Journal, 28 of 45 respondents say the recession is already behind us, and 16 say it will end by December of this year.

I don’t know about you, but that’s a hugely bullish factor to me. But there’s more: GDP forecasts are also on the rise. Take a look…

As you can see, economists are calling for a big improvement in GDP over the next year. In fact, even though GDP contracted 6.4% and 1% in the first and second quarters of this year respectively, analysts are looking for improvements for next four consecutive quarters in the 2.1% to 2.8% range.

Bottom-line: Stock prices are zooming higher and are now cleared to take out levels not seen since August of last year. In addition, strong fundamental factors — including an improving real estate market, a huge call for an end to the recession and solid GDP projections — are adding solid foundation to more price surges. And no matter how you slice it, that’s positive for your portfolio.

Best wishes,
Wayne Burritt

September 1, 2009

Stocks Are Set to Rocket in September was originally featured in the Penny Sleuth.

As you can see, stocks are on a roll. In fact, from a low of 667 in March to a recent price of 944, U.S. stocks are up a mind-blowing 41%.

That’s a ton of upside action in a relatively short amount of time. And while I anticipate the typical 3-5% pullbacks along the way, there’s little doubt this market is headed higher in a strong and decisive way.

In fact, while I’ve told you here many times that I was confident this market was going to head higher, I’m impressed by how solid and steady that uptrend has really turned out to be.

But that’s not all…

The market has powered above the 930 resistance level – set during the beginning of last month – like a walk in the park. That level should now become a solid support level for more movement to the upside.

But here’s where it gets tricky: If you take a long, hard look at a daily chart of the S&P 500, you’ll quickly realize that the near-term 930 level actually balloons to include a range extending all the way to 944. And since that level was established on a medium-term high in January, we’re really looking at resistance in the 930-944 range.

In other words, for the market’s recent action to really get legs, I’m looking for a decisive move above 944, not 930. And since we just pierced 944 this week and have yet to establish support, don’t be surprised if we get some lower prices in the days and weeks ahead.

Now, if you listen to the pundits and talking heads, you’ll probably hear that the move in the broader markets that I’ve been predicting and talking about for months doesn’t have any fundamental power behind it: It’s all just smoke and mirrors.

I love it when I hear stuff like this.

In fact, using many of the so-called experts in the investment field as contrary indicators – in other words, buying when they say sell and selling when they say buy – has put cash in my subscribers’ pockets time and time again.

You can mark my words: When everyone says it’s time to get into this market for good, you can bet your bottom dollar the market’s big moves will be history. It’s just a fact of life that you can’t wait for the herd; you have to take reasonable chances, and you have to have vision of what’s going to happen, not what’s already in the hopper right now.

And while there’s no doubt the broader fundamentals aren’t rosy, they’re certainly on the mend. And the biggest one – recovery in the real estate sector – is beginning to show more life:

• Existing home sales in April jumped an impressive 2.9%, to an annual rate of 4.7 million units. Plus, distressed properties – read: foreclosures – continue to be cleared from the market, a big key for price stabilization down the road

• Interest rates are at record lows, home prices are super-attractive and first-time homebuyers can enjoy an $8,000 tax break. In my book, those are all positives.

And it’s not just real estate fundamentals that are on the mend. I’m also seeing upticks in industrial production, consumer spending and consumer confidence.

Best wishes,
Wayne Burritt

June 5, 2009

Searching for Decisive Market Moves was originally featured in the Penny Sleuth.

Just as I predicted, the broader U.S. stock market continues to surge higher. Take a look at this daily chart of the S&P 500:

The S&P 500 is a good proxy for the broader U.S. stock market. And as you can see, stocks continue to march higher. In fact, from a low of 667 on March 9 to last Thursday’s high of 889, U.S. stocks have shot up a mind-boggling 33%.

But that’s not all. Take a gander at the large arrow on the left of the chart. It marks the summit of the market’s last upside run. Because the market reversed course to the downside that day (Feb. 9) and at that level (875), that peak is called – in technical parlance – a “resistance” level.

The market also failed to penetrate this resistance level just a few trading days earlier, on Jan. 28. All told, that means 875 is a pretty tough point for the market to get above.

That’s why the market’s most recent action is more significant than most investors and traders are thinking: It smashed above key resistance at 875 like a walk in the park. No doubt about it, that shows uncommon technical upside strength.

Here’s the best part: When the market breaks through resistance – especially after failing to do so in previous attempts – that resistance level has an excellent chance of becoming a stopping point when the market decides to turn down again.

In other words, strong resistance – once defeated – becomes solid support for future price action. So when the market pulls back – and it surely will – it’s very likely to not fall too much below 875. And I don’t have to tell you that can be very reassuring.

There’s more good news. Just as I thought, the most recent run continues to be backed by higher average volume. And on the chart, that’s marked by the upward sloping average volume line near the bottom of the pane.

Significant? Certainly. When strong upside runs – especially when they include breaks above strong resistance levels – are powered by increasing average volume, it’s a clear sign that higher prices are attracting more investors and traders. And they’re buying more and more shares to prove it. That means lots of upside pricing pressure in the days and weeks ahead.

But before we start the big celebration, take another look at the chart. Notice that while the market has surged higher, it’s done so with very few significant pullbacks.

In other words, the market’s most recent run since the beginning of March – including a staggering 33% pop in prices – has been practically straight up.

I don’t have to tell you that’s a ton of upside action in a short amount of time. And for someone who’s been around the block a time or two like me, that’s a red flag.

Why? Because like many things in life, markets don’t go straight up for very long. And if they do for a while, it only makes sense that they’re going to pull back and take a breather.

Plus, big run-ups mean some traders are likely sitting on some juicy profits. So when they take some of that money off the table, that selling pressure will cause prices to drop.

Here’s what I’m looking for: Over the course of the next few months, we’ll likely see a significant pullback in the 10-15% range. On the S&P 500, that means a drop of 90 to 134 points.

Now, it probably won’t happen violently and quickly. I think there’s just too much investor optimism for that. But it could easily happen over a few weeks, with downdrafts in the 1-3% range.

Best wishes,
Wayne Burritt

May 6, 2009

Why You Should Remain Cautiously Optimistic As the Markets Surge Higher was originally featured in the Penny Sleuth.

The market has also bounced on higher average volume, which is indicated on the volume section of the chart by the black line. Significant? Certainly. When market moves to the upside are driven by higher-than-average volume, it’s a clear sign that bullish investors are getting involved and are willing to buy shares to prove it.

But that’s not all. To find a similar bounce to the one we’re in the midst of right now, I have to go all the way back to last November. Then, the S&P surged from a low of 741 to 944 in January. That translated to a 203-point upswing, or a whopping 27% upside run.

My take: A bounce similar to the one we’re in right now ignited a move of nearly one-third in U.S. stock prices just a few months ago. Considering that we’ve moved 23% in just a matter of days, my thoughts are the recent surge has decent legs.

Sure, we’re not out of the woods yet, not by any stretch of the imagination. But facts are facts, and the recent market action bears that out: We’re moving in the right direction… especially in one of the most important sectors – real estate.

Ever since the financial crisis began, I’ve said that one of the big triggers of a decent, well-founded recovery – in the economy and the stock market – will be an improvement in the real estate sector. And while the latest news isn’t mind-blowing, there are a few positive morsels.

Remember, I’m looking for positive moves in real estate for a simple reason: Improvement in this sector means increased sales and stabilization in prices. That, in turn, will ignite new lending. After all, with reliable prices and positive sales movement, homebuyers know what they’re buying won’t get crushed. And lenders know what they’re lending will likely be paid back.

Now, even when the real estate market recovers, we’re not going to see the surge in prices and buying that started one of the biggest asset bubbles of all times. A ton of that was fueled by under-qualified borrowers and downright lousy lending practices. And while banks have short memories, they aren’t that short.
Rather, the recovery in real estate will begin with baby steps: small moves in the right direction. And the latest news is just that. Take a look…

As you can see from this chart, existing home sales in February jumped to the upside. In fact, compared with January, home sales were up 2.6% in the West, 6.1% in the South and a whopping 15.6% in the West. All told, existing home sales in the United States increased a solid 5.1%!

The news gets better. Sales comparisons with the same period last year – which tend to be less volatile than month-over-month numbers – show some huge bright spots. In fact, while overall home sales in the United States were down 4.6% in February compared with last year, sales in the West were up a stunning 30.4%.

That’s right, February home sales in the West – which includes the super-important Southern California and Las Vegas real estate markets – rose nearly a third compared with last year. Plus, it marked the eighth straight month of year-over-year increases for the region.

Now get this: With the real estate market in the West generating a whopping 1.2 million units in annualized sales, sales activity is now a staggering 38% above its cyclical low point of 870,000 units marked in October 2007.

That means – from a sales angle – a market bottom in this key real estate region is way, way in… and has been so for months.

So what’s driving the bullish numbers in real estate sales? No surprise here: The median home price in February was just $165,400, 15% below its year-ago level.

Sure, we want to see these prices stabilize. But the fact is with 45% of home sales distressed – either in foreclosure or in short sales – these prices are going to take a hit. And while the process is painful, the market needs to clear off unwanted inventory before it can really begin to get back on its feet.

But mark my words: Lower prices aren’t going to last forever. And it’s not just because sales activity is beginning to accelerate. See for yourself…

As you can see from this graph, the National Association of Realtors says housing affordability is rising fast. In fact, at a current level of 167, home affordability is now 25% easier than the year-ago 133 level.

So what does a Housing Affordability Index (HAI) level of 167 really mean? It’s pretty straightforward. An index level of 100 means that the typical family earning the median income in the United States has exactly enough income to qualify for the average mortgage.

So with the HAI at a whopping 167, the average family in the U.S. has 167% of the income necessary to buy an average home. Talk about buying power!

Bottom line: The stock market is in the midst of a solid bounce. Plus, the real estate sector – a big key to a sustained recovery – is showing signs of life, especially in the important West region of the United States. Together, these factors point to more bullish action for stocks down the road.

Best Wishes,
Wayne Burritt

April 1, 2009

How to Play Real Estate’s Recent Moves was originally featured in the Penny Sleuth.

As you can see from this chart, existing home sales in December shot to the upside. In fact, compared to November, home sales were up 4% in the Midwest, 7.4% in the South and a stunning 13.6% in the West. And while the Northeast took a bit of a hit, all told home sales in the U.S. rose a respectable 6.5%!

Good news? No doubt about it. Rising home sales mean that buyers are coming back into the market. And that means that one of the biggest investments out there for most people — buying and paying for a house — is showing signs of health. Now, factor in the ripple effect sparked by home sales transactions — including banking business, contractor activity and a boost in tons of home-related products and services — and the news gets even better.

But that’s not all. The latest report from the National Association of Realtors also shows that the supply of existing homes is falling. With about 3.7 million units on hand, current existing home inventory amounts to 9.3 months of supply. That’s the lowest supply level in a year and is significantly off last year’s high of 11.2 months booked in April.

The culprit? No big surprise here: Tumbling home prices. In fact, during December the average home in the United States fetched $175,400, down 15% from the year-ago period’s $207,000. And while that’s painful for home sellers, it’s also the sign of a sector beginning to right itself.

Here’s my point…

Imagine you’re an average retail store owner. You’re managing the store day-in and day-out, and you know that times are tough. Sales are weak and customer flow is just not what it used to be. And while your daily bank deposit isn’t terrible, it’s certainly not what is used to be.

So, what do you do? In a nutshell, you hunker down. You buy the products that carry high-margins — read: high profits — and that are in big demand. You keep inventories lean by buying just enough to keep the store stocked. And for those inventories that haven’t been moving, you make the oldest move in the book to get them off the shelf: You drop prices.

That’s exactly what the real estate market is doing: It’s lowering prices and, as a result, sales are beginning to spark. And while that may seem plain and simple, I don’t have to remind you of markets where, no matter how low the prices fell, no one wanted to buy.

Bottom-line: While the real estate market is hardly out of the woods, the latest data is certainly a step in the right direction. And no matter how you slice it, that’s a positive for the broader economy and the stock market.

Best wishes,
Wayne Burritt

January 28, 2009

Existing Home Sales Show Glimmer of Hope was originally featured in the Penny Sleuth.

When our portfolios are headed higher, we usually go out and spend like the dickens.  After all, with nice fat investments we feel like we have a lot more money to spend.  And, as well all know, spending drives the economy.  Result:  Stock prices and the economy get a boost.

In addition, the wealth effect is a brand of self-fulfilling prophecy, which makes it even more powerful…

By investing in stocks that go up, we have more wealth.  Having more wealth causes us to go out and spend.  That spending, in turn, causes the economy to grow.  Economic growth then leads to better times for companies which, in turn, lead to higher stock prices.

Unfortunately, the power of the wealth effect works in reverse as well…

When we see our stock portfolios getting hammered, we feel a lot less wealthy.  That loss of wealth causes us to pull back on spending.  Less spending means slower economic growth, which is lousy for companies.  Poor outlooks for companies mean lower stock prices.

And declining wealth isn’t limited to stocks.  Take a look at this chart of real estate prices…

As you can see from this graph, the year-over-year change in home values — indicated by the dark solid line — began to slow around the beginning of 2006.  But economic growth — indicated by the red dashed line — didn’t begin to slow until the middle of 2008.

In other words, the wealth effect in real estate wore off long before the economy began to sputter.  In this case, the declining value in real estate was a huge leading indicator of poor economic activity to come.

In fact, changes in just about any asset — from stocks to houses to commodities — can cause their owners to adjust their spending habits.  And those spending adjustments are going to happen after the owners’ assets take a hit.  And that makes them a great predictor of where things are headed.

I’ve told my readers time and time again that a recovery in real estate prices — and stability in the real estate market — is likely going to be one of the biggest pluses for a stabilized economy and higher stock market values.  Real estate got us into this mess and it’s going to get us out.

Using These Leading Indicators for Profit

So, how can you make money off the predictive abilities of the stock market and other asset classes?

Simple.  While others are waiting for the big economic indicators — such as solid growth, the labor market, and the credit crisis — to get back on their feet, you can slip into key investments long before anybody else gets wind. The markets are telling us loud and clear patience will be rewarded.

Best wishes,
Wayne Burritt

January 7, 2009

Profiting from the Wealth Effect was originally featured in the Penny Sleuth.

And I’m not just talking stock investors, either: Just about every asset class out there — from real estate to commodities to fixed income securities — are getting taken out back.

But mark my words: This is not going to last forever. It never does and it never will. The fact is I’ve been through a ton of crises and know how to handle them, no ifs, ands, or buts about it.

Does that mean I can tell you with absolute certainty what investments are headed higher? Nope: No one can. But I can tell you that — right now — the stock markets are ready to deliver simply mind-blowing bargains.

As you can see from the top part of this chart of the S&P 500 — a good proxy for the broader U.S. stock market — stock prices have taken a beating. While that’s painful for all of us, it’s far from news.

But take a look at the bottom part of the chart: The price-to-earnings (P/E) ratio for the S&P 500 is at historically low levels. In fact, it’s around 10 for the entire stock market. And that is news.

Remember, the P/E ratio takes a stock’s — or in our case, a market’s — price and divides it by the amount of earnings it makes. So, a P/E of 10 means that for every dollar in stock value, that company earned 10 cents.

Is that significant? You bet. With the stock market making 10 cents in profit for every dollar investment, it’s booking returns of 10% for stock investors. Those are stellar numbers, for sure, and blow away just about every other asset class out there.

But that’s not all. The chart also shows that when the market was at similar levels as today — which was way back in 2002 — the P/E ratios were much, much higher. In fact, the market’s P/E ratio of 45 in mid-2002 is nearly five times its current rate.

Meaningful? Yep. It shows that earnings are in much better shape than they are today. After all, when prices stay the same and P/E ratios decrease, earnings are on the rise.

But even more importantly, today’s relatively low market P/E means that it’s jam-packed with bargains – in fact, many more than in 2002. That means there are tons for stocks for sale at rock-bottom prices. And that’s a huge plus for a new bull market.

My Readers’ Portfolios are Going Gangbusters!

Let’s get down to brass tacks: While stock investors have had a tough time of it over the past few months, my portfolio has been delivering outstanding returns. Take a look for yourself…

As you can see from this chart, since April stock investors have booked a mind-blowing 29% in losses. This is based on a whopping 401-point loss from April to October on the S&P 500, a good proxy for overall stock market profitability.

Meanwhile, my Easy Money Options subscribers have amassed a solid 16% profit, on average, over the same time period. That means they’ve outperformed the average stock investor by a staggering 45%!

And don’t forget: They’ve collected these profits during one of the biggest financial messes of all time. To join my readers at Easy Money Options and find out how you can collect significant gains, even in this market, check out this free report. Even if you never tried options investing, I’ll show you how easy and profitable it can be.

Best Regards,
Wayne Burritt
December 3, 2008

Cheap Stocks and Mind-Blowing Bargains was originally featured in the Penny Sleuth.

As you can see from this graphic, from a high of 14,198 last October to 7,885 this October, the Dow has lost a staggering 6,313 points. That translates to a whopping 44% loss and a boatload of pain for just about everyone out there.

It gets worse. For the Dow to recover from its low of 7,885 to its high of 14,198 — in other words, to regain all of its recent losses — it would have to book an 80% gain. That’s nearly twice the size of its original loss and a mammoth amount of upside action.

But if you think now’s the time to throw in the towel, think again: While stock owners are taking it on the chin, option players are faring much, much better. Take a look…

This is a chart of the VIX index from the Chicago Board Options Exchange, the granddaddy of all options exchanges. Without getting into a bunch of mathematical jargon, the VIX measures the volatility — or expected price changes — in the broader U.S. stock market. And because volatility leads to uncertainty and uncertainty leads to fear, the VIX is sometimes called the “investor fear gauge.”

As you can see from the chart, the VIX is through the roof. In fact, at a level of 76, the VIX over twice the threshold of 30, a key level that indicates skyrocketing fear and uncertainty. And this is good for options traders for two big reasons…

First, high levels of volatility and uncertainty mean the time value part of your options’ prices are likely headed way, way up. Why? Because with time comes uncertainty. And as an options owner you’ll be compensated — often handsomely — for bearing that uncertainty.

But that’s not all: With the VIX at these nosebleed levels, market sentiment is so uncertain, so negative that there’s no way a recovery can be too far off. In other words, a high VIX level can indicate a contrarian move in the market is very, very likely. And in our case, that contrarian move would be to the upside.

Best wishes,

Wayne Burritt
November 4, 2008

P.S.: I started Easy Money Options to open the lucrative options world up to everyone. It doesn’t matter if you never traded a single option in your life or you’re a seasoned pro, my service is right for you.

How to Hedge Your Penny Stock Plays was originally featured in the Penny Sleuth.

In fact, when we talked about the general outlook for the economy, overall growth, the rise and fall of prices and how interest rates and the Federal Reserve play a huge role, you were probably saying to yourself, “Heck, I know a ton of this stuff already!”

That’s great: A solid foundation in economics will serve you quite well when it comes to picking stocks and options.

But before we jump right into looking at big option plays, we have an intermediate step: Researching sectors that have solid promise.

In other words, we begin with economic fundamentals, move to promising sectors, and then take a look at outstanding companies in those sectors. Fundamental investing like this is called “Top-Down” and it looks something like this…

So now that we have a bead on the economy, let’s talk about sectors.

Sectors are sections of the economy that have similar characteristics. They’re really no more than groups of companies that are in the same business.

In other words, if the economy is like the theater, a sector is the orchestra section within the theater. Smaller than the theater itself, but not quite an individual seat yet.

Standard & Poor’s (S&P) — the huge financial data provider and publisher — has things broken down into nine sectors: Consumer Discretionary, Consumer Staples, Energy, Financial, Health Care, Industrial, Materials, Technology and Utilities.

S&P’s nine sectors break down the economy nicely!

There are certainly tons of ways to break down the economy outside of these nine sectors, but I like to use S&Ps sectors for a couple of reasons.

First, they make sense. Take a tour around these nine sectors and you’ll find just about every kind of business represented. From financial powerhouses to utilities and health care, S&Ps sectors are a great place to delve deep into sector research. In fact, all told, these nine sectors represent all of the companies in the S&P 500.

But here’s the bigger reason. Each one of these sectors is represented by an “Exchange Traded Fund” (ETF) called a Select Sector SPDR (Standard & Poor’s Depository Receipt). An ETF is a fund that tracks an index — read: sector — but, unlike a mutual fund, is tradable like a stock.

So if I’m interested in a particular sector, I can actually buy the sector by investing in its corresponding Select Sector SPDR. That’s why in the graphic above, each Select Sector SPDR has a symbol next to its name:  XLF for Financial, XLK for Technology, and XLU for Utilities, and so on.

But that’s not all. Since Select Sector SPDRs trade like stocks, they can also have options attached to them. That’s great for our purposes because if we get interested in an entire sector — and not just a company in that sector — we can make a play on it.

Here’s another reason I like focusing on a sector’s ETF: Since they trade like stocks — and unlike an index — ETFs can reflect actual investor interest in a sector. You can use investor interest gauges — such as volume, buying and other related technical analysis methods — that simply can’t be used on an index.

Next time, we’ll dig right into how to look at sectors, both fundamentally and technically.

Best wishes,
Wayne Burritt
September 15, 2008

Investing in Sector ETFs Using Options was originally featured in the Penny Sleuth.