When I moved to Florida in 2005, the real estate market was hot, sizzling hot. We sold our Harrisburg PA home for a tidy profit, but the purchase of the new house in Jacksonville caused us to pay up. It was at the height of the real estate boom. Ouch!
When the prices of homes sunk, it took 15 years to get back even. Luckily, I didn’t move and had a good amount of equity. Still, I had a young family and needed a place to live as I was pursuing a new job. Luckily, I wasn’t highly levered (little equity and lots of debt) on the purchase of the house.
It is a tough lesson to learn when paying too much for something. The bigger the item, the more pain it can cause.
We’re now in another real estate and stock market boom. It’s back….!
I’ve never considered my home as an investment. It is in many ways, but I look at it mainly as a place for my family to live. Although there will likely be a return on it in the end, I consider that gravy. Anyways, homes don’t really appreciate much over long time periods. If I sell it for a new house of comparable characteristics, I will get a gain and have to pay up for the next one. That is a wash in my view.
All this brings me to equities, the market is very high now and many have bought at “recent prices”. If the price paid is too high, it can take a long time to recover for the overpayment.
With the S&P P/E over 40, it can be a steep cliff down. Suppose a company earns $1.00 and its P/E is 40, the price of the stock is $40 (1*40). If the market tails off and the P/E shrinks to 10, the stock price will drop to $10 ($1 *10) or a drop of 75%.
Another real factor is that the $1 earnings could drop off to $.50, which means the stock price would be $5 ($.5*10). That is a loss of 87.5% ( 1-(5/40)). Add leverage into the equation and it can load on a “heap of hurt”. To get back to EVEN, the price has to rise 700 percent ( (1/(1 - .875))-1). The only stategy in that case is hope and hope isn't a good strategy!
There is much history of stocks sinking and staying down for a while. It doesn’t always happen like 2018 and 2020 where it bounced back quickly. Don’t fool yourself. This is a regular occurrence.
Owning cheap is especially important because it provides a margin of safety. Projections of the future are almost always rosy. And..no one is EVER able to definatively project it. I haven't found a crystal ball or the fountain of youth yet even though we all hope that they are out there somewhere!
The good thing about stocks is that you don’t have to “live in it”. It can be sold for cash and cash can be held for extended time periods.
Be smart, be well-read, be aware and be successful.
