For Every Stock, There's a Time
Value investors view all industry sectors as cyclical, meaning that each sector, and hence the stocks making up that sector, will go through periods of out performance when market mavens predict strong sales and earnings growth for all participants for the foreseeable future. Then, as sure as night follows day, the sector companies over-expand their manufacturing capacity, growth falters, profit margins contract in the face of product oversupply, and stock prices plunge. Eventually the excess capacity is absorbed, demand picks up, and the cycle repeats.
Rather than trying to predict the timing of these cycles, value investors compare a stock’s current valuation ratios (e.g. price/earnings or price/book) to their historical ranges, and from that information determine whether it’s time to buy or sell the stock.
For instance, suppose that you’ve determined that over the past five years, a particular stock’s price/earnings ratio has ranged between a low of 15 and a high of 50. Value investors would consider the stock a buy candidate if its current P/E is around 20 or less. Once purchased, they would hold the stock until its P/E moved into the 40 to 50 range when they’d consider selling. The only reason they’d sell sooner is if the company’s long-term fundamental outlook significantly worsened.