Gone are the days when even a smile was called as Kodak moment; after all this over 130-year old photography was a generic name for anything to do with pictures. Times for changed for worse and those who were bullish on the company’s stock for years are have now given up.
One such story is of Bill Miller, Legg Mason Capital Management Value Trust (LMVTX), who had been stocking up Kodak shares since 2000; so much so that by 2005 his firm owned 25% stake in the photography giant of yesteryears. He was often quoted as optimistically saying that his Kodak shares were worth around $100 each. After holding on over a decade, he dumped the stock in recent months at less than $4 a piece; resulting in a loss of over US$550mn.
So, great names are not always good investments. There are various reasons why these stocks or household names are not as great as they appear to be on the surface.
Such stocks or household names are most of the time overpriced due to their past records. We all know that every product, business, services or industry passes through four stages - Market introduction stage, growth stage, maturity stage, saturation stage and decline stage. When you look at these big names you know that these companies have been around for quite some time and have earned a glorified status. Most of them have matured businesses. Until and unless the company has some strategic plans to revive its growth it becomes difficult to sustain growth. In turn, this leads to decline in stock prices.
Also, everyone expects a lot out these great names if they fail to perform as per the expectations then the market is quick to punish the stock. This is often evident when the prices of these stocks plunge when their earnings are declared. Also, the sector plays an important role. If there are any policy changes or any positive news these stocks start trading at high premium and vice versa.
So, the best time to invest in such big names is when they are undervalued, one way to identify if the stock is overvalued or undervalued is to look at its PEG ratio that is price-to-earnings-growth ratio. The PEG ratio is estimated price-to-earning ratio divided by long term growth.
A stock is considered to be fairly valued when the PEG ratio of that stock is 1, and if is over 1 it is considered as overvalued and below 1 will be considered as undervalued. Of course you need to pay close attention to the business prospects and outlook instead of blindly following set formulas.
You need to keep close track of the companies that you are looking at. The short term volatility impacts share price of the companies, many policy changes also impact their prices, so try to grab the opportunity to invest in the company when it is facing short term fall.
Remember, stock prices are based on future prospects of a company and sector, not past successes.