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The 6 Secrets To Getting Rich On Wall Street: Part 6

The 6 Secrets To Getting Rich On Wall Street: Part 6

Posted On June 18, 2021 4:00 am
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In part one of this series, I explained the single most important secret to getting and staying rich on Wall Street.

In part two I showed why the safety of individual companies is the next step in achieving a rich retirement.

In part three, we saw why quality at a reasonable or attractive valuation is the easiest road to riches you can travel.

In part four we looked at the importance of safe and high-quality yield, including some of the best sources of generous income you can buy today.

In part five, we learned the importance of growth, in helping you achieve your long-term financial goals.

Now finally, we come to one of the most powerful but often overlooked secrets to getting rich on Wall Street.

Valuation Matters And It Matters A Lot

According to a study by Bank of America’s quants, since 1987 80% of blue-chip returns have been explained purely by valuation mean reversion.

I think it’s essential to remember that just about everything is cyclical. There’s little I’m certain of, but these things are true: Cycles always prevail eventually. Nothing goes in one direction forever.”

  • Rule number one: most things will prove to be cyclical.
  • Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.” – Howard Marks

Howard Marks co-founded Oaktree Capital and has delivered 19% CAGR total returns since 1995.

And purely with a focus on safety and quality first, and attractive valuation and strong risk management always.

Valuation risk is the easiest kind of risk to avoid.

It means never knowingly overpaying for even God’s own company. It’s simple disciplined financial science and here are three good examples of popular hyper-growth blue-chips with varying degrees of sound valuation.

Apple 2023 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

Apple (AAPL) is 68% overvalued, meaning that in the short-term the consensus return potential is horrible.

However, Apple is so overvalued, that its pricing in the next six years of growth.

Apple 2026 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

The fundamental risk of losing 100% of your investment in Apple is very low, about 0.29% according to S&P.

                    Apple Credit Rating Consensus

Rating Agency Credit Rating 30-Year Default/Bankruptcy Risk Chance of Losing 100% Of Your Investment
S&P AA+ stable outlook 0.29% 1 in 344.8
Moody’s Aa1 (AA+ equivalent) stable outlook 0.29% 1 in 344.8
Consensus AA+ stable outlook 0.29% 1 in 344.8

(Source: S&P, Moody’s)

But just because Apple isn’t likely to go out of business doesn’t mean that anyone buying at these nose-bleed valuations won’t deeply regret their decision. Not just for a few years, but likely for decades.

Alphabet (GOOG) is just 8% overvalued, which means mostly relatively weak short-term return potential.

GOOG 2023 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

GOOG 2026 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

If GOOG grows as analysts expect, and returns to its historical fair value of about 26X earnings, within the next five years you could double your money.

However, take a look at what happens if you buy GOOG at fair value and a modest 10% margin of safety.

GOOG 2026 Consensus Total Return Potential From Fair Value

(Source: FAST Graphs, FactSet Research)

GOOG 2026 Consensus Total Return Potential From 10% Margin Of Safety

(Source: FAST Graphs, FactSet Research)

A 10% margin of safety is sufficient to compensate you fully for GOOG’s risk profile.

I can’t tell you when GOOG will again trade at a 10% discount, or what the price will be when it does. But I can tell you that all blue chips cycle between overvalued and undervalued, allowing patient and disciplined investors to get rich.

Facebook (FB) is 15% undervalued, and a potentially good buy today.

Facebook 2023 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

Facebook 2026 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

The consensus return potential is actually about the same as GOOG’s, but the valuation risk is lower.

In other words, FB compensates you for its complex risk profile and GOOG doesn’t.

If something goes wrong, FB is far more likely to still deliver solid returns, while GOOG buyers at today’s price might see high single-digit returns.

Ok, so that’s an example of how you can practice disciplined investing with popular hyper-growth blue chips.

But here’s the power of deep value investing.

British American Tobacco (BTI) is 50% undervalued.

BTI 2023 Consensus Return Potential

(Source: FAST Graphs, FactSet Research)

BTI 2026 Consensus Return Potential

(Source: FAST Graphs, FactSet Research)

That’s what allows this 4.5% CAGR growing company to offer better total return potential than Facebook or Alphabet today.

Or what if you want to stick with hyper-growth and have a hankering for a Buffett-style fat pitch deal?

Alibaba 2023 Consensus Return Potential

(Source: FAST Graphs, FactSet Research)

Alibaba 2023 Consensus Return Potential

(Source: FAST Graphs, FactSet Research)

Alibaba (BABA) is 43% undervalued, and the best hyper-growth blue-chip deal on Wall Street.

Analysts expect 25% growth and incredible value to deliver over 300% total returns over the next five years.

These aren’t even the most undervalued companies on Wall Street. There are some companies worth buying that trade at over 60% discounts to fair value.

In fact, they are priced for -8% CAGR long-term growth, while analysts and management expect 2% to 4% CAGR.

Such slow-growing anti-bubble stocks can also deliver about 300% total returns in the next five years.

And keep in mind that all of these investment opportunities are available when the market is 33% overvalued.

During the recessionary lows of March 2020, blue chips were available at 69% discounts, and some above-average quality companies were 85% undervalued.

The point is that its always a market of stocks, not a stock market. No matter what kind of investor you are, something great is always on sale, if you know where to look.

 

 

 

 

About author

Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.

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