Investors usually hate it when they buy a stock and the price goes down. However, being upset with a price drop is not always the appropriate response. There are situations where a price drop is a disaster, and there are times where a price drop is a gift. This is a distinction that relates to valuation. Kroger has recently experienced two major price drops of which I contend that one was justified, and the other and more recent price drop unjustified.
Bad Losses – Good Losses?!
Obviously, there are no good losses. However, not all losses are the same. A loss that comes as a result of paying too much in the first place, is a bad loss. The time for recovery with a loss from overvaluation is usually so long as to be considered permanent. There is no fixing this type of loss, it is a huge mistake. It’s a different matter altogether if you paid a sound and attractive price for your company based on strong fundamentals and the “stock market” had an irrational panic attack. In this case, your sound investment has become a speculator investment and represents a golden opportunity. Understanding and making these true distinctions is vital. Alas, few investors actually do.
In today’s F.A.S.T. Graphs video, I will show clear examples of these important principles based on simple arithmetic. The numbers tell a compelling story that is too obvious to deny. I am sure that there are investors in Kroger who are believing that they could not possibly get their money back within their lifetime, they are contemplating walking away from what I believe appears to be a literal gold mine and risk getting the shaft instead. I believe that Kroger is extremely undervalued at its current valuation level which portends a powerful future upside. If navigated properly, this market panic may in actuality be a great opportunity in disguise.
Mary Buffett (Warren’s ex-daughter-in-law) and David Clark said in their book Buffettology: “Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.” I agree with the above quote as long as prices are sinking from attractive or at least sensible values. More importantly, that is what I believe is happening now with Kroger. The Great Recession we have since recovered from was a catalyst that at first cleansed excessive overvaluation. First in housing, then followed by the stock market. The stock market specifically had gone from one extreme – overvalued – to the other – undervalued – and for many stocks now back to overvaluation. Nevertheless, the recent price action in Kroger indicates it to be an exception.
Fixing a Good Loss
Moreover, a short-term loss can be fixed and future upside enhanced by averaging down. Buying more stock at undervalued levels will give you more shares to ride the upswing than you rode down with the fall. That’s leverage. If you don’t have the money available, then I suggest you might consider consolidating. Get as much of your money in front of your best opportunities as you can. I believe Kroger currently represents such an opportunity.
By The Numbers – A F.A.S.T. Graphs™ Fundamental Analysis
Source: F.A.S.T. Graphs Video
With the following F.A.S.T. Graphs™ video analysis, I will take a close look at Kroger based on important fundamental attributes offering a case study in the distinction between good losses versus bad losses.
Summary and Conclusions
Kroger was significantly overvalued based on fundamentals towards the end of 2014, all of 2015 and over the first half of 2016. However, by August 2016 the shares reverted to the mean by dropping into fair value territory. Nevertheless, even though Kroger’s valuation had become reasonable, the price once again took a significant fall.
Therefore, the 29% drop from the beginning of 2015 through September 30 of 2016 was both justified and necessary. On the other hand, the 32% drop in Kroger’s stock price since the beginning of 2017 is not justified, and therefore, I believe that Kroger is currently significantly undervalued based on fundamentals and historical norms.
Consequently, the opportunity I see is related to the P/E ratio for Kroger’s stock price expanding back to more normal and rational levels. The opportunity for P/E ratio expansion once a stock becomes significantly undervalued is what I refer to as natural leverage. From these levels, Kroger does not need to grow; it just needs to maintain its earnings levels. If it does, short to intermediate returns could be substantial. However, I suggest the reader conduct their own due diligence.
Disclosure: No position at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.