Commentary by Joe Clark
Diamonds are a traditional gift to commemorate an engagement, or celebrate a milestone anniversary. Stocks are a less common (and many people would say less romantic) gift! Fear not – I’m not advocating we replace diamond solitaires with stock certificates. But it might surprise you to consider that the quality of stocks and diamonds can be viewed through similar lenses!
A diamond’s “color” actually refers to its transparency. The more color, the lower the gem’s quality. The more transparent a business is, the easier it is for analysts and investors to evaluate the business. Google recently reorganized its stock to offer investors greater transparency.
Clarity refers to defects. Diamonds are formed over eons, with pressure and heat refining imperfections. Investors can evaluate a company’s investments over time, including its use of cash, management tenure and performance, and contrast these under various economic cycles. Viewing data over time improves clarity when determining a reasonable price for the stock.
Cut refers to how a diamond reflects light. Some economists believe our economy functions in a four or five-year cycle, cresting at a peak, contracting into recession and then expanding to a new peak. This theory posits that different types of companies will fare better at different stages of the cycle. This perspective seems reasonable, but proves imperfect when the economic landscape shows two opposing sectors moving in the same direction (like we see in the current cycle).
Carat weight often serves as a price indicator. The investment world would replace carat weight with market capitalization to determine a stock’s size, along with factors like price-to-earnings (PE) ratio to compare expenses between companies. The higher the ratio, the more investors pay for a stock relative to current earnings. That’s why the PE ratio is only one metric in the valuation. Typically companies with smaller market capitalization have higher PE ratios than large cap businesses.
Applying diamond evaluating criteria to stocks may seem unusual but the point is simple: It isn’t just a stone and it’s not just a stock. We are in a stock picker’s market right now and may the best gemologist win!
Joseph “Big Joe” Clark is a Certified Financial PlannerTM and the Managing Partner of the Financial Enhancement Group, LLC, an SEC registered Investment Advisor. He is the host of “Consider This” found on WQME Saturday mornings at 9 Securities offered through World Equity Group, Inc., member FINRA/SIPC, a broker dealer and SEC registered Investment Advisor. Advisory Services can be provided by Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated and are not affiliated. Big Joe can be reached at [email protected], or (765) 640-1524.
