I have been looking at the charts for the global autonomies recently and have a question about your approach. Specifically, how much do you take market valuation (PE ratio) for a share into account when you buy / sell? I have read your book (twice, it is excellent by the way), so I understand your overall approach, but do you ever decide not to buy a share that has a great story / chart, but a very high valuation as well? Salesforce.com is a good example: nice story, nice chart, astronomic PE. Or Nike: nice story, nice chart, pretty high PE. By the way, I ask this question as an unleveraged investor, not a trader. Thanks.

Eoin Treacy's view

Thank you for a question of general interest and for your kind words. I’m delighted you enjoyed Crowd Money. Valuations are important but the perceptions of those valuations are often more important to a share’s performance. I agree Nike’s historical P/E of 30 is high but its Estimated P/E of 27 suggests revenue growth is expected to continue. Investors also look at additional features such as the steady 16% dividend growth rate and the company’s dominant position as the global leader in the shoe and active wear sector when deciding whether to buy. 

This is well reflected in the share’s trend which at today’s overextension relative to the trend mean, suggests a lot of short-term good news has already been priced in. Perhaps the greatest risk from a high valuation is in an earnings miss because the margin for error is less. The consistency characteristics of the trend indicate that temporary overextensions generally revert towards the mean so the best time to enter positions is following such periods.    

Disney has slightly lower valuations but a higher dividend growth rate and is also temporarily overextended. 

When valuations are high you have to make a judgement call on whether the price action justifies the view that valuations will improve. Facebook is a great example of that where today’s valuation is still high in nominal terms but is a fraction of its IPO value. I’d be a lot more worried about high valuations in an accelerating price environment because that would be reflective of bullish expectations diverging from what is rationally achievable.