In May 2006, we saw some of the stocks in the technology sector reaching a price/earnings ratio of 15. And these are technology stocks that are expected to see some growth in the next few years. So we have found some value stocks in the tech sector at that time. Fast forward a year and a half later, these stocks appear to have performed well. The following table illustrates its performance:

Company

Share price 06/05

stock price now

Return

Microsoft (MSFT)

$23.77

$33.38

40.4%

Intel (INTC)

$19.00

$25.29

33.1%

Dell (DELL)

$24.89

$27.17

9.16%

Symantec (SYMC)

$17.00

$17.12

0%

Average Return

20.66%

When looking at the average return, you have to agree that it’s a decent return for stocks that were expected to languish due to their own short-term woes. Again, this solidifies our belief in the concept of fair value of common stock. All of these stocks had an expected price-earnings (P/E) ratio of less than 15. As you recall, a P/E of 15 means an annual return of 6.67%, which is still higher than the Treasury rate. Risk free. Therefore, we would expect these shares to revert to their P/E of 15 fair value. Look at this. Last year, Microsoft had an expected P/E of 13.9, Intel: 16.3, Dell: 12.6, Symantec: 14.5.

At first glance, Intel looks like the most expensive of the bunch with an expected P/E of 16.3. However, Intel was expected to earn $1.00 last year. Now? It is expected to earn $1.20 per share for fiscal 2007. Therefore, its increased earnings have caused Intel shares to rise even higher as well. Of course, you’ll have seen some stocks fail to move toward fair value despite lower P/E going forward. Does this invalidate the concept of fair value? Not precisely.

First, common stocks don’t always reach fair value fairly quickly. So, if you’ve bought undervalued stocks and done the math correctly (ie, forecasted earnings per share equals actual earnings per share), the stock may not rise toward fair value. Second, there are seasonal factors that can impede a stock’s movement toward fair value; Mainly, institutional purchase/sale. Institutional investors make up the majority of the trading volume in the stock market. Therefore, shares depend on their trade to move towards fair value. For example, towards the end of the year, institutional investors will get involved in what is commonly called ‘window dressing’. Therefore, the best performing stocks of the year will be bought to make your portfolio look stellar. As a result, underperforming (but undervalued!) stocks may be falling, making you wonder if you’re buying the stock at a high price.

So don’t worry. Eventually, what is a good investment (aka undervalued stocks) will rise, and patient investors will be rewarded. Since stocks regularly go up and down by a significant percentage, you can find a lot of deals at any given time.