No one should ever overpay for a stock. No matter how good the company is, paying too much for a stock will make your total returns suffer. Every stock’s price will eventually fall back to a “normal range” if the price gets too high. In the stock market there is no such thing as “A bargain at any price.”

To achieve our goals of a comfortable retirement, living off of our dividend income, we must make wise decisions as to not just which stocks we buy, but also when. We must balance the stock’s dividend growth and yield, with the stock’s valuation, and only buy when a stock is undervalued, or at worst fairly valued. As Warren Buffet said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” So, at PTI we are always looking at the stock’s valuation to find the proper buying points.

This can be demonstrated by studying the past performance of some classic Dividend Growth Investing stocks, and how they would have performed for us had we bought them at different times. Using FAST Graphs (Fastgraph.com) we can see the times when the graph was telling us to load up on the stock, and other times when it was telling us to stay away. And by learning to recognize these buying opportunities, we can use them going forward to help us to decide which new stocks to buy.

Without getting into the technical details of a FAST Graph (I suggest you go to Fastgrpah.com and watch their tutorial video), basically the orange line on the graphs shows the “fair value” of the stock, while the black line shows the actual price. When the black line is above the orange line the stock is over price. When the black line is below the orange line it is underpriced. When the price is right on the orange line it is fairly valued.

In the graph at the top of the article we see a recent FAST Graph of Amgen (AMGN). We can see that the stock has done very well, moving from about $60 in 1999 to almost $200 today.

But that doesn’t mean that AMGN would have been a good buy at any time during that time period. From 1999 through early 2007 AMGN was trading above the orange line, indicating that it was overpriced. But if you really liked the company, and ignored valuation, you could have bought AMGN in 2005, when the price broke out and hit a new high of $79.90 (to many people breaking out to a new high is a buy signal). A $10,000 investment would have grown into $29,146 today (including dividends collected). It would have produced $3509.96 in total dividends paid and achieved an annual return of 7.9%.

Amgen FAST Graph showing the returns if purchased at breakout in 2005

But if you had used FAST Graphs you would have seen that AMGN was overpriced, and that it was not a good time to buy, even though it was breaking out to new highs. It was simply too expensive. The FAST Graph was telling you that the fair price for AMGN was about $26, not $79.90. Instead, had you watched it patiently, and waited for it to become fairly valued, (not undervalued, just fairly valued), you could have waited until 2007 when the price had fallen, and the orange line had risen, such that at that time AMGN could have been bought at what was finally a reasonable price. You could have bought it at $55.88 (by then the fair price was about $60). Your $10,000 investment would have turned into $39,584 today, the position would have produced $4955 in total dividends, and you would have achieved an annual return of 11.6%.

Amgen FAST Graph showing returns if bought at fair value in 2007, including dividends and total return.

Here is a comparison of how you would have fared buying at the two different times.

Date PurchasedStock PriceTrue WorthShares BoughtFinal ValueAnnual ReturnDividends Collected
8/31/2005$79.90$26.00125.16$29,1467.90%$3,509.96
3/30/200755.88$60178.95$39,58411.60%$4,995.92

Notice that had you bought in 2007, even though you held the stock for a year and a half less than if you bought it in 2005, you still collected more dividends. This is because you were able to buy many more shares when you bought AMGN at a fair price.

Conclusion:

It is better to find stocks that are around, or below, their true worth, as shown on FAST Graphs, rather than reaching for the overpriced ones. Although not overpaying for a stock seems like an obvious idea, the actual effect it can have on returns can be striking, and these examples can help to really drive home the point. Some looking at my examples might say “All you’re showing is that if you buy at a lower price, you’ll do better. DUH!” But that, of course, is not what I’m saying. It’s not that simple. What I’m trying to show is that all stocks, even ones as stellar as Amgen, can become overvalued, and reach a price where they are too expensive. And if you overpay for these stocks, even if they continue to provide excellent earnings and dividend growth, your total return will suffer.

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