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Add a company's expected earnings growth rate to its dividend yield, then divide by its price-to-earnings ratio. A stock whose growth-plus-yield is roughly twice its P/E offers far more return per dollar of price than a popular growth stock. This one ratio lets you compare fast-growing companies with slow-growing ones on the same scale.
When a stock trades at a low P/E, the market already expects little, so bad news does little further damage. Good news, or even the absence of bad news, forces the market to raise its valuation. High-P/E stocks work the other way: they need everything to go right, and one disappointment can collapse their price.
The best targets are companies growing earnings at a moderate 7 to 20 percent a year that the market prices as if they were not growing at all. These firms are unexciting enough to be ignored but solid enough to compound. Very fast growth attracts crowds, inflated prices and eventual stumbles, so Neff deliberately passes it up.
For cyclical companies, a high P/E on depressed trough earnings is often the time to buy. A low P/E on peak earnings is often the time to sell. Because the market anticipates the cycle, you buy cyclicals while earnings still look bad and sell before earnings peak.
Sell a holding for one of two reasons: its fundamentals deteriorate, or its price rises to the value you expected when you bought it. Don't hold on hoping to catch the last bit of gain. Selling into strength while buyers are eager, and recycling the money into new unloved stocks, keeps the portfolio positioned for undervaluation rather than popularity.
Around 1990–91, fears about bad real estate loans drove bank stocks down, and Citicorp in particular was treated as possibly doomed. Windsor built a large position at depressed prices, judging that the franchise's earnings power would outlast the crisis. When the banks recovered, the stock rose several times over. The case shows the payoff from buying solid businesses when fear is at its peak.