March 10, 2015

The magic formula for investing is “risking a little, to make a lot.” When you do this, and spread your risk, you only have to be right a handful of times to make outsized returns.

With this in mind, let’s take a look at two stocks that are among the most widely traded in the world, Facebook and Apple.

The average consensus analyst target price target on Facebook is $90. That’s only 12% higher than current levels. By purchasing Facebook today you are risking a lot to make a 12% potential return. Facebook is trading at 75 times trailing earnings and 37 times forward earnings. High P/E stocks tend to underperform in rising interest rate environments. And that’s precisely where we are headed in the coming months.

What about Apple?

The average consensus analyst price target on Apple is $140, just 10% higher than Apple’s current share price. At best, buying Apple today you will get a potential 10% return. Apple trades at 18 times trailing earnings, and 15 times next year’s earnings estimate. While it’s a stock that is far more fairly valued than Facebook, a 10% upside doesn’t compensate for the downside risk.

So, while Apple and Facebook are the darlings of the stock market, neither offer a potential reward great enough to compensate for the risk to your capital.

On the other hand, here is an example of a stock that does: Chicago Bridge & Iron, symbol CBI.

Chicago Bridge & Iron Company is a Warren Buffett-owned stock. It has an average consensus analyst target price of $72. That’s more than 52% higher than its current share price. The stock trades for just 9 times trailing earnings, and 7 times forward earnings. A low P/E ratio is what Buffett calls a “margin of safety” — it gives him limited downside with potential for big upside. Buffett owns more than 8% of Chicago Bridge and Iron.

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