Value Investing's Golden Rule: Whirlpool, GE

If you hold GE, how long will you have to wait for a $40 stock quote? The short answer: I don't know. The wait could be a couple of months or it could be a couple of years. Pessimism permeates the market, making it difficult to secure bids that approximate value. Even if you have to wait two years, though, you'll get some nice benefits. Not only will you collect $2.48 a share in dividends (assuming there is no change in the dividend payout), but your asset will likely be more valuable in a couple of years. It's reasonable to expect that GE's business value may reach $47 or $48 a share by 2010.

Note that your cost basis in GE stock is irrelevant in applying the rule above. Whether you paid $4 or $40 for your stock doesn't matter. In deciding whether to sell the GE stock in your IRA, the only numbers that matter are the current price and the current value.

Remember the reciprocal of the rule.

Unbridled enthusiasm over stocks is coming; I just can't tell you when. Optimism will envelop the stock market and prices will soar to excessive levels. It's difficult to fathom in the context of the current market, but it will happen. It will be the flip side of the current market.

Today, bargain-priced stocks abound. It's easy to find companies whose stocks are trading at 50 cents per dollar of value. And there are lots of quality companies whose stocks are trading at 20 or 30 cents per dollar of value. Two or three years into the next bull market, though, it will be difficult to find bargains.

How can you protect yourself from getting caught up in the enthusiasm in the next bull market? You can protect yourself by remembering the reciprocal of the rule above. That is, as prices increase, risk increases, and your anticipated rate of return decreases.

This was originally published in two parts on RealMoney (July 7 and July 10, 2008). For more information about subscribing to RealMoney, please click here.