If you’re new to investing, learning how to choose stocks and investing in the stock market can be overwhelming. Probably the largest mistake that young investors make is to look at the price of a stock as a measure of its worth. In fact, the price of a stock is virtually worthless when trying to value a company.
Disadvantages of the P/E Ratio
1. Healthy P/E ratios may differ between industries: The concept of using a set P/E ratio to determine if a stock is overpriced fails to take into account the individual nature of the underlying company. Stocks in high-growth industries like the technology industry tend to have higher P/E ratios. On the other hand, some industries such as utility companies tend to trade at much lower multiples. Before you can decide if a stock is under or overpriced, you need to take into consideration the industry in which it operates. Continuing with the example above, let’s say Company B was a high-growth tech company forecasted to earn Rs. 100 per share next year and Rs. 150 per share the following year, while Company A was a low-growth oil company that was forecasted to earn Rs. 60 per share next year and Rs. 70 per share the following year. Now that you have a fuller picture of the two companies, it becomes clear that Company B would in fact be the better company to invest in due to its massive growth potential. Company B’s stock price will likely skyrocket if the forecasts are correct, while Company A’s stock price may not budge by much over the next couple of years. Thus, by ignoring other aspects of the company, an investor might have falsely assumed that Company A represented the more valuable stock opportunity.
Do you really find it difficult to search for companies with strong fundamentals? Do not worry, simply subscribe to Hidden Gems & Value Picks and start investing systematically in small and mid cap companies with great businesses to create wealth in long term. Avail attractive discounts and valuable freebies under our ongoing Saral Gyan - 5th Anniversary Offer. Hurry! Offer is for limited period and closes on 31st July'15. Click here to know more about the offer.
Do contact us in case of any queries, we will be delighted to assist you.
Wish you happy & safe Investing!
Team - Saral Gyan