Are Stocks Cheap or Expensive- What Does it Mean?

Buy or Sell May Trigger if you Know The Answer

When you make an investment in any stock in the stock market, what does expert mean when they are saying “stock is cheap or expensive”? In this connection you may have heard a story many times in the market that it is the best time for buying or selling.

To become a successful investor in the stock market it is very important for you to acquire knowledge how to use technical analysis or fundamental, and some time, combination of both, for evaluating a stock. For fundamental analysis several tools are used, these tools give investors the true picture of company’ strength and tell you how the market will evaluate its stock. You should also have knowledge about the future prospects of the company as well as their business analysis. You can get important information about a company’s strength from the Securities and Exchange Commission.

Often, in the market its pundits are pointing out to the price earnings ratio (PE) of stocks. This tool lets you know how much price investors are ready to pay against the earnings that a company produces. Usually, it is observed that the higher a company’s Price earnings, the more expensive it stock.

The price earnings ratio (PE) of a company’s stock is calculated by taking the present price a share and divided it by the (EPS) earnings per share. So, its Formula is: Price a share/earnings a of stock = price earnings ratio.
Like , a company with two dollar earnings per share (ESP) and a present share price $20 will have a price earnings (PE) of 10. Its mean that investors are ready to pay out ten times EPS for that stock.

You can look if earnings stay same , but the price of a share continues to increase the price earnings will be higher. In this situation, a time will come that the stock would be deemed expensive; at that time usually a sell recommendation is given. On the other hand if the PE falls, same stock will be recommended as a buy candidate because of its cheap price.

PE is only one tool for evaluating stocks, but it does not give any idea to the investors at what PE a stock is cheap or expensive. However, if you want to see individual stocks, you should see at industry peer for comparison of PEs. If other companies’ PEs is higher, then your candidate might be cheap. As well, if the other sector has low PEs, the stock might be expensive.

If you are in search of cheap or an expensive stock, then, you are also recommended to look at the entire stock market, the best method to do is you examine the price earnings (PE) for the Standard & Poor 500 index, it is generally considered the representative of the entire stock market. As PE of stock is an important tool, so it’s recommended to the investor that always try to use it wisely.