Use Price/Eearning to Help Value Stock
Good company, but unsafe stock?
In case, it seems odd to you that a good company may be risky for investment, then consider this whole scenario.
A cash machine “Acme Cumquats”, about which investors are confused how the management of the company is able to discover new markets for “Acme Cumquats”.
Cash flow comes into the company’s account and, quarter after quarter turns into record profits.
Obviously, investors want great yield without much effort, so far having that yield, they are ready to give a premium. Obviously, no problem with desiring a portion of this kind of a company. The problem appears on late arrival, when the stock price has increased too high.
A question that is frequently asked by every investor that, ‘how it is to be considered too high’?
The answer is, usually investors jump into the stock when they need to remain sidelined and have a firm look.
Investors should try to find good companies, to have a chance of success. Like Acme Cumquats companies, which have had superior management as well as quarter after quarter consistent earnings.
But , a lot of work to be done yet to locate a good stock .
Good Company a Good Investment
For the sake of a good investment in any good company’s stock, it is necessary that it should be correctly valued.
Investors always make profit by buying a stock of any company at a lower price than actual value. In due course a good company would give incentive to the investors in the shape of growth in the price of the stock as well as dividends.
If do not pay attention to dividends for a while, you may get a rough valuation of any stock by multiplying the EPS (Earnings per share ) by the P/E.
Keep in mind, Price earnings ratio is a factor that how much investor is willing to give for earnings.
If a company earns $2 a share and its Price earnings 25, the worthe of the stock would be $50 a share, and if the earning does not change, while Price Earning drops to 20 , then stock worth would be $40 a share.
If investor sentiment changes and stock’price fall, then the problem starts for paying too much. In this situation investors have no idea how the market will react and what influence might be seen in the price of the stock.
If you buy a stock of any company at a lower value than its actual worth, definitely company will help you protect from speculative influence on the market price.
Price earning is neither only nor the best measuring tool for a stock’s true valuation, but it does point out why buying high value stock is a risky strategy.