How Much Should You Pay for Stocks?
Market Value Not Equal to Actual Value
A small loan can help you if you are short of cash until your next payday, but if you invest in the stock market and follow the crowd in their buying and selling habits, you may end up with many more liabilities than assets. Why? Have you ever noticed how much the stock market fluctuates over the course of a day, and how much the share prices go up and down? Does this mean the value of a company fluctuates just as much as share price, or is there some sort of other force at work? As you can see, market value of a share doesn’t equal ACTUAL value of the same share, in terms of the value of a company.
Market Price Based on Emotions, Not Logic
One of the pioneers in value investing, Benjamin Graham, believed that many people rely too much on their emotions when investing rather than their logic. This explains why the market fluctuates so much, and why so many people claim that the stock market is risky. What makes it risky is the constant buying and selling that goes on day after day, hour after hour. Constant trading drives share prices up and down, and also creates a lot of the risk.
Ben Graham suggested in his book “The Intelligent Investor” that if you want to build your wealth from the stock market, you need to use a “dollar cost averaging” technique, meaning to consistently buy more shares at a lower price over time. As inflation and company values grow over time, your investments will be worth more in the long run. It’s also known as the “buy low and sell high” technique. Unfortunately, most people tend to bring their emotions into their investing, and will panic and sell when the price is going down, because they are afraid to lose any more money on their investments, leaving them open to take out a small loan to survive.
Beyond the Smoke and Mirrors
The stock market is riddled with confusing terms, acronyms and policies, making it very difficult for the average investor to understand. All this is just smoke and mirrors designed to keep most people in the dark and dependent on high-priced brokers to navigate the investing maze for them. But if you take a look behind the scenes, you’d see what’s confusing you is what could be referred to as BS.
Inflated Price? Inflated Value!
Brokers and fund managers will buy or sell enough shares to drive price up or down, depending on where the price is trending, to control the market. Maybe it’s because a company got some bad news, or even good news, and investors are trying to position themselves to either make or avoid losing a lot of money. However, this tends to skew the value of the share price, making the market unbalanced. Thus, a share price that has risen too quickly will have many shares sold off by fund managers or brokers to drive the price back down. Likewise, if a share price is going down too fast, they will buy as many shares to make it even. So if there are inflated prices, don’t go believing it’s actually worth that much. In fact, they may not be worth much at all!
P/E Ratio Tells it All
There is a very simple way to determine if a certain share price is on target or not—look at the Price per Earnings ratio. This is a method of valuation that takes the current share price on the market, divided by per-share earnings over a period of time, for arguments’ sake, a year. So, if a company’s share price is $ 24 and the earnings per share over the past 12 months have been $ 2, the P/E ratio is 12. Typically, the higher the P/E ratio is, the higher the expectations investors will have for company growth. This means that you will be able to see higher earnings within the next year with this company. The lower the ration, the slower the growth regardless of what’s going on in the market.
Buy Low, Sell High
When you can learn how to find the correct value of a company or share, you will know when the share price is at its lowest, and when you can buy. After share prices crest, you can sell your shares and pocket the rest without needing a small loan. If this is the track you take, you could make money in the stock market while others are losing.
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