Friday 14 February 2014

Cheap & Expensive Stocks

A: Any good shares to recommend?

B: You can take a look at company XYZ, not bad.

A: What is the price now?

B: RM 4.00

A: Wah, so expensive!

B: Er.....

Are you A or B?

I think most new stock market investors will have such "expensive" feeling.

In the early days, I also like to look for stocks traded below RM1, because it seems like I can earn money faster from them.

If a stock at 50sen rises 10sen, then it is a 20% gain.

If a stock at RM5 rises 10sen, it is only a mere 2% gain.

It seems like penny stocks can double its share price easier.

Furthermore, penny stocks always have high volume and can be "fried" to higher level more easily.

So, speculators like penny stocks the most.

To determine whether a stock is cheap or expensive, it is more appropriate to use investment valuation ratios such as
  • Price/Earning ratio
  • Price/Book value ratio
  • Price/Cash flow ratio
  • Enterprise Value Multiple  etc.

A more commonly and widely used ratio is Price/Earning ratio, 

PE Ratio =  Share price / Earning per share

A meaningful PE ratio should be compared to peers in similar sector or industry.

Furthermore, it is important to get rid of one-time gain or loss in calculating earning per share, and also consider future positive or negative growth in determining the value of a stock using PE ratio.

So, what is the appropriate or fair PE value for each sector such as plantation, consumer, oil & gas, manufacturing, property etc?

Well, I really don't know.

But, I think you can roughly get the "feeling" of fair PE ratio after you gain more experience in stock market and read more analyst reports.

If someone offers you Nestle at RM30 a share now, is it expensive?

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