Value Investing-A Fool-Proof guide to Investing for Beginners III

INTRODUCTION

Hi everyone. I know it's been some time since I posted. With recent events of spammers and people throwing articles everywhere that mean little, I have dug my heels in to providing quality well-researched articles to enrich my readers. With that said, I present my third article on value investing. It's time to dig in to some delicious knowledge.

We continue from where we left off. I wish to begin the article by looking at the next valuation indicator, the:

Price to Earnings ratio

The Price to Earnings ratio is simply calculated by dividing the share price by the earnings per share. Again earning per share can be found in quarterly reports but you can research the actual price to earnings ratio for any particular stock.

High P/E ratio

A high P/E ratio basically means you pay far more for the share than the profit each share makes. This could be interpreted in one of 2 ways

1) The stock is over valued. This would mean as a value investor this world not be a good investment

2) The high price reflects investor confidence in the stock therefore it's value on the exchange increases

As such we go back to previous articles and continue to say it is difficult to make a decision about a stock based on one indicator.

Having said that we can now combine what we've learnt so far, namely the P/B ratio and the P/E ratio.

1)Low P/B low P/E

A low P/B ratio would indicate an undervalued stock but at the same time might indicate low investor confidence which caused the market price to slide. Applying the P/E ratio to the mix, a low P/E ratio might indicate an underrated stock or further confirm the position that the stock is not a market performer. We would still need further analysis of other indicators.

2)Low P/B High P/E

A low P/B value would speak to either an undervalued stock or low investor confidence. In this case a high P/E would indicate investor confidence isn't low so the only explanation left would be that the stock is undervalued. We might want to confirm using a third indicator but we can be relatively certain a that the stock is undervalued and would be able to make a decision based on that.

3)High P/B High P/E

The high P/B value would indicate an over valued stock or high investor confidence whilst a high P/E ratio would still indicate the same. Generally it would be difficult to come to a conclusion and further investigation with other indicators would be useful at this point.

4)High P/B Low P/E

A high P/B would indicate an over valued stock or high investor confidence. Coupled with a low P/E we would be led to the conclusion that the stock is over valued as a low P/E would mean low investor confidence.

My Comments

I find that these simple valuation tools can be used to repetitively buy stocks on purpose that will always give you not only steady profit but peace of mind. As I was writing this article I asked for input from a colleague who has a degree in Financial Accounting. He found that this information provides the necessary information for the average Joe or Jane to make effective financial decisions when it comes to Investing. This is the goal of my series, to educate the simple person to begin to operate and think like the rich. The end will be that what we see and practice we become.

Signing Out

Victor