Is the share undervalued or overvalued?
One way that stock market investors make money is by buying shares at a low price and selling it at a higher price. But how do you know when to buy and when to sell a share? You may have heard stories of people who bought shares of good companies but didn’t make money. That is usually because they paid the wrong price for their shares.
So how do you know if you’re buying or selling shares at the right or wrong price? Well, you’d have to look at its valuation.
Valuation for a share, as some say, is more of an art and not a science. It is made up of a combination of how investors feel about the company and how the company has been performing financially.
One way to check the valuation of a company is by looking at its PE ratio. The PE ratio is the company’s share price (P) divided by their earnings (E) (net profit). For example, the average PE ratio of all Malaysian companies on Bursa Malaysia today is 18 times. This means on average, a Malaysian public-listed company is valued at 18 times their current earnings.
But how do you know if a company’s valuation is fair? A good way to check is by looking at another company you can compare it to.
To help you analyse a company’s PE ratio, you can look at these factors:
- PE ratio for the whole market: The average PE ratio for the whole market and how it has changed over time. For example, the PE for Bursa Malaysia over the last 10 years has been 16 times. Over the last 6 months, the PE ratio has been 18. That shows that the overall valuation is not much more expensive or cheaper than it was from the previous year. If the current PE ratio was much higher than the long term average, then there is a risk of it coming down. (But if the current PE ratio is much lower than the long term average, then there’s a chance it will go up.)
- PE for the company: Secondly, look at the average PE for the company over 10 years and how much it is currently. If the current PE ratio is much higher than over the last 10 years, there could be a risk of the ratio coming down soon.
- Compare the PE ratios of different companies: To do this, you’ll have to find companies that sell similar products or services.
The main reason why investing in shares can be difficult is because there are so many things to look at. Investing in shares also requires you to keep a close eye on your investments. Remember, it’s common for people to make mistakes when investing in shares and maybe even lose some money from time to time.
So, it’s important that you spread out your risk and not put all your investments in one place. That way, if the stock market crashes and you lose all your investments, you won’t be too badly affected and your other investments may be able to cover the losses you have made.
Now you know what to look for when you’re choosing shares to invest in, you might be ready to get started with investing! Click here to learn more about shares and how to start investing in shares, or to learn more about other types of investments, click here.