If you’re new to trading on the stock market and you’re trying to learn how to spot a good deal, you’ll need to be able to assess for yourself the true value of shares. It’s one thing to keep track of what people are paying for them, but even the most cursory reading of financial journals will show you that sometimes shares are undervalued or overvalued by a great deal, so if you simply go along with the crowd you could miss out on great opportunities or find yourself in trouble. What should you be doing to work out what shares are actually worth?
Is it undervalued?
The simplest route to success in trading lies in finding shares that are undervalued, snapping them up at a good price and then selling them for more once their true value has emerged. You can’t assume, however, that just because a share looks as if it’s undervalued, it actually is. The price could be low for some reason that’s not immediately obvious, such as legal issues facing the company. Always do your research before you buy.
Is it overvalued?
If a share looks overvalued, that doesn’t mean it’s necessarily a write-off. If lots of people seem to think it’s worth paying extra for, it may be the case that the higher cost represents an unusually high anticipated rate of growth. Shares can also be valued like this if a company is about to be bought by a larger company which is ready to invest heavily in its success. The Bull share tips and analysis online, and also offer outlook on many different share types.
Three valuation systems
There are three generally accepted ways to assess the value of a company whose shares you might be interested in:
- P/E ratio – this is the relationship between the price the share is trading at and how much you will earn from it (if nothing else changes) in each year for which you own it. By this measure, shares with lower P/E ratios are worth more, but you should bear in mind that they can’t usefully be compared across different sectors.
- Peg ratio – this is the P/E ratio divided by the historical growth rate of the company, year by year; it works like the P/E ratio but is widely believed to provide a fuller, more accurate assessment of the likely value of shares over time.
- P/B ratio – this is the relationship between the price the share is trading at and what it would be worth if all the company’s assets were immediately sold off. It can be a useful ratio to consider if you know a young company has invested heavily in equipment that retains its value, but you’re not thoroughly confident of its survival prospects.
Should you buy?
Ultimately, every share purchase represents a risk. Whether or not you should buy depends not only on the share price but also on your personal risk tolerance. It may also be influenced by how the shares will fit into your portfolio. Nobody can make this assessment for you, but the more time you spend trading, the easier it will become for you to make decisions that will lead to good returns.