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FAQ
- Frequently Asked Questions
1. What is a PE? How do I use that to value stocks?
By definition, PE refers to the current stock price divided by the company’s
earnings per share. Comparing Stock Y and Stock Z:
Price EPS PE
Stock Y 10 1 10
Stock Z 20 4 5
Stock Y is priced at $10 a share, and its earnings per share over the past year was
$1, its PE ratio will be 10 (10 divided by 1). If Stock Y continues to make the same
level of earnings, it will take ten years for you to recoup your $10 a share from
the company’s earnings.
Another stock, Stock Z, is priced at $20 a share, and its EPS over the year was $4,
its PE ratio will be 5 only. It will take shorter time to recoup your capital
compared to Stock Y.
Hence, the lower the PE ratio, the more attractive the stock is, as it means shorter
time period to recoup your investment. Another good thing about low PE stocks
is that during stock market crashes, these low PE stocks are more resilient too.
However, it will be more meaningful if you compare the PE ratios within the
same industry to see if the stock is overpriced. Sometimes a high PE ratio does
not mean the stock is expensive, because the stock may have high growth
prospects in its future earnings, so investors snap up the shares in anticipation of
the future. This is especially true for tech stocks.
2. What to do when a stock takes off before I buy?
This happens most of the time because most likely, we read some good news
regarding the company in our daily newspaper and act on the news at the same
time. When demand more than supply, price is pushed up.
Whether or not to buy depends on several factors, first, is the stock trading at a
fair price now, how's its PE? Second, does the company has strong earnings
growth potential? Third, is the news reliable or purely speculation? Buying stocks
based on speculation is not investing!
Take your time to study the stock thoroughly. Usually, after a few days, the price
may drop a little due to profit taking by traders. May be that's a better time to
buy if you really think the stock is worthwhile.
3. Should I use the average down strategy when my stock falls?
It depends on the quality of the stock. If it is a penny stock, or a stock that has
poor earnings, then you should apply a 10% or lower cut loss strategy. However,
for a blue chip stock with great dividend policy, average down strategy is a great
way to accumulate good quality stocks at low prices.
4. Should I buy stocks or invest in unit trust?
As an investor, we can have both stocks and unit trust in our portfolio. Its part of
asset allocation and a form of asset class diversification. The main advantage of
unit trust is that it is run by professional fund managers (but make sure you
choose a reputable unit trust company). Personally, I prefer stocks because I don't
have to pay for the management fees as in the unit trust. Furthermore, my return
is higher when compared to unit trust.
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