ON PICKING UP BARGAINS
July 9th 2008 00:00
One indicator that investors, who normally stay in the safety of the sidelines during economic downturns, actually braved the odds and went in to pick up some bargains is the sudden change of color from red to green in your market’s indices. (Pretty much like the changing of colors of your street’s traffic lights.)
That is, despite the fact that the red color representing your market positions, as shown in your own computer screen, hasn’t changed at all. But then, knowing that is easy and I suppose, even our fellow “newbies” are already aware of it.
What may not be immediately evident is the fact that in the streets, when the traffic light turns green, it normally means it is already time for you to step on the gas pedal to move ahead. In the stock market indices, seeing green usually means that the other investors have already gone to where you should have been.
What still remain a mystery to many though, are the ways on how to spot a bargain.
One of the things being recommended by the experts for this purpose is a scrutiny of the earnings yield of a stock. Again, this requires a peek on the financial statements of the companies that ticked our interest.
Earnings yield is simply the ratio of the price of individual shares of stocks vis-à-vis the profits of those same shares of stocks made the past year.
To get this, one has to divide the profits made by the company in question with the number of stocks the company has. If let us say that amounts to US$2 earnings per share and the price of the shares of stock is US$10 then, you have an earnings yield of 20%.
They call this the opposite of Price/Earnings (PE) Ratio, which, using the same example will give you a PE of 5.
The way to interpret this, again, depends on your interpretation of what makes a good stock to buy. I mean, some people would say that the lower the PE of the stock the better it is. But others would say that low PE stocks are bad because those stocks with low PE are not performers.
But, if you can make up your mind and agree even for a while that a low PE is good then we can actually say that a stock may be considered a good buy if it has a low PE (price to earnings ratio) or a high earnings yield.
The earnings yield is also useful in deciding on the question of whether to continue putting a big chunk of your resources in bond or to start shifting some of it into stocks.
Earnings yield is normally presented as a percentage and so is the bond yield. Now, if your bond is giving you let us say a 10% yield and your stock based on past earnings has the potential of giving 20%, where are you going to bet?
Of course, a stock that will give you exactly the same earnings yield as that of a government bond will be at a disadvantage here because a government bond is always considered safer.
I’m pretty certain you wouldn’t want to pick-up more risks for the same amount of profit.
Sure, okay, traffic is bad and the lights already changed several times and you are still there. But should you really be sleeping on the wheel?
What may not be immediately evident is the fact that in the streets, when the traffic light turns green, it normally means it is already time for you to step on the gas pedal to move ahead. In the stock market indices, seeing green usually means that the other investors have already gone to where you should have been.
What still remain a mystery to many though, are the ways on how to spot a bargain.
One of the things being recommended by the experts for this purpose is a scrutiny of the earnings yield of a stock. Again, this requires a peek on the financial statements of the companies that ticked our interest.
Earnings yield is simply the ratio of the price of individual shares of stocks vis-à-vis the profits of those same shares of stocks made the past year.
To get this, one has to divide the profits made by the company in question with the number of stocks the company has. If let us say that amounts to US$2 earnings per share and the price of the shares of stock is US$10 then, you have an earnings yield of 20%.
They call this the opposite of Price/Earnings (PE) Ratio, which, using the same example will give you a PE of 5.
The way to interpret this, again, depends on your interpretation of what makes a good stock to buy. I mean, some people would say that the lower the PE of the stock the better it is. But others would say that low PE stocks are bad because those stocks with low PE are not performers.
But, if you can make up your mind and agree even for a while that a low PE is good then we can actually say that a stock may be considered a good buy if it has a low PE (price to earnings ratio) or a high earnings yield.
The earnings yield is also useful in deciding on the question of whether to continue putting a big chunk of your resources in bond or to start shifting some of it into stocks.
Earnings yield is normally presented as a percentage and so is the bond yield. Now, if your bond is giving you let us say a 10% yield and your stock based on past earnings has the potential of giving 20%, where are you going to bet?
Of course, a stock that will give you exactly the same earnings yield as that of a government bond will be at a disadvantage here because a government bond is always considered safer.
I’m pretty certain you wouldn’t want to pick-up more risks for the same amount of profit.
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