Everyone loves cheap, especially investors. But when cheap becomes crap, cheap becomes expensive. In the stock market, investors are seduced by low-quality stocks looking cheap and promising at first sight. The moment of happiness lasts until they realize that the stock’s performance is moderate at best. And low-quality stocks often result in capital losses and dividend cuts.
A notorious dazzler
Dividing price by earnings is a common metric to determine a stock’s valuation. Unfortunately, “common” does not equal “correct.” In an open market, whenever something looks cheap, something is rotten. The stock market is one of the most open markets, thus cheap means something must be very rotten.
Don’t believe? Let’s have a look what “cheap” really means.
How cheap looks like
These charts show the relationship between earnings growth and price-earnings. As earnings decline, the stock price declines even faster, leading to a contraction of the price-earning-ratio. The stock becomes “cheap” because the company is in serious “earnings” trouble, and the market does not believe in fast recovery.
The stock price tumbled from above $70 in 2014 to less than $23 now. A painful capital loss for anybody invested. If you “took the chance” and bought in 2017 when the price-earnings-ratio was “only” 10, you still lost about 50 percent. Sole consolation: when all earnings are gone, there is no price-earnings-ratio anymore.
No price-earnings-ratio — then what?
Long-term investors should always invest in high-quality stocks, but the price-earnings-ratio has no clue about quality. That’s the problem, and that’s why we need other metrics. Which one, I’ll tell another time.
P.S.: The same goes for the price-to-book-ratio.
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation in writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.
Epipoli confirms the positive trend of digital payments
In the first quarter of 2021, the positive trend and the acquisition of important projects with brands including Gruppo Arena,...
Nexkin Medical seeks one million euros to reinforce its market entry
The device developed by Nexkin Medical enables skin prick test reading with the help of state-of-the-art technology, streamlining clinical procedures,...
Morocco’s employment policy: unemployment rate under close scrutiny
The impact of the health crisis on the rise in unemployment has been a real challenge for the government since...
A crowdfunding campaign was launched for Avanchair, the innovative wheelchair
The crowdfunding campaign for Avanchair, the electric wheelchair that can greatly improve the daily lives of the disabled, started on...
Pharma Mar’s first-quarter profit fell 66% to 24 million
Pharma Mar's investment in research and development (R&D) rose by 19.6% to $17.7 million (€14.7 million). Other operating expenses fell...
Cannabis6 days ago
Morocco, the world’s largest cannabis producer legalizes it
Business5 days ago
Silver Bugs Unite on Squeeze to Send the Metal’s Price ‘to the Moon’
Business7 days ago
What Google’s new core web vitals rankings mean for small businesses
Crowdfunding5 days ago
Walliance reached the maximum collection goal for a real estate project in Milan in only a few minutes