Stock Markets are considered one of the best investment opportunities but they are not insulated from their share of Risks.Ask people who have burnt their hands in Stock Markets and all you get from them is
“Share Market is Gambling”
Now,that holds true for them for several reasons.One of the primary reasons why some people consider the Stock Markets a gambling business is because we get into them without handy knowledge at hand.Though,i accept the fact that no amount of knowledge can guarantee you success but yes,it sure helps to have a better shot at it.
So,with this aim in mind,I plan to start a series on understanding primary fundamentals
Simply put,it is the price you are paying for buying the share based on the companies earning.
If a particular stock is trading at 100 rupees and the average earning per share for year-on-year basis is 10 rupees, the p/e of that company is 100/10=10.
Now,how can a P/E ratio help in determining the stock to buy?
It sure does because it gives us an idea to categorize the stocks and pursue the one that suit our financial goals.
I am not very sure but this is the information i have gathered over time.
A)High P/E Ratio: Stock of Companies having a high P/E ratio are generally termed as Growth Stocks. A high P/E is due to positive investor sentiment wherein the investors have faith in the stock and that makes them overvalued i.e. High P/E.The investors take in the hope that the company has a good growth potential and the profit yield is bound to grow in time.
These companies are generally the ones which expand very quickly or have good future growth plans.They invest most of their earnings back into the business thereby not providing bonus,dividends but their stock prices have the potential to zoom big time.
Some of the growth stocks on my list are Bharti Airtel,ICICI Bank.
B)Low P/E: Unlike High P/E stocks there can be companies which are trading with lower P/E’s.Now,a naysayer observation would reveal that a low p/e stock means nothing but losses.But,that is not true.A company might get into trading below their true value based on various external factors that may have factored in for some reasons, but the company fundamentals might still be strong.These stocks are considered as Value Stocks by some.These are considered to be safe havens for investors to park their money in.The investor does not end up paying a high value for his investment and also low P/E stocks have been phenomenal in sharing their profits with their investors in the form of Bonus Issues,Dividends and stuff.
Some of the value stocks in the market are Varun Shipping,power grid etc.
C)There are some stocks which do not factor in the P/E too much and can have fluctuating P/E’s over the horizon.These stocks are known as Momentum Stocks and are hugely driven on big trade volumes.These shares are traded on a daily basis in huge quantities and they generally move along with the Market Sentiments.They are basically aimed at maximizing the profits on a daily basis,but to my knowledge can be risky since a lot of money is put into these and they can be dominated by Speculations alone.But,yes they follow a certain pattern in their prices so i think they can form a small part of the portfolio.
A momentum stock that i personally keep is Nagarjuna Fertilizer.It is traded in huge volumes and follows a price band between 30-50 levels.The idea i follow is to enter the stock at around 30-35 levels and exit at 45-50 levels booking my profit.Keeping it for a long term does not make sense since they follow a cyclical price band.
This is the basic categorization that i think can be based on P/E.
It is important to understand that P/E is just one of the parameter and not the deciding one.
Also,When choosing a stock based on P/E,efforts should be made to compare the P/E of the companies in the same kind of business ,otherwise it makes no sense.
Disclaimer::The views here are based on the my understanding and may be wrong.Please use you own research while Investing.
Think i have got it all wrong.Please correct if you think so,i am always game to learn.