Skip to main content

All that is cheap may not be good

Avoid buying stocks based on cost alone. Highly priced stocks may be expensive but provide better returns

Whenever we buy a product or service, we look at its cost. Cheaper products seem more affordable and hence attractive to buy.

The same applies to stocks. Low-priced ones attract more buying interest. However, do they give good returns? One must know how to compare stocks, the pricing and how to find value for money.

The simplest way to know if a stock is cheap or costly is comparing the price-to-earnings ratio (P/E ratio). Suppose stock A has a price of `1,000 and its earnings per share (EPS) is `100. Then, the P/E ratio is 10. Another stock B, has a price of `200 and its EPS is `8. Then, the P/E ratio is 25. Stock B is said to be costlier than stock A.

Another method is to compare the price -to-book value (P/BV). Taking the case mentioned above, if the book value of A is These two are the most common and universally utilised methods for evaluating the prices of stocks.

WHY HIGH PRICES?

Let us see why some stocks are highly priced: market and in their industries. But inspite of their high prices they have been able to give better returns. This is because their earnings growth is superior. They also have grown at a faster pace.

In contrast, many of their cheaper peer sates their business model and innovation and this is reflected in stock prices.

Better resource raising: Most blue-chip stocks with high prices are of companies self-sufficient in capital and able to fund growth entirely through internal accruals. Either because of enormous generation of cash flows or because the business doesn't have much capital requirement. Their shareholders don't have to suffer equity dilution, nor would they have to raise high-cost funds which dampen equity earnings. As a result, these companies get much higher valuation than their cash-strapped peers and this is reflected in their high prices.

Good corporate governance: The companies with good corporate governance have a better valuation in the market. The prices of these stocks are always at a premium, as the investing community have a lot of respect for the management and believe in their business philosophy and decisions. Examples are Infosys, Wipro, Tata Group companies, HDFC. It is important to know about corporate governance when investing in a company.

Liquidity: Stocks with better liquidity usually get higher valuation and stocks which are less liquid have lower valuation. For example, Asian Paints and Kansai Nerolac, are both fundamentally good companies operating in the paints industry. However, the valuation for Asian Paints is higher as compared to Kansai Nerolac, as the latters shares are less liquid.

Market perception: Market perception also helps in determining the stock valuation. Companies in sunrise industries like education, healthcare and telecom usually get a better valuation.

PRICE AND RETURNS

In the table given, we have taken some of the highly priced stocks not only in absolute terms but also in relative terms. And, compared their five-year returns with those of their low-cost peers. As can be seen in the table, the richly valued stocks have beaten their low-cost peers substantially.

PRICE STUDY

Remember that if stock price was the only indication of whether a stock was cheap or not, nobody would have been buying stocks like Infosys, SBI, HDFC and so on. But these high-priced stocks have always delivered better returns than the market

Conclusion: Retail investors should not be worrying only about the cost price. If any stock is providing value for money they should go for it, irrespective of the price. If investing in small-and mid-cap stocks, look before you leap.

Popular posts from this blog

Understanding Your Cibil Credit Information Report

   WE ARE all familiar with the anxiety and uncertainty that we feel when applying for a loan. After all, it's the lender who decides whether we can own our dream home, our first car, or whether our children can pursue higher education. In a nutshell, a better life depends on the lender's decisions.    While other factors do play a part in the lender's decision, the Cibil Credit Information Report ( CIR ) plays a crucial role in a lender's decision to approve a loan application.    Previously, lenders would treat all loan seekers equally. Each applicant, if approved by the lender's internal credit policy, would be charged at the same interest rate for a particular loan size and purpose. The lenders would charge a higher interest rate to all the borrowers, in order to compensate for the possible default of a small portion of the loan disbursed. In other words, it's like a professor (the lender) punishing an entire class (borrowers) for the mischief played b...

What are the factors affect the changes in Interest Rate of Fixed Deposits?

  What are the factors affect the changes in rate of Fixed Deposits? Fixed Deposits are now considered to be a very old fashioned method of saving, but still attract many investors since they have guaranteed returns at the end of the tenure of the investment at a decent interest rate. There are various factors that affect the rates of interest for a Fixed Deposit. Policies of the Reserve Bank of India   - The several norms and restrictions posed by the Reserve Bank of India , in order to gain optimum control over credit and inflow and outflow of fund throughout the country. The repo rate changes, cash reserve ration tends to change and these changes affect the banking products like Fixed Deposits, loans etc. Recession   - When unemployment in a country crosses the benchmark set Recession hits, and slowly the country faces an economic slow movement, affecting the purchasing power of the people in the country, forcing the Reserve Bank of India to release more funds in the financial marke...

Myths about Exchange Traded Funds (ETFs)

1) ETFs Are Similar to Individual Stocks: Like MFs, ETF consist of an underlying portfolio of securities that's designed to follow a specific index or investment strategy. Hence, they are as diversified as various mutual funds. 2) ETFs Only Invest in Equity: Since they are listed on the exchange, the general belief is that ETF only consists of equity asset class. Globally, ETFs are available across asset classes – equity, debt, commodities, real estate and so on. In fact, over the past couple of years, India has also seen the emergence of Gold ETFs. 3) All ETFs Are Index Funds: ETF started as a fund which used to track indices and hence they were branded as index funds that are listed. However, ETFs have progressed rapidly and are no longer associated only with passive index funds. Globally, we have seen the launch of actively-managed ETFs. In India, also we recently saw the emer gence of fundamentally-weighted ETFs on Nifty, which busts the myth that ETFs are index funds and can...

REC Tax Free Bond Issue

Tax Saving Mutual Funds Online Current open Infra Bond Application form   Download REC Tax Free Bond Application Forms REC (Rural Electrification Corporation) is going to issue tax free bonds and the issue will open on March 6 2012 and will close on the 12th of March 2012 When you buy 80CCF infrastructure bonds, the amount you invest in those bonds get reduced from your taxable income but in these bonds that's not going to be the case. The interest on these bonds will be tax free and they are similar to the other tax free bonds like the HUDCO, NHAI and PFC issues. For the two of you interested in knowing this – these bonds are tax free under Section 10(15)(iv)(h) of the Income Tax Act. Now on to the issue itself and let's start with the high credit rating that the issue has got. The REC tax free bond issue has been given the highest rating by all issuers since the government owns the majority stake (66.8%) in REC, it has been consistently profit making,  this is a se...

Good Loan

Why Is It A Good Loan?: Loans against gold are cheaper and better than personal loans as the former are available at lower interest rates. In contrast, the interest rates on personal loans are not standardised and can vary from bank to bank. Also, a personal loan depends on a host of factors including, the borrower's salary, profession and the purpose for which the loan is being taken.      For instance, the interest rate on a personal loan of 5 lakh falls in a wide range of 15-30%. But loans against gold are available for as low as 11%. Secured borrowing such as a loan against gold, investments or property is cheaper because it is backed by some assets, which command a good value at any point of time. If the borrower defaults on the loan, the banks can liquidate the assets to settle the loan account.    Being a secured loan, the risk of default and credit losses is significantly lower in this loan compared to other forms of loan for personal use. Given the lower risk, gold loa...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now