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

National Savings Certificate

National Savings Certificate Here's everything you need to know about the 5-year savings scheme offered by the Government This is a 5-year small savings scheme of the government. From 1 July 2016, a National Savings Certificate (NSC) can be held in the electronic mode too. Physical pre-printed NSC certificates have been discontinued and replaced with Public Provident Fund-like passbooks. What's on offer The minimum amount you can invest in them is Rs100 and there is no upper limit. Under this scheme, all deposits up to Rs1.5 lakh qualify for deduction under section 80C of the Income-tax Act, 1961. The interest earned is taxable. You can invest in multiples of Rs 100. These certificates can be owned individually, jointly and also on behalf of minors. The interest rates for all small savings schemes are released on a quarterly basis. The effective rate for NSC from 1 October to 31 December is 8%. The interest is calculated on an annual compounding basis and is given along w...

Am you Required to E-file Tax Return?

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300   Am I Required to 'E-file' My Return? Yes, under the law you are required to e-file your return if your income for the year is Rs. 500,000 or more. Even if you are not required to e-file your return, it is advisable to do so for the following benefits: i) E-filing is environment friendly. ii) E-filing ensures certain validations before the return is filed. Therefore, e-returns are more accurate than the paper returns. iii) E-returns are processed faster than the paper returns. iv) E-filing can be done from the comfort of home/office and you do not have to stand in queue to e-file. v) E-returns can be accessed anytime from the tax department's e-filing portal. For further information contact Prajna Capit...

Mutual Fund Review: HDFC Index Sensex Plus

  In terms of size, HDFC Index Sensex Plus may be one of the smallest offerings from the HDFC stable. But that has not dampened its show, which has beaten the Sensex by a mile in overall returns   HDFC Index Sensex Plus is a passively managed diversified equity scheme with Sensex as its benchmark index. The fund also invests a small proportion of its equity portfolio in non-Sensex scrips. The scheme cannot boast of an impressive size and is one of the smallest in the HDFC basket with assets under management (AUM) of less than 60 crore. PERFORMANCE: Being passively managed and portfolio aligned to that of the benchmark, the performance of the index fund is expected to follow that of the benchmark and in this respect, it has not disappointed investors. Since its launch in July 2002, the fund has outperformed Sensex in overall returns by good margins.    While every 1,000 invested in HDFC Index Sensex Plus in July 2002 is worth 6,130 now, a similar amount invested in Sensex then wo...

Different types of Mutual Funds

You may not be comfortable investing in the stock market. It might not seem like your cup of tea. But you can start by investing in Mutual Funds. Many first-time investors invest in Mutual Funds. This is because they do not know how to invest in individual securities. Basic information on Mutual Funds People invest their money in stocks, bonds, and other securities through Mutual Funds. Each Fund has different schemes with specific objectives. Professional Fund Managers look after these schemes. Your Fund Manager could help you invest in a scheme that suits your financial goal. Functioning of Mutual Funds You could make money through Mutual Funds in different ways. A single Mutual Fund could hold many different stocks, bonds, and debentures. This minimizes the risk by spreading out your investment. You could earn dividends from stocks and interest from bonds. You could also earn capital by selling securities when their price increases. Usually, you could choose to sell your share any t...

IDFC - Long term infrastructure bonds - Tranche 2

IDFC - Long term infrastructure bonds What are infrastructure bonds? In 2010, the government introduced a new section 80CCF under the Income Tax Act, 1961 (" Income Tax Act ") to provide for income tax deductions for subscription to long-term infrastructure bonds and pursuant to that the Central Board of Direct Taxes passed Notification No. 48/2010/F.No.149/84/2010-SO(TPL) dated July 9, 2010. These long term infrastructure bonds offer an additional window of tax deduction of investments up to Rs. 20,000 for the financial year 2010-11. This deduction is over and above the Rs 1 lakh deduction available under sections 80C, 80CCC and 80CCD read with section 80CCE of the Income Tax Act. Infrastructure bonds help in intermediating the retail investor's savings into infrastructure sector directly. Long term infrastructure Bonds by IDFC IDFC issued an earlier tranche of these long term infrastructure bonds on November 12, 2010. This is the second public issue of long-te...
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