Watch Valuations and Rapid Price Moves
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Watch Valuations and Rapid Price Moves
Investment criteria will vary from investor to investor. What’s important to one stock investor isn’t necessarily key to another. There are, however, a few things that all stock investors ought to monitor.
Things To Know
- If a stock’s P/E or price/fair value shrinks significantly, take notice.
- Understand why a stock’s price moves the way it does.
Prices and valuations
When most people buy a stock, price is a consideration. Maybe you’re a bargain-hunter whose eyes light up at the sight of a low price/earnings ratio. Or maybe you’re a go-go growth investor who’s willing to pay a steep price for a company with terrific growth prospects. Either way, you have a price you’re willing to pay for an investment. Anything above that makes the stock too expensive for your taste.
Once you’ve bought a stock, valuations still matter. If a stock’s price/earnings, price/sales, or price/fair-value ratio jumps significantly from where you bought it, that increases your price risk, because more of the company’s value is in the unknowable future. (Price/earnings and price/sales ratios are widely available; price/fair-value ratios are available from some equity analysts, for example, Morningstar. They are calculated by dividing the company’s share price by what an equity analyst thinks that company is worth, based on discounted cash-flow analysis.) If the expectations underlying that higher valuation don’t pan out, the stock’s price can plunge back to earth.
Conversely, if a stock’s P/E or price/fair-value shrinks significantly, take notice. You may still like the company, and you now have the opportunity to buy more of it at the cheaper price. But if a shrinking share price signifies deteriorating fundamentals at the company, you may no longer want to own the stock. Only you can determine what falling prices means for you.
Investigate rapid price moves
If a stock’s price shoots up or down, something’s going on. Maybe the company has reported better-than-expected financial numbers, and its stock price has risen on the news. Or maybe the stock’s price is sinking like a stone after the company announced operational problems, or the loss of a key customer. In either case, you should be aware of any such price swings in the stocks you own.
Rapid price moves aren’t necessarily anything to panic about. However, understand why the stock’s price moved the way it did. Then, decide what to do. In many cases, you’ll probably want to sit tight. Again, if the stock still meets your investment criteria, why sell?