Value Comes At A Price
In the stock market, what seems cheap could literally be expensive and what looks expensive may turn out to be the next super performer. The simple fact is that value comes at a price.
The typical P/E ratio indicates historical results and does not take the future into account.
It's important to focus on companies that report strong earnings, which then generate upward revisions in earnings prediction.
It is hard to get away if you buy a cheap stock because it’s tough to sell if it moves against you because then it's even cheaper. Most investors look for discounts instead of looking for leaders.
The best growth stocks rarely trade at a low P/E ratio. In fact, in history, many winning stocks have traded at more than 30 or 40 times earnings before experiencing their biggest advance.
While dealing with a dynamic new leader or new industry, it is extremely difficult to predict the span of the growth phase and the level of slowdown that will occur over a particular time frame.
In June 1997, Mark bought Yahoo! shares when it was trading at 938 times earnings. Every investor disapproved of the unknown company. However, Yahoo! was driving a new technological revolution- the Internet. The potential of the then-new industry was widely misjudged. Yahoo! shares increased a remarkable 7,800% in just 29 months, and the P/E broadened to more than 1,700 times earnings.
Image Source: Trade Like A Stock Market Wizard
Stock prices are not moved by value but by people placing buy orders. As a thumb rule, Mark doesn't buy shares of a company with an extremely low P/E, particularly if the stock price is near it's 52-week low. A stock with an exceedingly low P/E ratio can prove to be a trouble. A stock trading at a multiple far below the existing industry multiple could indicate a fundamental issue. The potential of the company may be debatable and it might even be headed towards bankruptcy.
Mark uses the P/E ratio as a sentiment measure that gives him an outlook about investor expectation. Generally, a high P/E means high expectations and a low P/E means lower expectations.
