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Are Stock Prices A Good Indicator To Use When Investing?

The stock prices of many companies in Singapore and elsewhere have risen tremendously over the last few years. In times like these, it’s useful to note that the price alone is not a good indicator to use when deciding whether a stock is cheap or expensive. This holds even when comparing stock prices across time.

So, if the stock price is not the correct number to use, what should investors be looking at? This is where valuation comes into play.

There are many valuation metrics that investors can use to make sense of how expensive or cheap a stock is. Some well-known examples include the price-to-earnings (PE) ratio, the price-to-book (PB) ratio, the price-to-free-cash-flow (PFCF) ratio, and the dividend yield, just to name a few.

These valuation metrics can be compared across time to get a sense of how cheap or expensive a stock is.  For example, if Stock ABC currently has a PE ratio of 25, and had a peak PE ratio of 45 and a low of 20, it tells us that Stock ABC has a high chance of being a cheap stock. But it’s also important to bear in mind that a company’s business conditions do change over time – so, even a low PE ratio may not signify a bargain if a company’s business would end up deteriorating significantly.

Another way to use valuation metrics would be to compare a stock’s numbers with its peers, or with its industry’s average. If Stock ABC’s valuation metrics are lower than its peers’, then it could be a potential bargain.

In conclusion, a stock’s price is not a good indicator of its actual value. The price merely tells you what the stock costs, but it is the valuation numbers that will point out what it is really worth.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.