Cheap Stock: What makes it cheap?
For many investors cheap stock occurs only when the price to earnings ratio is low. This ratio shows the multiple of earnings at which a stock sells. This ratio is calculated by dividing the current stock price by the current earnings per share. A higher multiple means investors have increased hope for potential growth, and have bid up on the stock’s price. The lower the price to earnings ratio the better it is for investors to assume that it will return to where the cheap stock was before it goes back up again, if it in fact does go back up again. Screening for stocks with a low price to sales ratio is also a good way to identify cheap stocks. Companies that have low stock prices in comparison to their revenue often have recurring high fixed costs and thin profit margins. These profit margins can grow even thinner or may even vanish when the economy is fragile. When sales pick up, however, and margins rise, the profits rise even quicker.
There are several factors that influence the price of a stock when looking for cheap stocks. It can be quite difficult to know exactly what drives the market, but there are stock price factors that can drive the price up or down. Basically, the more demand there is for a stock, the higher the price will be and vice versa for cheap stocks. There are so many factors that drive stock prices, but in the end, the demand still determines what buyers and sellers will agree to. This demand is affected by politics, industry news, and the market. Demand can be entirely different than it was the previous day. Luckily, every morning in the stock market is a new day. Stocks that closed very high the day before could be falling quickly today. When trying to identify cheap stocks, remember that the stock market is in constant fluctuation.
The stock price history of a company is also an important indicator in addition to the price to earnings ratio when looking for cheap stocks. A future stock price doesn't only depend on earnings from the current year or the next. The price also depends considerably on how well the company’s management performs on the job along with so many other factors. Because the stock market mainly looks at future performance and earnings, the future price to earnings ratio plays a more important role. It really all comes down to approximation and speculation when looking for cheap stocks. If the approximates are incorrect and market expectations are not met, the investors are very disappointed and as a result the stock or possibly the entire market goes down. Keep this in mind when looking for cheap stocks as this unfortunately happens very often when playing the stock market.
Good investors do not jump on cheap stocks, but they take the time to recognize what the fair price for a specific stock is. These investors do not rush into overpaying for stocks either. Good investors look at the company and other factors when determining the price. If a stock is falling along with that market sectors or overall market, they might wait patiently for a good price. Historically, cheap stock is based on several evaluation measures in which to provide good returns. If trading and investing in the stock market was that easy, everybody would just buy stock with low price to earnings ratios! Continue to research potential cheap stocks starting with what you have read in this article. Research is pertinent in playing the stock market game.