Tuesday, January 10, 2012

"Cheap" Stocks Versus "Expensive" Stocks

When I first started learning about stocks, I thought that a stock that sells for $50 per share was too expensive and I wanted to find a stock that sells for $25 per share. I learned that this view of stocks is overly simplistic and just plain wrong. Google (GOOG) is $623 per share. Jim Cramer has talked about how the movement of stock prices is tied generally to the basic economic theory of supply and demand. $623 is a lot of money for one share, but with a price to earnings ratio, or multiple, of 21, some would see it as a bargain. For comparison sake, Amazon (AMZN)sells for $179 per share, with a P/E ratio of 94. Google is in high demand since it is a company that has proven to be innovative and well managed. Apple is in the same category. In 2008, Google dropped as low as $260 dollars per share. Now it is over twice that amount. Smart investors would have bought Google in 2008 and sold it recently, turning a handsome profit. People will pay a premium for Google since the balance sheet shows that its total assets have almost doubled from the end of 2008 to the end of 2010, going from $31 billion to $57 billion. Total liabilities have gone from $3 billion to $11 billion over the same period. So, at the end of 2010, the total liabilities were only about 20% of the total assets, which is impressive in this day and age where many companies (and individuals) are carrying so much debt. The ratio of assets to liabilities for Amazon is over 50%. There are other valuation criteria for evaluating stocks other than P/E and the balance sheet analysis, but these are a couple of things to consider when picking investments. It makes sense to compare stocks in the same sector. So, if you want to buy a tech stock, you can compare Google to Apple, Microsoft, Amazon, E-Bay and others. Do your homework such as listening to conference calls, examining the balance sheet, following news about the company, analyzing the annual report, and other tasks. You can monitor trading of insiders who own large quantities of the stock, and look up historical prices/dividend yields by using sites like Yahoo Finance or MSN Money. Look at the 52 week high and 52 week low. Search for bargains, just like when you buy anything else. Buy low, sell high is the cardinal rule of investing. Past performance gives you an idea of the stock's track record and volatility, but future performance is more important. Look at the figures for revenue, earnings per share and growth rate. Google went public on August 19, 2004, selling for $100 per share. How many of us would like to take a time machine back to that day and load up on shares of Google? Ten shares bought for $1000 back then would be worth $6230 now.

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