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Advice Regarding Buying The Cheapest Stocks

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Buying The Cheapest Stocks – How To Properly Value Stocks

Cheapest StocksThe mantra of the stock market is to buy stocks low and sell them high to make money.  This inevitably leads stock market traders and investors to investigate the cheapest stocks in terms of price for potential future gains, so they can be sold at a higher price for a profit.  However, the cheapest stocks according to price do not always have the best valuations in the stock market.

The most common and most widely used stock valuation method is a stock’s price-to-earnings ratio (P/E ratio).  A stock’s P/E ratio is a number that is derived by dividing the current price of a stock by reported company earnings for the past year per outstanding shares (known as the trailing earnings).  A low P/E ratio may indicate an undervalued stock based on price and earnings, while a high P/E ratio may indicate an overvalued stock based on price and earnings.  For example, if Apple Inc. is selling for $400 per share, and it earned $25.00 per outstanding shares over the past year, then Apple Inc.’s stock has a P/E ratio of 16, which is relatively cheap for a stock in the technology sector (with many high growth technology stocks carrying P/E rations of 25 or more).

While professional traders and investors use a variety of complicated stock valuation methods (see:  Advice On Stocks – Definitions and Valuation Methods) for many traders and investors of all levels, evaluation the cheapest stocks by valuation boils down to price and earnings, which leaves them examining a stock’s P/E ratio.  It is important to understand that a P/E ratio is just a backward looking snapshot of a company and stock’s performance, and is only one measure to determine if a stock is cheap.

There are many things to consider while looking at a stock’s P/E ratio to assess whether a stock is really one of the cheapest stocks trading on the stock market and worth buying.  For example, a stock might be inexpensive as far as the P/E ratio and price is concerned, but if it has earnings that are projected to fall or it will soon be losing money, then the P/E ratio will be on a course to rise or disappear altogether, as earnings decrease or turn into losses.  This is known on Wall Street as a “value trap”.  A stock that appears cheap based on price and the P/E ratio, but really is not cheap because future earnings growth will not materialize to send the stock price higher.

Conversely, some stocks that trade at relatively high prices, such as Apple Inc. stock (AAPL), are actually considered some of the cheapest stocks trading on the stock market because future earnings growth and modest P/E ratios should lead to additional appreciation of the stock’s price in the quarters and years to come.  The cheapest stocks are actually the ones that have prospects for earnings growth, not the ones that trade for the lowest price.  Of course, there are some low priced stocks that can be considered some of the cheapest stocks on Wall Street, if they experience a turnaround in earnings that leads to higher future trading levels.

Buying The Cheapest Stocks – Buyer Beware

The bottom line regarding finding the cheapest stocks trading on the stock market is that future earnings projections are the really important factor to focus on to find the cheapest stocks.  While at face value a stock may appear cheap due to its price and P/E ratio, it really is the potential future earnings that will drive the price of a stock higher.  Many novice investors make the mistake of focusing exclusively on cheaply priced stocks, rather than stocks that are cheap in relation to their future earnings projections.

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