Myth 1: Stocks with High PE ratio are Expensive
The most common myth among the investors is that the Price to Earning Ratio (P/E) is the ultimate analytical tool to understand the valuations of a company’s stock price. Even as the P/E is one of the most important gauges to base an estimate on the stock’s valuations, it is not the sole statistical figure that throws light on whether to buy a stock or not.
Investors feel that if P/E is high, stock is over-valued and vice versa. However, that is not correct. Just give a thought – When are share prices allotted high P/E valuations?
The market allots a high P/E to a particular scrip’s valuation when the prospects or fundamentals of that counter is estimated to be an out-performer in terms of earning potential over a period of time, say, for example, 1 year forward earnings.
Even as the stock price could be quoting at a higher P/E valuation currently, the market signal could well be that as proceeds from the higher earnings start trickling in; the valuations of the stock will be rendered with a sobering effect going forward.
Myth 2: Stocks quoting Below Rs.50/- are Cheap
Yet another most common understanding among new investors is that stocks which quote below a certain price range, say, for example, stocks quoting below Rs.100 or Rs.50, are cheap in terms of valuations.
Over here, one must remember that a stock price in no way indicates the actual valuation of the company’s stock. The valuations of a stock price are gauged by factors such as P/E, Price to Book Value, Price Earnings to Growth Ratio (PEG), Earnings per Share (EPS), Return on Assets and Growth Rate among others.
Just imagine, if stocks could have been valued simply by price, people would have never bought stocks which quote above, say, Rs.1000 or 2000. They would always buy stocks within the range of Rs.50-100/-. Don’t you agree?
Suppose you want to invest Rs.10000 in equity markets. With so much money you can either buy 4 shares of Infosys Technologies quoting at around Rs.2600 or 525 shares of Hindustan Motors (HM) currently at Rs.19 per share.
But, if you calculate the percentage rise or fall (let’s assume 3% up) in the stock price of both – 4 shares of Infosys and 525 shares of HM – you will realize that the net gain in actual terms for both the stocks remains same from the fluctuation in the stock prices.
Myth 3: Multi-baggers can be Explored only amongst Mid-caps
The term ‘multi-bagger’ is the most over-rated in the world of stock markets. First of all let’s discuss as to what does a multi-bagger mean? The term multi-bagger is used for stock where the price appreciation has been significantly higher than other stocks.
Usually, we measure the returns from a stock price in terms of percentage price appreciation, for example, 30% gains or 40% gains. Whereas returns from a multi-bagger stocks are measured in terms of certain number of ‘times’ of the original investment or more than 100% returns, for example, a stock ‘X’ has appreciated 2 times or 5 times from the price an investor could have bought.
The most common myth about the term multi-bagger is that most of such stocks could be explored amongst small or mid-cap stocks with lower base size. However, that is not true. Investors can as well explore such multi-baggers amongst fundamentally sound large-cap counters but at a time when the valuations are at their cheapest.
Take, for example, during the recent global recession, several large-cap jewels had sullied at depressing lows. The stock price of Bajaj Auto had slumped to Rs.315/- as on December 5, 2008 and has surged to a Rs.2200/- as on June 8, 2010, a whooping 7 times price appreciation for its lows.
There are plenty myths among investors in the stock markets. But, I’ve mentioned only three of the most common ones in the mindset of gullible investor
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