Is a $5 stock a deal, and a $500 stock overpriced? Even savvy investors can’t answer that question because there isn’t nearly enough information — and it’s important to get all the necessary information before buying.
Well-known investor Warren Buffett who ran Berkshire Hathaway for 60 years often warns investors against a major investing mistake: overpaying for stocks. Even a stock of a strong company could be a poor purchase if the price of the shares are too high, according to Buffett.
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In other words, just because a stock looks cheap, doesn’t mean it’s worth buying. In fact, often a stock may be cheap for a reason. Here’s how you can tell if a stock is fairly valued so you avoid overpaying.
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The risk: paying too much for stocks
Investors can use several metrics to help them gauge if a stock is valued fairly. The price-to-earnings ratio (P/E ratio) indicates a company’s stock price relative to its earnings per share. If a stock is undervalued, it typically has a low price relative to how much money the company is earning.
A stock’s debt-to-equity ratio offers insight into a company’s financial health. It shows how much a company relies on debt, so a high ratio could show that a company relies heavily on borrowing money, which may indicate risk. There’s return on equity, too, which signals how effectively a company can turn shareholder capital into revenue growth.
It’s also important to avoid investing in a stock just because it has a high yield. While a high yield translates into more cash flow, that heightened yield may be temporary.
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Why this mistake is especially dangerous after age 50
An investing mistake will sting at any age, but it can be especially harmful in your 50s or beyond because your investment portfolio has less time to rebound. If retirement is getting closer, market downturns of 10% and 20% that didn’t spook you in your 20s may cause more stress with a shorter time horizon.
Poor financial management and succumbing to emotions during volatility — including buying a stock just because it looks cheap — can lead to significant losses. Yield chasing and ignoring valuations can result in long-term pain even if those same assets have promising short-term momentum.
Grow your investing confidence with expert-selected stock picks
How to reduce risk
Buffett had a risk-averse approach to investing, and was a proponent of buying quality companies at reasonable prices.
He looks at a company’s fundamentals before determining if it presents a solid buying opportunity. You can look at metrics to make sure you aren’t buying stocks at lofty price levels.
But diversifying your portfolio across several sectors is one of the best ways to reduce risk, and retirees can do this by investing in well-balanced exchange-traded funds (ETFs) and mutual funds. Dollar-cost averaging into these funds helps ensure that you get a little more exposure each month.
Must Read
- Experts are Bullish on Gold — Here’s How to Get In
- 3 Ways You Can Make Cash on Your Couch
- These Are the Best High-Yield Savings Accounts Right Now
Is a $5 stock a deal, and a $500 stock overpriced? Even savvy investors can’t answer that question because there isn’t nearly enough information — and it’s important to get all the necessary information before buying.
Well-known investor Warren Buffett who ran Berkshire Hathaway for 60 years often warns investors against a major investing mistake: overpaying for stocks. Even a stock of a strong company could be a poor purchase if the price of the shares are too high, according to Buffett.
Must Read
Experts are Bullish on Gold — Here’s How to Get In
3 Ways You Can Make Cash on Your Couch
These Are the Best High-Yield Savings Accounts Right Now
In other words, just because a stock looks cheap, doesn’t mean it’s worth buying. In fact, often a stock may be cheap for a reason. Here’s how you can tell if a stock is fairly valued so you avoid overpaying.
Vet bills can cost thousands — see what pet insurance might cost you
The risk: paying too much for stocks
Investors can use several metrics to help them gauge if a stock is valued fairly. The price-to-earnings ratio (P/E ratio) indicates a company’s stock price relative to its earnings per share. If a stock is undervalued, it typically has a low price relative to how much money the company is earning.
A stock’s debt-to-equity ratio offers insight into a company’s financial health. It shows how much a company relies on debt, so a high ratio could show that a company relies heavily on borrowing money, which may indicate risk. There’s return on equity, too, which signals how effectively a company can turn shareholder capital into revenue growth.
It’s also important to avoid investing in a stock just because it has a high yield. While a high yield translates into more cash flow, that heightened yield may be temporary.
Still paying for subscriptions you don’t use? See what you could cancel
Why this mistake is especially dangerous after age 50
An investing mistake will sting at any age, but it can be especially harmful in your 50s or beyond because your investment portfolio has less time to rebound. If retirement is getting closer, market downturns of 10% and 20% that didn’t spook you in your 20s may cause more stress with a shorter time horizon.
Poor financial management and succumbing to emotions during volatility — including buying a stock just because it looks cheap — can lead to significant losses. Yield chasing and ignoring valuations can result in long-term pain even if those same assets have promising short-term momentum.
Grow your investing confidence with expert-selected stock picks
How to reduce risk
Buffett had a risk-averse approach to investing, and was a proponent of buying quality companies at reasonable prices.
He looks at a company’s fundamentals before determining if it presents a solid buying opportunity. You can look at metrics to make sure you aren’t buying stocks at lofty price levels.
But diversifying your portfolio across several sectors is o
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