Want to Learn Why Most Expensive Stocks are a Con?

Tweet

The “efficient market theory” means that, through the magic of millions of investors buying and selling stocks daily, you get what you pay for. That there is a reason why a company is cheap and another is expensive, and many investors swear by this theory.

However, it may not be all that solid. The truth is that the market runs as much on emotion as it does on logic, and the extremes rule! Investors are either too pessimistic or too optimistic.

In reality, an investor rarely gets what he pays for when he invests. He normally gets too little or too much, and lately, when it comes to expensive stocks, the rule is to get too little.

There are many companies out there with price-to-earnings (P/E) ratios over 100. In a P/E ratio, a share price greater than 100 times annual earnings or returns per share is very high. To justify such a price, the business must grow in a huge way and prove without a doubt that it will continue on this path.

But, if you do your homework, you may discover that very few of the companies that appear with such a P/E ratio earned it due to strong growth. Normally, they got it because their earnings fell faster than their price.

Let’s see an example: At one point, eBay’s earnings dropped 65% over 12 months, but its price dropped only 8%. At a P/E ratio of 98, eBay’s price at that point was a lot higher compared to its earnings than what it had been a year before. In other words, eBay became more expensive after having a bad year instead of after having a good one.

Very few super-expensive companies can claim that its high P/E ratio was due to an ultra-fast growth in revenue and earnings; so, run away from them as you would run from a deadly virus… unless of course, you know, by studying their past earnings, that you are in front of a prodigy.

If you liked this article, tell all your friends about it. They’ll thank you for it. If you have a blog or website, you can link to it or even post it to your own site. You can get more tips on how to invest your money wisely at CherryShares.com