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Wow! What a crazy and volatile few weeks investors have had in the stock market!
I encourage investors to always check the value of an investment or asset class before buying it. Asset class is simply investing lingo for the type of investment, such as bonds or stocks. This is the same principle that you would use when shopping for anything; you would never buy a new handbag without first checking the price tag, so be sure to do the same with your investments.
One of the ways to check the value of an investment is by looking at stock charts, which are no where near as scary as they sound. (I like to say a picture paints a thousand words.) The other way to check the value of an asset class is by looking at the PE ratio.
This is simply how much something costs relative to the amount it is earning. Makes sense, right? Historically, the stock market PE ratio average has been about 15 since the 1870’s, according to Doug Short in his informative blog for financial advisors.
Today on CNBC Bob Pisani said that the Price Earnings ratio is now about 11.5. Sounds like a buy, right, since lower is cheaper? It all depends on the earnings of the companies that make up the stock market. The “earnings” in this PE ratio are based on a forecast of future earnings. It’s just like the designer handbag that looks like a bargain at first glance, but loses its appeal after finding the rip in the lining upon further examination.
Investing, like everything else in life, sometimes calls us to dig a little deeper. Remember, the goal is to avoid buying at the very top and selling at the very bottom, so you can capture some of the uptrends and avoid massive losses. Being aware of the PE ratio, this simple and timeless investing number, will, at a minimum, allow you to monitor your investments with more confidence.