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POSTED BY ON September 25, 2010 9:39 am COMMENTS (9)
How do I know if a stock is over-priced? When does one say that a particular stock is over-priced? For eg, a friend recently said that he thinks Infosys stocks are over-priced? What did he mean? What are the disadvantages of investing in an over-priced stock?
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@Manasa
That matter when they are coming up with an IPO i.e. for new company in the market . Ppl may not subscribe if its over priced.
Otherwise every share (whatever is available for public holding) is with one or other investor.
95% IPOs r overvalued , very few companies leave money on table for investors.In fact they r against investors interest.as they r offered to investors when they r willing to pay a higher and outrageous valuations in boom times.It makes sense that u should wait for bear markets to pick up IPOs .Always avoid chasing these stocks on listing or during offer period.
Thanks guys, but I have yet another question. If stocks are over-priced, then isn’t that worrisome for the company, because people don’t invest in their stocks due to over-pricing?
Yes it is a matter of worry for cos when their stocks are overvalued . They have several options to bring down prices like stock splitting etc.
Based on the P/E ratio we can know whether the company is over-priced or not. the P/E ratio of the stock acts as an indicator of how expensive (overpriced) or how cheap (under priced) the stock is.
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
where, the Earnings per share = Net Profit made by the company during the previous year/ Total number of shares in the company.
Now lets come to real world example of infosys. the P/E ratio of the infosys is 30. Arithmetically, P/E= 30 or after cross-multiplying P=30*E. i.e the share price of the infosys is 30 times the annual profit (earnings) made by the companies (per share). In other words, market is willing to pay 30 years’ profit upfront to buy their shares (without considering growth in profit). Doesn’t that look so much expensive? It would be wise to purchase if it is available @ PE 15-18.
Hope it clears the doubt.
Happy investing 🙂
@Manasa
If you are asking just the meaning of “over-priced” in stocks , take an example, if you go to market to buy banana , and they say its Rs 50 per piece , then its over priced, Its not sensible to pay that much , however if there are chances that it can go up to Rs 100 , it can be a good idea to buy it .
However in case of stocks its not that easy to understand when stock is priced , it would take some home work and calculations to understand when a stock is over priced
Manish
Few weeks back Manish had posted an article on “Market Price of Stocks”.
Have a look at it, has very good examples.
Rakesh
Stocks are measured by a concept called PE. Which is Mkt Price of the script (P) and Earnings per share (E).
The higher the PE the higher is stock valued. Now this should be compared to other co’s in same industry and say if industry PE is 12 or 15 and co your evaluating is trading at 30 or 35 times PE then the stock is considered overpriced.
Disadvantage of over priced stocks are that there’s generally not large room for further upside and if market tanks, such scripts come dowm tumbling faster.
For valuation of stocks , P/E ratio is not the only concept used for the purpose. Generally Price/ Earnings to growth, Price to Book ratio, EV / EBITDA are considered alongwith P/E ratio to decide whether the stock is undervalued or overvalued.