Many investors wonder how to know the signs overvalued stocks since that will affect their buying list. Buying overvalued stock sill only bring them loss. The best way to estimate a company’s value is by looking at its price-to-earnings (P/E) ratio.
Signals of Overvalued Stocks
If the P/E ratio or earnings projection does not support the current stock price, then, the stock is overvalued. People usually call the P/E ratio as an earnings multiple.
For instance, the overvalued stocks are those with 50 times earnings if we compare it to the company 0that is trading for 10 times earnings.
Some investors believe that there will be no average investors who can get the information fast enough to know that a stock is overvalued. The reason for that is the efficiency of the stock market and the immediate effect of the factors on the stock prices.
However, according to the fundamental analyst, you can find always those overvalued or undervalued stocks through the irrationality of investors.
If you are looking for those signals, you better start with reviewing the company’s annual report, income statement, balance sheet, and other disclosures.
Also read: Factors Drive Stock Bull Market
PEG or Dividend-Adjusted PEG Ratio
You can calculate the PEG ratio by dividing the P/E ratio by the company’s earnings growth rate. Meanwhile, for the dividend-adjusted PEG, you can divide the P/E ratio by the earnings growth and dividend yield.
The lower number of PEG and Dividend adjusted PEG ratio is better, anything at 1 or even bellow should be a good deal.
Relative Dividend Yield Percentage
The dividend yield of overvalued stocks is at the lowest of 20 percent of its long term historical range. The company’s core operation will be stable unless its sector undergoes a profound change.
The Earnings Yield
The earning yield can also provide a clue for an overvalued stock if we compare it to the Treasury bond. If you witness the Treasury bond yield exceed the earning yield by 3-to-1, then the stock is overvalued.