Question

You have two roommates who invest in the stock market

7a.)One roommate says she buys shares only in companies that everyone believes will experience big increases in profits in the future. How do you suppose the price-earning ratio of these companies compares to the price-earnings ratio of these companies compares to the price-earnings ratio of other companies?What might be the disadvantage of buying shares in these companies?

b) Another roommate says she only buys shares in companies that are cheap ,which she measures by a low price-earnings ratio.How do you suppose the earnings prospects of these companies compare to those of other companies? What might be the disadvantage of buying shares in these companies?

Answer 1

1. While buying shares of those companies which everyone believe that will have big increase in profits in future will best suit for short term.investments. Share markets are one industry which can never be forecasted or predicted. When there is least sale happening then the prices will go up due to demand. When there are a lot of sale happening then the prices might come down due to its increased supply. Hence predictions might not work in shares. Buy when one intends to buy a share which is forecasted to have increased returns in future, they have to be very tactical and sell their shares once it reaches the peak value. The price earnings ratuo will be very less since for instance there is a share for $98 which is expected to raise. This price is a higher rate when compared to other shares. Hence the his share can utmost earn a return of say $2 or $3 since it is already on the higher side. Hence the price will be more and earnings will be less. The main disadvantage of this type of investment ia that it is short term investment and has to be traded immediately.

2. Buying or procuring shares of companies which are cheap will give good returns in the long run. The returns from the shares will be high since they are already offered in the least price. For instance a share which is in its cheapest price say $6 will only go up as oy cannot go down further hence is the person buys say 100 shares and waits in the long run, the price will definitely reach $8 or so. This is a good margin and will fetch good returns. The risks of loss is less when cheaper shares are bought.

The main disadvantage of buying shares of these companies is the time it needs to have good price earnings ratio. The price of the shares will be less where as the earnings will more.