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Investing is a job that demands dedication, discipline and knowledge, in order to know and understand where we are placing our money. In the financial markets we must have these 3 qualities in order to be successful, however, there are some assets that are not analyzed in the same way as others, or at least that is what I think according to my experience since I have been operating. These assets are stocks, technically we could devise a strategy that allows us to obtain profits, however, if we want to obtain a high return in the long term, we must take into account many other aspects that I will detail in this publication and that I have been learning over time.
Firstly, if we are not doing research and previous analysis of the companies that interest us, we are not investing, we are betting. Part of the research that an investor should do is to analyze the fundamentals of a company.
The Price Earnings Ratio (RPG) is one of those fundamentals that a value investor
(that is, an investor with a business perspective) should look at. Many people think that a stock that is traded at an expensive price is the same as investing in an expensive company and this is totally false. The price of a stock says absolutely nothing about the underlying company, so it is a company's profits, its free cash flow, its margins, its capital requirements, and its capitalization structure that tell you whether a stock is expensive or not relative to its fundamentals.
I have been learning more about this over time, as I have been investing in some stocks, so I will talk briefly about the RPG and how it helps an investor get a quick idea of the stock.
The RPG tells you if a company is expensive in relation to its profits, based on this, we must keep in mind the following formula:
RPG = Share Price / Earnings per Share.
An easy way to think about RPG is as follows: How much are investors currently willing to pay per share for every $1 in profits? An RPG of 200 means that investors are willing to pay $200 for every dollar of profit, so this is not expressed in any unit, but is simply a multiple that is used to value whether a stock is cheap or expensive relative to its profits.
A high RPG can mean that the company is
"overvalued", which means that the stock price is very high compared to the company's current earnings. High RPG occurs when there are high expectations for a company and it is expected to make a lot of money in the future. A recent example of this is
"Tesla", whose shares were once traded at an RPG of 1,000 and so that we can have a clearer picture, historically shares have been traded at an RPG of between 10 and 20, however this can vary greatly depending on the industry.
However, a high RPG doesn't necessarily mean that you shouldn't invest in the stock, as there is a possibility that the company will be able to increase its profits with the expectations of investors, so there is not much to worry about. But if over time the company continues to report earnings that don't meet those expectations, the stock will most likely drop considerably in price and it should be kept in mind that this always happens.
In the same way, a
"low" RPG means that the stock may be
"undervalued", however, this is not always a good thing. Many times there are logical reasons why a stock is sold at a low price in relation to its earnings, in that sense it may be facing a strong and expensive demand, the industry is in decline, margins have changed significantly, etc.
We must keep in mind that looking at the RPG of a stock does not tell you the whole journey and history of a company, so just by looking at this ratio, you will not know if this is a good investment or not, based on this we must take this little guide as a start. Also, RPGs change considerably from one industry to another, in a few words, the RPGs of technology companies are the highest of all industries. You can't compare Apple's RPG with AT&T's.
As I learn more aspects about stock investing I will be publishing about it to complement this guide, I must say, that the opportunities to obtain very good returns are always present in this type of assets, but, of course it doesn't mean that we shouldn't take special care when investing, so always my recommendation for everyone is to
"Educate yourself" and keep learning about it.
"Knowledge is power"
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