The common denominator for everyone who invests in stocks is to make predictions on the price evolution in order to capitalise on market movements and consequently make money. But how they go about it is dependent on how risk averse they are, and the time frame over which they want to realise profits.
Investing in the stock market is both an intellectual challenge and a reflection of your own character. Before you decide which stocks to pick you need to understand what kind of investor you are.
Growth investors tend to focus on a company’s potential for future profits, and whose earnings are rising the fastest. Since growth-oriented investors are interested in big future earnings, they are often willing to pay a high price for a stock relative to what it earns right now. The metric used to value stocks here is the price-to-earnings ratio (commonly referred to as the P/E).
Value investors hone in on the current value of a company’s assets (factoring in its debts), and look for stocks that are cheap compared to those assets. Optimistic forecasts for profits are less important for them so they end up buying stocks with lower P/E ratios.
Taking the value approach sounds like a more conservative approach, but there is the risk that these stocks go out of style for long periods of time.
What may have initially looked like a bargain may turn out to a bad investment which other investors avoided because they identified serious problems with the business.
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