A user who goes simply by “B.” asks: “Dear We Seed, because the stock market can be very confusing, I have a question. How does buying stock that is undervalued pay off in the end? If the stock price is too low, how is it a good buy? What if the company ends up declaring bankruptcy?”
Hey “B.”-
We’ve heard the phrase “buy low, sell high” so many times, it’s almost lost all meaning. Kind of like, “Sir, you’re making a scene.” (Ok, we’ll cop to a gratuitous Simpsons reference.)
But truth be told, that really is the way to go with the market: You want to buy a stock when it’s cheap, then sell it when its share price is higher. In other words, you’re hoping its share price is undervalued by the market, and that the price will rise as people discover the true potential of the company.
And if the rest of the world eventually agrees with you, that undervalued stock price will rise, so you can eventually sell your stock at a higher price.
Sounds simple enough, you say. So what’s the catch?
Here’s the catch: You need to know when the company you’re buying is the diamond in the rough and not fool’s gold. You can find plenty of out there called “penny stocks” that are really cheap. The thinking is, Hey, these shares don’t cost much, I may as well buy a lot of them. If they go up, great! If not, no huge loss.
The problem is, of course, that there’s a reason these companies are so cheap – they’re often not very good. Also, there’s a school of thought that says just because a stock has a low price doesn’t mean it’s “cheap.” But that’s a whole new story.
So how do you determine whether a company is worth buying? Now THERE’S a good question. Some of the mucky-mucks on Wall Street think use ratios like P/E, P/S, and so on to figure out if the company is “cheap” and whether you should buy it.
If you like looking at the numbers, We Seed has a place for you here in the Friendly Financials and through the Fair Price Tool. That said, the We Seed philosophy is that you should pay attention to what the people around you are buying, listen to what people are talking about, and buy what you know.
Then, after you find that Next Big Company, take a little time to learn about it. Find out what products it makes, who owns this stock, and what the company has been up to lately. Try and figure out if the company is cheap because no one is buying its products anymore, or if it’s cheap because no one realizes how popular its products are yet. If you decide that this is the company for you, then grab some shares for your We Seed account and see what happens.
Happy trading!
Got questions? We’ve got answers. Shoot us an email and ask us the investing issues that have you confused, baffled, bewildered, in a tizzy, etc. We’ll answer the best questions and send you a We Seed T-shirt if we respond to yours.
Photo courtesy of Getty Images.
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