The difficulty with calculating the value of a publicly listed company today, is that many can either seem wildly overvalued or incredibly risky. This is because the March market crash magnified the good and bad points in businesses. Stocks were perceived as either a great buy, so everyone piled in, or a risky buy, so everyone ran a mile. This has pushed the value of some companies up, giving them a price-to-earnings ratio (P/E) higher than the norm of a pre-pandemic world. Meanwhile, the poor performers have ended up with an overly low P/E. So how do you know which shares to buy?
Distinguishing good stocks from bad
The two extremes of overvalued versus undervalued, make it difficult to choose which shares to buy, as in effect they all seem risky. However, if you take a step back and really think about the future; companies on both sides of the coin will still be here. The trick is to identify the strong survivors and be confident in your conviction to own them.
For example, AstraZeneca, Avon Rubber and Rentokil Initial each have a high P/E and I’m confident they’ll still be here in the decades to come because they create niche products in high-demand markets.
On the underappreciated side of the stock market, Aviva has a low P/E today. Aviva has over 33m customers in 16 countries and is well known for its insurance and pension products. Its recent financial results were positive, and I think it’s another one that will still stand for many years to come.
To get an idea of why the P/E should often be taken with a pinch of salt, look at the success of Amazon. Its share price has steadily risen since it first listed, but its P/E has always been considered high. Going by P/E alone, it has never looked a great share to buy. This will have potentially put investors off the stock, yet it’s made a lot of shareholders very rich.
If you look at the price chart of Amazon, you will see there are many times in the past it has looked an expensive stock, only for it to go on and outperform repeatedly, through diversification and a powerful business model.
Amazon AMZN share price history data by YCharts
The power of planning
Investing is a long-term pursuit, and to take part you should look for quality businesses to invest in for years ahead. Companies you believe will be here for many years and that you’d be happy to own a piece of for a long time. Good investors have a plan, thoroughly research the business they’re buying into and understand the sector it operates in. I think the easiest way to begin is with some specific criteria to help you identify excellent investments.
Look at when the company was established as new companies are harder to evaluate. Is it selling something that’s in demand and likely to remain so for many years to come? Does it have an edge on its competition? Does the management team appear dedicated and driven to ensure future success?
Knowing which shares to buy after a stock market crash is difficult, but if you take a long-term and level-headed approach, you could build considerable future wealth.
