Growth Stocks Investment
December 2nd, 2009
Capitalization or cap refers to the combined value of all the share of a company’s stocks. The division between large cap, mid cap and small cap are often blurry and not sharp. When you start looking for good stocks, you often come across these terms like large cap, mid cap, small cap, growth and value. Let’s discuss these terms for a moment.
Mid caps are companies with $1 to $5 Billion in capitalization and small caps are companies with $250 million to $1 Billion in capitalization. Anything below $250 million can be considered as micro cap. However the following divisions are generally accepted: Large caps are companies with over $5 Billion in capitalization.
Perhaps the most important ratio is the Price to Earnings Ratio (P/E). Now the most important term that you come across is growth stocks and value stocks. How do you determine this is a growth stock or a value stock? Suppose, company ABC stock is presently selling for $50. Now suppose that last year company ABC earned $5 for every share of the stock outstanding. This means stock ABC P/E ratio is 50/5=10. So the higher the P/E ratio, the more investors are willing to pay for the stock. What is the P/E ratio? The P/E ratio divides the price of the stock by the earnings per share.
Now the higher the P/E ratio, the more growth the company is supposed to have. So it can be either the company is growing real fast of the investor have high hopes of its growth. Now these hopes can be realistic or foolish, you never know!
The lower the P/E ratio, the more value the company has. Low P/E ratio companies are not considered to be the movers and shakers in the market. Now, if you follow financial news than you must know that the large growth companies always grab the headlines. But do the growth stocks really make best investment? According to Fama and French, two famous researchers who did ground breaking research on stocks, over the last 77 years, large growth stocks have only seen 9.9% annualized rate of return as compared to 11.5% for the large value stocks.
Now intuitively you might have thought that growth stocks are better. What can be the reason for their lower performance over the years? The most probable cause seems to be their immense popularity. Since most of the headlines are captures by high growth companies, investors seem to think that they are the best investments.
So large growth stocks tend to get overpriced before you are able to buy them! Think about Google, how its stock price shot up within a matter of weeks after it hit the market. Weeks after that it began to cool off.
Mr. Ahmad Hassam has done Masters from Harvard University. Try these cash printing Forex Signals from heaven. Discover a revolutionary Forex Robot System! This and other unique content ‘forex’ articles are available with free reprint rights.