When to Buy an Expensive Stock

Is it better to buy a good stock going up or a poor stock going nowhere?

That may seem like a dumb question. If you had the choice to “overpay” for a good stock that was going to continue to grow, wouldn’t you willing do that rather than save money on a bad stock that was going to languish?

Stock A has a P/E (price earning ratio) of 30, while stock B has a P/E of 10. Using this one metric, one would say stock A seems overpriced. (Read this article to learn more about P/E. )

Of course, no one is going to buy a stock on the strength of one metric, but let’s say for the sake of discussion that every price metric for Stock A registered in the overpriced category.

Meanwhile, Stock B shows all the signs of being just about or below “fairly priced” by the market.

Stock A is trading near a 52-week high and Stock B is down 20% from its trailing 180-day average.

There are two traps at work here that investors often fall into:

• What goes up must come down
• What goes down must come up

It would be easy to jump to the conclusion that Stock A is headed for a fall or at least a retreat. It is overpriced by all the usual metrics and near a 52-week high. Stock B must certainly be ready for a rebound, since it is clearly ready to be discovered by the market again.

Buying High

Is it ever okay to buy high? Of course it is if you believe the stock will continue to grow. A stock that is growing by 20% per year with no visible barriers to halt that growth is worth paying the going price, because today’s price is probably as cheap as the stock is going to get for some time.

You may wish you had bought Stock A six months ago, but that shouldn’t stop you from getting on board if you have done your homework. Just make sure you aren’t following the crowd because the crowd on Wall Street isn’t always right.

Sometimes, a stock won’t come down. Despite the hard lessons of the dot.com bust, stocks that grow from $20 per share to $100 per share are not automatically doomed to fall back to $20.

That’s not to say that the price won’t have ups and downs along the way, but a true growth stock with solid prospects will keep moving up.

Buying Low

The goal of buying low and selling high is a great one; however don’t let it blind you. Just because a stock’s price has dropped doesn’t mean it will come back up.

The value investors who successfully buy low and sell high are very selective about what they buy. A stock’s price is only one of dozens of considerations. The biggest factor is whether the stock has a chance of growing over time.

In a down market, good stocks often take a beating, but investors shopping for bargains must look deeply past the stock’s price before making a buy decision.

Conclusion

What goes up may or may not come down. What is down may stay that way. Don’t make investment decisions based on assumptions that stocks must react to some set laws that don’t exist.