When it comes to building a strong investment portfolio, selecting assets based on solid financial indicators is crucial. Among the most important metrics are Return on Equity (ROE), Price-to-Earnings (P/E) ratio, and Price-to-Earnings Growth (PEG) ratio. Understanding these indicators and applying them effectively can help you identify undervalued assets and avoid overpaying for stocks that are overvalued.

Simple Invest Indicators You Should Know

PE: Price/earnings-to-growth ratio

The market P/E ratio is a financial ratio used by investors to determine a stock’s fair value. It is derived by dividing the price of a stock by the stock’s earnings. The P/E ratio shows what the market is willing to pay today for a stock based on its past or future earnings. A high P/E could mean that a stock’s price is high relative to earnings and possibly overvalued.

PEG: Price/earnings-to-growth ratio

The price/earnings-to-growth ratio (PEG ratio) is a metric used to value a stock by considering the company’s market price, its earnings and its projected growth.

ROE: Return on Equity

Return on equity (ROE) is a measure of a company’s financial performance. It is calculated by dividing net income by shareholders’ equity. Because shareholders’ equity is equal to a company’s assets minus its debt, ROE is a way of showing a company’s return on net assets.

Steps You Should Follow

Focus on High ROE Assets

Return on Equity (ROE) measures a company’s profitability relative to its shareholders’ equity. A higher ROE often indicates a more efficient business, one that is using its resources to generate profit effectively. When choosing assets to invest in, prioritizing companies with high ROE is essential, as it tends to indicate sound management and a solid return on investment.

A consistently high ROE can also be a signal of sustainable competitive advantage and long-term growth potential. By focusing on companies with high ROE, you ensure that your capital is placed in assets that are likely to deliver superior returns over time.

##Buy When P/E Percentile Is Low The Price-to-Earnings (P/E) ratio is a common indicator used to evaluate whether a stock is undervalued or overvalued. A lower P/E percentile means that the stock is priced relatively low compared to its historical averages, presenting a potential buying opportunity. In contrast, if the P/E is at a historically high level, it may signal overvaluation, and purchasing at such a time could expose you to the risk of price corrections.

By purchasing stocks when their P/E ratio is in a low percentile, you can take advantage of market inefficiencies and buy valuable assets at a discount.

Use PEG to Assess Growth Potential

While the P/E ratio is useful, it does not account for the company’s growth prospects. This is where the PEG ratio comes into play. The PEG ratio adjusts the P/E ratio by factoring in the expected earnings growth. A low PEG ratio suggests that the stock is not only undervalued based on its current earnings but also has strong growth potential.

A PEG below 1 typically indicates that the stock is undervalued relative to its growth potential, making it an attractive buy. Conversely, when the PEG ratio is high, it suggests that the stock’s price might be inflated relative to its growth prospects, which could be a sign to sell.

When to Sell: High P/E and PEG Ratios

It is important to recognize when a stock has become overvalued. If the P/E ratio rises to historical highs and the PEG ratio increases, this can indicate that the stock’s price has outpaced its earnings growth. In such cases, the potential for future returns may diminish, and it may be prudent to consider selling. High P/E and PEG ratios often indicate that the stock is priced for perfection, and any deviation in performance could lead to significant declines in value.

By monitoring these indicators and being disciplined about selling when stocks become overvalued, you can protect your portfolio from unnecessary risk.

Real-World Examples

KraneShares CSI China Internet ETF (KWEB):

Despite KWEB’s relatively low valuation, its Return on Equity (ROE) is only around 7%, which is roughly half of the S&P 500’s average ROE of 15%. While its lower P/E ratio may suggest that the stock is undervalued, the weaker ROE raises concerns about the efficiency and profitability of the underlying companies. Investors should be cautious, as a low ROE may limit the potential for long-term returns, even if the current price appears attractive. In this case, relying solely on P/E could be misleading, and it’s essential to consider the broader financial health of the companies within the ETF.

S&P 500 Index:

The S&P 500 includes large-cap U.S. companies with generally stable earnings and high ROE. In periods of market downturns, the P/E ratio of the S&P 500 tends to fall, presenting a buying opportunity for long-term investors. Conversely, when the P/E ratio of the index reaches historical highs, as it did during the late stages of bull markets, it might indicate that stocks are overvalued, making it a potential time to sell or reduce exposure.

Nasdaq-100 Index:

The Nasdaq-100, which includes major technology companies, often has a higher P/E ratio due to the growth-oriented nature of the tech sector. A low PEG ratio for this index indicates that tech companies are still poised for strong growth, even if their P/E ratios are higher than the broader market. However, if both the P/E and PEG ratios rise too high, this could signal overvaluation, as seen in previous tech bubbles.

Conclusion

A well-informed investment strategy involves focusing on companies with high ROE, buying when the P/E percentile is low, and considering the PEG ratio to assess growth potential. These indicators provide a solid foundation for identifying valuable assets and avoiding overpriced investments. By carefully applying these principles, you can improve your chances of achieving long-term financial success.

Invest indicators: take care of your holdings and avoid buying asset unwisely