Share trading has been challenging in 2022, with stock markets hit by concerns over high interest rates and inflation. Amid fears of a global stock market crash or recession, some investors may be wondering whether to sell their shares. For others, the downturn may provide an opportunity to buy shares at lower valuations.
Given the volatility in equity markets, it’s a good time to review your share portfolio. But what should you consider when you’re trading in stocks and shares?
Are you looking for capital growth?
You may have seen the term ‘P/E’ or ‘price-to-earnings ratio’. It’s simply the current share price of a company divided by its earnings per share.
P/E ratios are a useful measure of valuation. A high P/E shows investors are willing to pay a higher share price today because they expect substantial earnings growth in the future. Earnings growth should, in turn, drive up the share price.
Let’s take a look at the relative performance of two shares. Three years ago, Amazon was trading on a P/E of 80, compared to a P/E of 13 for PepsiCo. Over the last three years, Amazon’s operating income increased by 100% and PepsiCo’s by 10%. Investors were rewarded with a 99% increase in the Amazon share price, compared to 46% for PepsiCo.
However, a high P/E may indicate the company is overvalued, so it’s important to compare them to similar companies. Shares trading at high P/Es can also be more susceptible to shifts in market sentiment. Rising interest rates have recently hit the valuations of high-growth technology stocks, reducing the heady P/E ratio of Tesla from 244 to 184, according to YCharts.
So if you’re looking at buying ‘growth’ shares with high P/Es, it’s important to evaluate whether their growth prospects justify the share price.
Do you want an income stream?
Investors looking for a regular income stream should focus on dividend yield. It’s calculated as the dividend per share divided by the current share price.
According to Morningstar, these were the top dividend-paying stocks in 2021. Shareholders in Imperial Brands would receive an average annual income of over 8% from their investment.
|
Company |
Expected dividend yield |
|
Imperial Brands |
8.1% |
|
British American Tobacco |
7.1% |
|
Vodafone Group |
6.4% |
|
GlaxoSmithKline |
4.7% |
|
Smiths Group |
4.5% |
High dividend yields often go hand in hand with low P/E ratios. Mature companies with stable but low-growth earnings typically pay higher dividends. High P/E ratio companies tend to invest in future growth opportunities over dividends.
However, high dividend-paying companies supplying essential goods and services may weather an economic recession better than high-growth companies. This can have a positive effect on their share price as investors move away from ‘growth’ into ‘value’ shares.
How can you minimise share dealing costs?
- Transaction costs can make a substantial dent in your profits. It’s worth taking the time to read our top-rated share dealing accounts before choosing a trading platform. Our brokerage cost calculator calculates the cost of different trading platforms based on the value of investments and the number of trades. The DEGIRO Trading Account may be attractive to high-volume traders, charging £1.75 per trade in UK shares.
- Consider buying shares using one of our top-rated stocks and shares ISAs. You can invest up to £20,000 per year and any income or capital gain is free from tax.
- The buy-sell spread on shares can reduce your profits. Although larger companies have a minimal spread, it can be significant for smaller companies. For example, if I wanted to buy shares in Bloomsbury Publishing through Hargreaves Lansdown, the current spread is 371p to buy and 389p to sell. The share price would have to rise by 5% before I could sell at a break-even point.
What tools help to manage risk?
Although investing in shares always carries risk, there are a couple of useful tools that can limit your exposure.
1. Use a stop-loss limit
A stop-loss order can limit losses. Your shares are sold automatically if the share price falls below the price you set. So, if I bought Barclays shares at 206p and put a stop-loss limit of 185p, my loss would be limited to 10%.
2. Consult brokers’ forecasts
I use brokers’ share price targets to help quantify potential downside risks. Searching for broker price targets for Diageo plc brings up forecasts from six brokers:
- Diageo’s current share price is 3,755p.
- Price targets range from 3,100p to 4,800p, with an average of 3,941p.
- The average price target suggests a modest 5% return. However, the ‘low’ target would result in a 17% loss.
Past performance is not an indication of future results, and the value of investments may go down as well as up.
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About the author
Jo is a writer specialising in personal finance and investments. She is a qualified Chartered Accountant, previously working in M&A at a UK investment bank and Arthur Andersen. Jo has written on a range of subjects, from in… Read More
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