In my opinion, there are two basic things to look for when buying stocks: the right company, and the right price. The first one is completely obvious: other things being equal, you’d rather invest in a company that lead its market, turned out consistently high-quality products, grew solidly every year, and had a boardroom that wasn’t full of crooks, for starters.
The ‘good price’ part though, is something that first-time investors usually ignore. People say ‘you get what you pay for’, and most of the time, that is true. When looking at stock prices on a website or in a paper, you can usually see something that says ‘P/E’ (or ‘PER’ in Korea); this means ‘price-earnings ratio’, and it is basically a measure of how expensive a stock is.
By expensive, I don’t mean the price of one share. Newbies often look at the price of one share, and think, ‘wow, Samsung Electronics is really expensive, because they are 1,000,000 won each’. That doesn’t mean it really is expensive, though. What you need to know is, when you divide the total amount of profit the company makes by the number of shares in existence, is that number high or low relative to that 1,000,000 won?
To illustrate, for every share of Samsung Electronics, the company generated 56,717 won in profit in 2009. When you divide that by the 1,000,000 won share price, you get a rather ugly number: 17.631. Which means, if you invest 17,631 won in Samsung Electronics, ‘your’ share of the company’s profits will be 1,000 won. That works out at about a 5.7% return.
Of course, they aren’t going to send you a cheque for that 1,000 won. You might get some of it back in dividends, but most of it will end up being reinvested in the company. If Samsung management is good, then this is what you want them to do anyway.
Still, don’t do anything just yet. If it were as easy as just buying the ones with the lowest P/E ratios, everyone would buy them, and they wouldn’t have low P/E ratios for long.