Watch Valuations

Investment criteria will vary from investor to investor. What's important to one stock investor isn't necessarily key to another. There are, however, a few things that all stock investors ought to monitor.

When most people buy a stock, price is a consideration. Maybe you're a bargain-hunter whose eyes light up at the sight of a low price/earnings ratio. Or maybe you're a growth investor who's willing to pay a steep price for a tech stock with terrific growth prospects. Either way, you have a price you're willing to pay for an investment. Anything above that price makes the stock too expensive for your investment strategy.

Once you've bought a stock, valuations still matter. If a stock's price-to-earnings (P/E) or price-to-sales (P/S) ratio jumps significantly from where you purchased it, that increases the price risk because more of the company's value is in the unknowable future. If the expectations underlying that higher valuation don't pan out, the stock's price may plunge back to earth.

Conversely, if a stock's P/E or price-to-fair value shrinks significantly, you may need to take notice. You may still like the company (and may now have the opportunity to buy more of it at the cheaper price), but if a shrinking share price signifies deteriorating fundamentals at the company, you may no longer want to own the stock. Your investment strategy will determine what a falling price ratio means for you.

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