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Yields and P/E ratios

THE MOTLEY FOOL
Ask the Fool

Published: September 10, 2020

Q: Are the best stocks to look for the ones with high dividend yields and low P/E ratios? -- B.W., Toledo, Ohio
A: Not necessarily. Remember that a dividend yield is the result of dividing the annual dividend amount by the current stock price, so if the stock plunges, the yield will soar. Looking for solid yields of, say, 2% to 4% (or even more) is fine, but do extra research before grabbing an ultrahigh yield. It's also good to seek out dividends that are being increased regularly and significantly over time.
Many great and growing companies don't pay dividends, though, so don't write off nonpayers. (Current nonpayers include Warren Buffett's Berkshire Hathaway, Amazon.com, Netflix, PayPal, Facebook, and Google parent Alphabet.)
As for the price-to-earnings (P/E) ratio: While a low P/E suggests a better value than a high one, remember that P/Es vary by company and industry (and that companies with no current earnings will have no P/E).
Do some digging and compare a company's recent P/E ratio with its five-year average to see if it's now relatively high or low. Compare it with peers in its industry, too. The "forward" P/E ratio, based on the coming year's expected earnings instead of the past year's earnings, is also good to check out. You can research companies at sites such as Fool.com, Morningstar.com, and Finance.Yahoo.com -- and look at many more numbers than just the yield and P/E ratio.
Q: What does it mean if investors are "long" on a stock? -- F.H., Scottsdale, Arizona
A: It means they've bought shares, expecting them to rise in value -- as opposed to shorting a stock, where they'd aim to profit if its price fell.
Fool's School
Know What You're Getting with IPOs
It can be exciting when a company first starts trading on the stock exchange via an initial public offering (IPO), and investors are often eager to rush in and snap up shares. That frequently turns out to be a mistake, though. Learn more about IPOs before you invest in any.
An IPO involves a company selling part of itself to investors by issuing shares. (Alternatively, it might raise money via banks or private investors, or by issuing bonds.) Some big-name IPOs last year were Pinterest, Zoom Video Communications, Uber Technologies, Lyft, Slack Technologies and Peloton Interactive. Airbnb is looking to hold an IPO this year.
One problem with IPOs is that most investors can't buy shares at their initial prices. It's often big clients of the underwriting investment banks -- such as pension funds, mutual funds, private equity firms and high-net-worth individuals -- who get that privilege. With a hot IPO, the early investors get in at the low initial price, and then stock begins trading at a higher price due to great demand.
Also, IPOs tend to be volatile. Often the companies are relatively young, without long track records of profitability. The IPO process itself also contributes to volatility, with the price often surging initially and then sinking back to earth after a few days, weeks or months.
Consider Pinterest. It was initially priced at $19 per share when it debuted in April of 2019, but due to heavy demand, it opened trading 25% higher, at $23.75. It closed that day at $24.40. Shares fell to a bit above $18 in early January 2020, dropped nearly to $10 at one point in March, and recently climbed above $36.
It's often best to steer clear of IPOs in order to let the dust settle and give management a chance to operate as a public company for a while, issuing required quarterly and annual reports. There are usually plenty of other great and more established companies to invest in -- at attractive prices.
My Smartest Investment
Friended Facebook
My smartest investment was buying shares of Facebook when they were only at $19 apiece, in 2012. -- H.H., online
The Fool responds: The Fool responds: You did well -- the stock never spent much time near such a low price. Here's hoping that you've hung on since then, as the shares were recently trading above $280 apiece, having risen nearly 1,400%. That's enough to turn a $1,000 investment (of about 52 shares) into a stake worth almost $15,000. It's a terrific gain, but what matters most at this point is where the stock is headed from here. If you think the shares are very overvalued, you no longer have confidence in management, or you don't expect the company to grow robustly, consider selling. (You might sell all your shares -- or compromise and just sell some.) If you're still a long-term believer and you expect the company to be much bigger in the future, with revenue, earnings and user numbers continuing to grow, hang on. Bulls today see great potential for the company, given Facebook's 1.8 billion daily active users, and they're impressed with its Instagram business as well. Bears worry about advertisers boycotting Facebook due to its handling of political content, and wonder whether many users will depart. Do your own research and thinking, and make your own call.
Foolish Trivia
Name That Company
I trace my roots back to 1972, when two guys noticed a storage business that had a waiting list for customers. They invested $25,000 each and opened a storage facility in California -- and agreed to keep opening more facilities until there was no more demand. Today, based in Glendale, California, I boast more than 2,500 locations, and I'm still growing. I'm the world's largest owner, operator and developer of self-storage facilities, with a market value recently near $36 billion. I serve about 1.5 million customers, with roughly 1 million moving in or out of units annually. Who am I?
Last Week's Trivia Answer
I was founded in 1993, and in 1995 was licensed to make games for the Sony PlayStation platform. I went public in 1997, and my stock has surged more than 1,900% over the past decade. In 1998 I bought BMG Interactive Entertainment, owner of Grand Theft Auto, and used its assets to form Rockstar Games. Today, I'm based in New York City, and my market value recently topped $20 billion. My portfolio includes many games such as Red Dead Redemption 2, NBA 2K21 and Grand Theft Auto V. Who am I? (Answer: Take-Two Interactive Software)
The Motley Fool Take
Index Funds in ETF Form -- For the Win
If you don't have the time, interest or skills to research and invest in individual stocks, consider index funds, which track various stock (or bond) indexes and generally sport low annual fees. Over the 15 years ending in December 2019, the S&P 500 index of 500 of America's largest companies outperformed fully 90% of U.S. large-cap stock mutual funds.
Exchange-traded funds (ETFs) make index-fund investing extra easy. They trade like stocks, and you can buy as few or as many shares as you want through your brokerage. Here are a few promising ones with low fees:
-- The SPDR S&P 500 ETF (SPY) tracks the S&P 500 itself.
-- The Invesco QQQ Trust ETF (QQQ) tracks the Nasdaq 100, so it invests in the 100 largest mostly nonfinancial companies in the world; these include technology giants such as Apple, Microsoft, Amazon, Facebook, and Google parent company Alphabet.
-- The Vanguard Total Stock Market ETF (VTI) tracks an index of more than 3,500 stocks, with small, medium and large companies included.
-- The SPDR Portfolio S&P 500 Growth ETF (SPYG) tracks the S&P 500 Growth Index, featuring S&P 500 companies with the best growth characteristics based on sales growth, price-to-earnings ratio and momentum.
Consider parking at least some (and perhaps many) of your long-term dollars in index funds.
COPYRIGHT 2020 THE MOTLEY FOOL, DISTRIBUTED BY ANDREWS MCMEEL SYNDICATION, 1130 Walnut, Kansas City, MO 64106; 816-581-7500.


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