what to consider before trading shares in a turbulent stock market | fool uk - motley fool uk

What to consider before trading shares in a turbulent stock market | Fool UK – Motley Fool UK

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Published in: 11th February 2022
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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?
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.
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.
Although investing in shares always carries risk, there are a couple of useful tools that can limit your exposure.
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%.
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:
Past performance is not an indication of future results, and the value of investments may go down as well as up.

Share dealing fees are not always straightforward. Use our free broker cost calculator to easily compare broker fees and see which providers listed offer the best value. 

Jo Groves (ACA)
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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