Without knowing the proper value of stocks, investors are hard-pressed to find the right time to buy or sell shares. Investors might miss out on buying and selling opportunities if they base investment decisions solely on a stock's market value. There are ways to evaluate the stock's company so investors reduce their chances of selling stocks too soon and missing out on future profits or buying a stock priced to high for what it is worth.
A stock's market value fluctuates throughout the course of a trading session based on the supply of shares coupled with investor demand. The market value lets an investor know whether shares are currently affordable. The value also becomes important when using trading strategies. For example, investors have the option to use buy and sell stop orders in the market, which are price limits for buying or selling shares. These orders can prevent financial losses or allow an investor to secure market gains, according to the U.S. Securities and Exchange Commission.
Without knowing when a stock is too richly priced, or over-valued, an investor may miss out on an opportunity to cash-in on an investment and profit. Worse, an investor might wind up owning a stock with a price that has nowhere to go but down. This became the case in 2012 when the U.S. Federal Reserve provided a stimulus to the economy. As a result, more than half the stocks in the market became priced at more than they were worth, according to ValuEngine data provided by Forbes.
By locating stocks in the market that are under-valued, or priced below where they are worth based on certain metrics, investors can seize an opportunity to earn profits. After the financial crisis in 2008, the stock market rebounded. For the three-year period ending in April 2012, the S&P 500, which represents some of the largest companies in the stock market, advanced more than 100 percent, according to MSN Money.
By overlooking a company's price-to-earnings ratio, an investor could miss out on the true value of stocks and wind up investing in the wrong companies. A P/E ratio is a measure of how much investors are willing to pay for a stock relative to the company's earnings. It is useful when comparing the stock price of one company to another that trades in the same sector. For five decades leading up to 2009, the average P/E ratio was 16.4, according to the Bloomberg website. The P/E ratio is calculated by dividing a stock's market value by average earnings per share over a period of time, such as the past year.