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What goes up ... well, sometimes it stays up for an awfully long time.
A common mistake among beginning investors is the short selling of stocks because they have a high P/E ratio. If you aren't familiar with short selling, it's an investing technique by which an investor can make money when a shorted security falls in value. (For more on this, check out the Short Selling tutorial.)
First of all, we believe that novice investors shouldn't be shorting. Secondly, you can get into a lot of trouble by valuing stocks using only simple indicators such as the P/E ratio. Although a high P/E ratio could mean that a stock is overvalued, there is no guarantee that it will come back down anytime soon. On the flip side, even if a stock is undervalued, it could take years for the market to value it in the proper way.
Security analysis requires a great deal more than understanding a few ratios. While the P/E is one part of the puzzle, it's definitely not a crystal ball.
Next: P/E Ratio: Conclusion »
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