When To Buy Shares

The stock market is a leading indicator; it generally falls before investors realize just how bad the economy is. It also recovers much before economic activity picks up.

Perversely, that means stocks often plummet during good economic times and rally before recessions come to an end.

Which is why down markets typically offer good opportunities to buy valuable shares at low prices. Here is the low-down on the best indicator of when share prices offer good buying value . . .

The relationship between price and value is clear, but is exceedingly difficult to measure. While price can be observed with certainty, no one can ever be sure what constitutes true value.

Although it may be impossible to objectively determine current value, in the light of hindsight it is clear that price does tend to revolve around it. Consequently, several indicators have been developed which purport to measure value and thereby provide a reference point for the relationship of price to value.

The logic is simple: if the market is undervalued, buy; if the market is overvalued, sell.

Dividend Yield

Long the most popular of valuation measures, the dividend yield is calculated by dividing the indicated dividend rate for the next twelve months by current price.

This figure can be calculated for any market average, or most meaningfully, for all stocks in aggregate. At times investor enthusiasm has been so great that the market has accepted a much lower dividend yield than normal.

When yields are very low, stock prices are, by definition, high, and frequently overvalued as well. The market, then, has nowhere else to go but down, so it is not surprising that, historically, a low market yield has usually been followed by declining prices.

Conversely, when the marketplace is rife with pessimism, investors demand a much higher than normal dividend yield to induce them to buy stocks.

Since an excessively high yield means that stock prices are abnormally low relative to dividends and are undervalued, the market frequently responds to such situations by climbing higher.