What’s a good price to buy stocks?  By itself this is an impossible question to answer but it is useful to understand what can cause prices to go up and down when considering where to put your money.

Picture yourself at flea market. At each booth someone is trying to sell you something. There’s the Certificate of Deposit booth, a guy selling government bonds, a guy selling corporate bonds, a woman selling real estate, and a woman selling stocks. You’re trying to decide what to buy, and they’re all competing for your business. Let’s say at today’s interest rates CDs are offering 2%, guaranteed. The government bond guy is offering 3%, with low risk of default, corporate bond lady is offering 4% at a bit more default risk, real estate people can show rents on her properties that give a return on investment of 5% and the stock woman is offering stocks that have average earnings of 8 cents for every dollar invested (In other words, earnings vs price of 0.08.  You will usually see company valuations given as the inverse of this, price over earnings–PE ratio.  With earnings of 0.08 per dollar, this would be a PE ratio of 12.5, and only one way of valuing stocks, but a useful on for this exercise). Today you decide to buy the stocks because even though they are the most risky—the corporate earnings vary a lot and certainly no guarantee—you feel the risk is worth the return compared to everything else. This is the key. You aren’t judging the price of the stocks all by themselves, you’re judging them in comparison to all other possible investments. Let’s say when you go back, the fed has raised interest rates, driving up yields on CDs and other bonds to double what they were before. Let’s also pretend the companies that you have invested in have done exactly as expected. Now, the stock prices have plummeted. Why? The companies are doing fine! At least in part, it’s because of the competing options available to investors. If I can now get a corporate bond at an 8% yield, I’m probably going to need the stock to yield more. It’s now expensive by comparison. If the earnings are the same, the only way to get the yield higher (e.g. PE lower) is the price has to drop:  the same earnings for a lower price. This is a simplified example and bond prices moving higher also hurts earnings themselves by making borrowing costs higher, but the important thing to remember is always evaluate the return and risk of an investment to every other alternative.  There isn’t a magic PE ratio for “cheap” vs “expensive”, it’s always relative to the times.