A friend asked, you often say that you want to buy in the undervalued area, so the risk is relatively low, and the probability of profit is also high.

So, where does the valuation come from, and how to judge overvaluation or undervaluation?

In fact, the method is very simple, and we will also come into contact with it in our daily life.

However, many people find it difficult to associate this principle with investment.

A little game, easily understand market valuation.

I have done a very classic Q&A game before, which is roughly like this.Certainly, here's the translation of the provided text into English:

Everyone can answer the following two questions.

- Question one: There is a company that consistently makes a profit of 1 million per year. How much would you be willing to pay to buy this company?

- Question two: It's still this company, but now it belongs to you. How much would you be willing to sell it to a friend for?

Add these two numbers together and then divide by 2, and you will have an approximate valuation of the company. Then, divide this number by 1 million to get the price-to-earnings (P/E) ratio you assign to the company.

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This game has been surveyed among thousands of friends, and the results are shown in the figure below:

(Note: The original text mentions a figure, but since there is no figure provided, the translation includes a placeholder for the figure.)It can be observed that the figures most friends have provided fall within the range of 8 to 15 million yuan.

That is to say, for a company that makes a profit of 1 million yuan per year, most friends value it at 8 to 15 million yuan.

The price-to-earnings (P/E) ratio of this company is around 8 to 15 times.

The average valuation in the A-share market is similar.

In the stock market, valuations are also akin to this.

Take the A-share market, for example, there are thousands of listed companies.Every listed company can be estimated to have a price-to-earnings (P/E) ratio using a similar method.

Then, by calculating the weighted average, the overall P/E ratio of the stock market can be determined.

In fact, the long-term average P/E ratio of the overall listed companies is slightly higher than the previously mentioned 8-15 times.

This is because companies that meet the listing requirements tend to be larger in scale, have a stronger leading position in their industries, and more stable profits.

After going public, they have more financing channels, which is also more beneficial for the future development of the company.

For example, the overall average P/E ratio of the A-share market is between 15-18 times.However, this is an average value.

That is, for most of the time, the overall price-to-earnings ratio of A-shares is within this range.

In fact, the market's valuation fluctuations can be quite significant.

During a bull market, investors are more optimistic, and their bids tend to be higher, which leads to higher valuations.

For example, during the great bull market of 2007, the price-to-earnings ratio of A-shares reached forty to fifty times.Bear markets are characterized by widespread pessimism among investors, leading to lower bids and consequently lower valuations.

For instance, during the great bear market from 2012 to 2014,

- The price-to-earnings (P/E) ratio of the CSI 300 index once hit a historical low of only 8 times;

- The P/E ratio of Moutai, a renowned Chinese liquor company, had dropped below 10 times at one point;

- A significant number of stocks had P/E ratios of only three to four times.

In simple terms,

The market is like a giant pendulum, swinging back and forth between doldrums and exuberance, bear markets and bull markets.Buy low and sell high.

Once you understand this principle, the logic of investing naturally becomes clear:

- When the market is down and everyone is pessimistic, you can often buy at a low price and hold for the long term;

- When the market rises and everyone is optimistic, you can usually sell at a good price to take profits.

As Warren Buffett said,

Be greedy when others are fearful, and be fearful when others are greedy.

So, in practical investing, what should you do specifically?You can refer to the star rating to judge whether the market is cheap or expensive.

The star rating takes into account the overall market valuation (such as price-to-earnings ratio, price-to-book ratio, Buffett indicator, etc.), earnings growth, trading volume, market sentiment, and other factors, and is divided into five levels.

- 5 stars: The market is at its cheapest and has the highest investment value.

- 1 star: The market is very expensive, basically entering a bubble phase, with huge risks.

For stock assets, the stages that are usually suitable for investment are between 4 and 5 stars.

For example, if the market is currently around 5 stars, there is a widespread panic sentiment in the market.However, at this time, the investment value of stock assets is often relatively high, making it a good time for us to "greedily buy".

If we can seize the opportunity of a 5-star chance, invest in some relatively cheap high-quality stock assets, and wait for the market to rise later, it is highly likely that we can also achieve higher returns.

Summary

The principle of investing is not difficult, and many people know it.

However, whether it can be well executed is another matter.

Understanding many principles, yet still not living a good life～This is also the significance of daily articles:

When the market fluctuates and some friends are about to give up, they can take a look and see, "He is still persisting in undervalued investment like me, and still persisting in posting valuations and articles every day."

Isn't this a little more courage to continue?