For instance, one member recently asked us about investing in stocks through split-share corporations, which are a good example of a structured financial product.

Structured products are investments that come with special characteristics that make them superficially attractive to investors. However, they tend to be far more profitable for brokers. That’s because, once commissions and other fees come out of these investments, it’s unlikely that you’ll wind up with a profit to match your risk.

To give you a clear sense of the drawbacks of investing in stocks through split-share corporations, I’d like to share our Inner Circle member’s question, along with our response. I hope you enjoy and profit from it.

Q: Your comments on Dividend 15 Split Corp. would be appreciated. The return looks impressive and it holds many of the stocks you recommend. Keep up the good work, I’ve been in the Inner Circle for years and have profited nicely by investing in stocks you recommend. Many thanks.

A: Dividend 15 Split Corp., $11.69, symbol DFN on Toronto (Shares outstanding: 11.2 million; Market cap: $131.2 million), is a split-share investment corporation that holds shares of 15 companies: BCE Inc., CI Financial Corporation, AGF Management, TransAlta Corporation, SunLife Financial, Canadian Imperial Bank of Commerce, TransCanada Corporation, Manulife Financial, TD Bank, TMX Group, Royal Bank of Canada, Loblaw, Bank of Montreal, Telus Corporation and Enbridge.

The company can also invest up to 15% of its portfolio in other equity issues.

Dividend 15 Split Corp. has two share classes: Dividend 15 Split Corp. capital shares (Toronto symbol DFN), and Dividend 15 Split Corp. preferred shares (Toronto symbol DFN.PR.A).

Don't take chances with your retirement nest egg. Protect and grow your portfolio with expert advice from Pat McKeough, cited by The Wall Street Journal as "one of only four investment newsletter advisors who have managed to serve their readers well over the long haul." Click here to learn how you can profit from Pat McKeough's The Successful Investor newsletter.

A split-share company issues two classes of shares. Usually, the capital shares get all or most of the capital gains and losses, and the preferred shares get most of the dividend income. In the case of Dividend 15 Split Corp., the preferred shares get a fixed monthly dividend of $0.04375 a share ($0.525 a year). That gives them a 5.1% yield.

Holders of the capital shares get a monthly dividend of $0.10 per share, for a 10.3% yield.

The company’s portfolio does not pay enough dividend income to pay preferred dividends, management expenses and fees, and a dividend for the capital shares. To make up the difference, the company has to make capital gains by trading the portfolio’s securities. It also aims to raise its returns by writing call options on the portfolio’s securities.

Frequent trading and selling call options carry heavy costs

Selling call options generates an income stream for Dividend 15 Split. However, selling calls also tends to diminish any capital gains that its portfolio might generate. When the stocks Dividend 15 Split owns go up, holders of the call options the company has sold will exercise those options and buy the stock from the company at the price fixed by the option’s terms. Meanwhile, Dividend 15 Split will want to hold on to its losers — stocks it owns that are going down — to offset its obligations under the call options that it has sold.

Options trading tends to generate a lot of brokerage commissions that eat away at the investors’ capital. Management fees and performance bonuses also erode capital.

The managers of Dividend 15 Split Corp.’s portfolio aim to keep most of their holdings in the range of 4% to 8% of the portfolio’s overall value. That means they will need to rebalance their portfolio’s holdings from time to time. This selling and buying also generates commission expenses.

Investing in stocks through split shares may increase your tax bill

The split shares will wind up on December 1, 2014. That’s a drawback to split shares in general, and Dividend 15 Split shares in particular — you’ll be forced to cash in your investment and deal with the tax consequences at that time, and you’ll face additional brokerage costs to reinvest the proceeds after you redeem your shares.

Although we like many of the stocks it holds, we advise against investing in either class of Dividend 15 Split Corp. shares.

If you have investment questions, or if you’d like to ask us about stocks you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.

By hidden value, we mean valuable assets that are not getting the attention they deserve from investors. When a company’s assets are wholly or partially hidden, the stock trades for less than it’s really worth, so you get to buy at a bargain price.

High research spending could mean big gains lie ahead for technology stocks

When we pick stocks in the more volatile technology field, one of our favourite hidden assets is high research spending. That’s because technology stocks have to treat their research spending as a day-to-day expense, much like maintenance or taxes. So research spending comes out of the current year’s sales, and it lowers the current year’s earnings.

As a result, many tech stocks’ earnings per share may look lower than that of stocks in other sectors. That causes some investors to overlook promising tech firms, or to see them as overpriced.

However, research and development spending has the potential to pay off in dramatic long-term returns. That’s because the products that grow out of this spending will help tech firms increase their long-term sales and profits.

My #1 U.S. pick could easily make you 50% or more profits in 6 months or less. You'll learn all about this exciting company in my Wall Street Stock Forecaster newsletter. Plus, every month I'll reveal other high-quality, low-risk U.S. stocks with the potential to bring you big gains. Click here to learn how you can profit from Wall Street Stock Forecaster.

High research spending will help leading technology stocks profit from a rebounding economy

We see high research spending as an especially important ingredient for technology stocks that will profit from a global economic recovery. That’s because they’ll be ready with new and improved products as businesses and consumers increase their technology spending.

In the current Wall Street Stock Forecaster, we’ve published a special analysis of 4 tech firms that stand to benefit from an economic recovery. As part of our analysis, we update our buy/sell/hold advice on all of these companies, including Autodesk (symbol ADSK on Nasdaq). The tech stock’s research spending is a very high 26.7% of its revenue (or $457.5 million U.S.).

Autodesk makes computer-assisted design software that lets engineers and architects analyze their products’ performance early in the design process. That saves time and money, and improves the quality of the final product.

The company’s revenue and earnings fell in its most recent quarter. That’s mainly because its customers put off upgrading their computer-aided design software because of the weak economy.

Even so, Autodesk has kept its research spending high. And its strong balance sheet should let it maintain its high research spending: the company is debt free, and holds cash of $1.0 billion, or $4.37 a share. That bodes well for the technology stock’s long-term prospects.

You can get our special analysis of technology stocks, which includes our latest buy/sell/hold advice on Autodesk and 3 other tech firms, in the latest Wall Street Stock Forecaster. What’s more, you can get this issue absolutely free. Click here to learn how.

ETFs are set up to mirror the performance of a stock-market index or sub-index. They hold a more-or-less fixed selection of securities that represent the holdings that go into the calculation of the index or sub-index.

ETFs trade on stock exchanges, just like stocks. Investors can buy them on margin or sell them short. The best ETFs offer well diversified, tax-efficient portfolios with exceptionally low management fees.

Exchange-traded funds have certain drawbacks

It’s important to note that not all ETFs are created equal. For example, there are a lot of ETFs that have been created to tap into popular, but risky, themes and fads, so you need to be very selective with your ETF holdings.

Moreover, ETFs tend to load you up on the hottest, most popular stocks or sectors as they rise. That’s because, as they rise, these stocks or sectors make up a rising proportion of the index.

The Resources sector provides an example. Many Resources stocks have made significant gains with the economic recovery, and this sector now makes up roughly 47% of the Toronto Stock Exchange.

However, over the next year or even two, resource prices are likely to be highly erratic as the economy continues to struggle to get back to normal. That’s why we believe that it’s better to be under-represented in Resources, rather than sit through a slump with too much committed to this volatile sector. Aggressive investors may want to commit up to 25% or 30% of their portfolios to Resources (provided they diversify widely within the sector), however a 47% weighting in Resources is far too high, even for highly aggressive investors.

Stick to our ETF recommendations

We recommend a small selection of exchange-traded funds in our Canadian Wealth Advisor newsletter. In our latest issue, we’ve published our analysis of 6 exchange-traded funds that track the major North American stock exchanges, including our clear buy/sell/hold advice. See below for our latest analysis of one of these funds: iShares CDN LargeCap 60 Index Fund (symbol XIU on Toronto).

"Mutual Funds Canada: Inside the Top 10 Canadian Mutual Funds": In this new special report, Pat McKeough and his team of investment professionals show you which funds could make you exceptional profits over the next year. You learn how Pat and his team rate the funds they select, how to choose the right funds to help you weather a market slump, and much more. Click here to learn how you can get started right away.

IShares CDN LargeCap 60 Index Fund: An easy way to buy some of Canada’s top stocks

iShares CDN LargeCap 60 Index Fund (symbol XIU on Toronto) is a good, low-fee way to buy the top stocks and income trusts on the Toronto Stock Exchange. The units are made up of stocks that represent the S&P/TSX 60 Index, which consists of the 60 largest, most heavily traded stocks on the exchange. Expenses are just 0.17% of assets.

Most of the stocks in the index are high-quality companies. However, as it must ensure that all sectors are represented, the index holds a few we wouldn’t include, such as Yellow Pages Income Fund.

The index’s top holdings are: Royal Bank, 8.1%; TD Bank, 5.8%; Bank of Nova Scotia, 4.9%; Suncor Energy, 4.8%; Barrick Gold, 3.9%; Canadian Natural Resources, 3.9%; Research in Motion, 3.7%; Potash Corp., 3.4%; Manulife, 3.4%; Bank of Montreal, 3.1%; Goldcorp, 2.9%; CIBC, 2.7%; CN Railway, 2.6%; and EnCana, 2.6%.

For our latest buy/sell/hold advice on IShares CDN LargeCap 60 Index fund and 21 other safety-conscious investments, be sure to consult the latest Canadian Wealth Advisor newsletter. Best of all, you can get this issue absolutely free. Click here to learn how.

For example, owning your house is a great tax shelter. That’s because gains on your principal residence are exempt from capital-gains taxes. However, this tax benefit only applies to your principal residence. You must still pay tax on gains on the sale of a recreational property, such as a cottage or a ski chalet. But these properties generally appreciate at a much slower rate than, say, a home in a major urban centre.

Many investors underestimate the risk and cost of owning rental property

Capital-gains taxes are also applicable to gains on homes you buy for investment purposes, such as rental properties. Moreover, this type of Canadian real estate investing involves a number of other commitments that can make it feel more like running a small business than, say, investing in stocks. With stocks, you only have to tell your broker to buy — everything else is done for you.

In contrast, when you own rental property, you have to spend time finding and dealing with tenants, arranging for maintenance, doing the accounting and so on. You can hire others to do these tasks for you, but that can get very expensive.

You want to protect your "safe money" -- the part of your portfolio you're counting on for the future -- yet you want to earn more than you're getting from the bank. That's where my Canadian Wealth Advisor newsletter comes in. I'll show you several proven ways to protect and grow your safe money. Click here to learn how you can get started right away.

Moreover, Canadian real estate investing can entail higher levels of risk than stocks. That’s because real estate is less liquid, expensive to manage and buy or sell, and highly geographically concentrated. Rising crime, unpleasant neighbours and other changes on the street or in your property’s neighbourhood can make it hard to find tenants or buyers. So can physical problems, like adverse traffic patterns, backed-up sewers and zoning changes that allow undesirable development, or limit what you can do with your property.

Many real-estate investing enthusiasts say that if you buy a property with a 20% down payment (which is the Canadian government’s proposed new minimum to qualify for government-backed mortgage insurance on a property that is not your principal residence), then a 20% rise in the property’s value means you have doubled your money.

However, that claim neglects the costs of selling (up to 5% or 6% for real-estate commissions, plus lawyer’s fees and related costs). It also overlooks any negative cash flow you may have experienced while you owned the property, because rents failed to cover expenses.

Real estate investment trusts offer an easier way to profit in Canadian real estate investing

We continue to believe that ownership of a primary residence is all the real estate exposure that most investors need. However, if you want to add to your real-estate holdings, one good way to do it is through real estate investment trusts, or REITs.

Real estate investment trusts invest in income-producing real estate, such as office buildings and hotels. That’s a segment of the market that is difficult for most investors to access through direct ownership of property. Moreover, real estate investment trusts save you the cost, work and risk of owning investment property yourself.

RioCan Real Estate Investment Trust (symbol REI.UN on Toronto) is Canada’s largest real estate investment trust. RioCan owns 258 shopping centres located across Canada. It specializes in big-box outdoor malls (these malls feature large stores that are usually part of a chain). We cover RioCan in our Successful Investor newsletter.

The best real estate investment trusts have good management and balance sheets strong enough to weather an economic downturn. They also have high-quality tenants, and they carefully match their debt obligations with income from their leases. The best ones are still doing well, despite the economic slowdown, and are taking advantage of low interest rates to refinance long-term mortgages.

If you have investment-related questions, or if you’d like to ask me about specific stocks you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.

Entitled “Royalty trusts: Flaherty’s tax not so scary after all,” the article covers many analysts’ opinions on how royalty trusts will be affected when the new income-trust tax takes effect on January 1, 2011. The article includes Pat’s opinions on royalty trusts, including Enerplus Resources Fund and Pengrowth Energy Trust.

If you’re interested in reading more, click here to see the full article.

The article was also carried on the CTV news website and on GlobeAdvisor.com.

You can see the full results of this poll, and a full archive of previous polls, on TSI Network. Just click the “Poll Archive” button below the main banner on the site’s home page.

Discounters’ lower commissions are a plus — but use caution

The main advantage of switching to a discount stock broker is lower commissions. Commission rates can be even cheaper if you trade stocks with your discount stock broker online, as opposed to placing orders over the telephone.

However, low commission rates sometimes lead investors to trade a great deal. They may assume they can’t lose because they can sell at the first sign of trouble. Being quick to sell can cut your losses, of course, but that’s not the same as making money. And, if you stumble onto an investment that has a huge rise ahead of it, you may wind up selling just before the move begins.

Imagine having me build you a portfolio that’s tailored to your specific investment goals. That's just one of the many ways you benefit when you become a client of our portfolio management services. But the service is not for everyone -- in fact, I limit the number of clients that we accept to ensure we can maintain a high level of service. Right now, there are a limited number of spots available. Click here to learn more about how you can profit from our Successful Investor portfolio management services.

On the other hand, a good stock broker or financial advisor (one who is experienced, knowledgeable, and oriented toward the long term) is worth the higher commissions that you are likely to pay. For instance, suppose your full-service stock broker charges an average commission of 2%, and you replace one-third of your portfolio every year (both figures are on the high side). In this case, you’d pay 1.34% of your portfolio’s value each year in commissions. That’s less than the 2% to 3% management fee on a typical mutual fund.

A discount stock broker won’t help you avoid costly mistakes

Before you switch to a discount stock broker, remember that doing so gives you unlimited opportunity to go wrong on your own. That’s because the clerk who takes your order won’t warn you if they see you’re about to do something you’ll regret, even if they know this to be the case. As well, you’ll receive no guidance or investment advice while entering trades on a discount broker’s web site.

So before you switch, put yourself through a brutal self-assessment. Are you able to single out a selection of investments that’s right for you, keeping investment quality and diversification in mind? If not, you may be better off with a full-service stock broker, provided you can find one who values your business and puts your needs first.

Making fewer trades is the best way to cut commission costs

In the long run, the best way to cut commissions is by sticking to high-quality investments and making fewer transactions. This also improves your tax deferral.

For instance, suppose you buy an investment at $10 and it goes to $20. As long as you hold on, the entire $20 keeps on producing dividends and capital gains for you. If you sell, you’ll have only $16 or so to reinvest after paying capital-gains taxes and commissions.

If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.

That’s also true of the investing world, as companies line up to get a piece of the roughly $12 billion (Canadian) that is being spent to build the Russian Olympics in Sochi. And one Canadian firm is set to play a big role: engineering firm SNC-Lavalin Group Inc. (symbol SNC on Toronto). SNC is one of the growth stocks we cover in our Successful Investor newsletter.

This growth stock’s international expertise makes it well-suited to help build the Russian Olympics

SNC designs and builds a variety of large-scale projects, such as roads, bridges and electrical power systems. The company has signed a deal to build and manage transportation and electricity infrastructure for the Russian Olympics in Sochi.

SNC gets about 40% of its revenue from overseas projects. It already has over 30 years of experience in Russia, and it continues to expand its operations in the country. In August 2009, it bought 48% of Russian engineering firm OAO VNIPIneft.

Pat McKeough's ValuVesting System generated a whopping 303.8% return since 1995 (126.8% above the 177.0% gain of the S&P/TSX) in one of the most volatile markets in history. That means if you had invested $100,000 in 1995, you would have $403,800 today! Click here to learn more about how you can profit from Pat McKeough's The Successful Investor newsletter.

And just last month, SNC formed a new joint venture with a Russian bank. SNC owns 49% of this new company, which will be called VEB Engineering LLC. The new firm will provide technical assessments and budgeting services to large infrastructure and industrial projects.

Operating in Russia entails special risks

The growth stock’s significant international operations — including its activities in Russia — expose it to significant currency and political risk. As well, many of its clients are government organizations, or in the resource sector. That leaves the stock vulnerable if resource prices fall, or governments cut back on public-works projects.

However, the growth stock’s long experience operating in Russia helps to mitigate some of its risks. Moreover, the 2014 Russian Olympics are not the company’s first Olympic experience. SNC also played a big role in the Vancouver Olympic games this year: The company built and continues to operate the Canada Line train, which connects the city’s airport to its downtown core. It also oversaw the engineering of upgrades to the Sea to Sky Highway, which runs between Vancouver and Whistler.

You can get our latest buy/sell/hold advice on SNC Lavalin and dozens of other growth stocks you may be considering buying (or selling) in our Successful Investor newsletter. Click here to learn how you can get one month free when you subscribe today.

1. Failing to follow a realistic stock market trading strategy: Some investors, particularly newcomers, plan to buy a few hot stocks (or funds, or options or futures), and double or triple their money in a few years. Then they’ll settle into a low-risk investing style that may only return an average 10% to 12% yearly. But if you could make 200% or 300% in a few years, why would you quit? If you could do it once, you should be able to do even better as you gain experience.

Of course, if you doubt that you can keep it up indefinitely, you should also question whether you can pull it off the first time. The best stock market trading style for most investors is one that will work for them more-or-less indefinitely. You’ll want to be sure it suits your circumstances and temperament, that it won’t take up too much of your time, and that it doesn’t require luck or extraordinary circumstances for success.

2. Putting too much faith in trends: It pays to keep in mind that the stock market anticipates things, and no trend lasts forever. Stocks put on lengthy downturns due to business and economic problems. The downturns go into reverse long before the problems get solved.

Remember, a highly dramatized story is far more entertaining than a straight explanation of facts, and more absorbing. But don’t let entertainment value, or your degree of absorption in the story, warp your judgment.

In today's turbulent economy, you need clear, personalized investment guidance more than ever. That's what you get when you become a client of my portfolio management services. When you hire me and my expert staff to manage your investments for you, we employ the same value-investing principles I've followed for my entire career. But hurry, space is limited. Click here to learn more about how you can profit from my portfolio management services.

3. Basing stock market trading decisions solely on past share-price movements: Share prices rise and fall based on a number of factors, including what’s going on in a company, its industry and the world.

A stock never gets so high that it can’t keep rising, nor so low that it can’t keep falling. That’s why you have to look beyond price changes when deciding when to buy or sell.

4. Failing to take a skeptical view of speculative investments: Some investors generally put too high a value on speculative ventures. They want to believe that innovations will succeed, and that they’ll get a fair chance to profit. Their innate politeness stops them from asking tough questions of smooth-talking promoters. Excess optimism plus a data shortage leads them to pay too much.

That’s why we focus our stock market trading on well-established companies rather than start-ups, even in Stock Pickers Digest, our advisory for aggressive investors. Most of our Stock Pickers Digest buys are far better established than your average penny stock.

5. Selling good stocks in anticipation of a market downturn: In times of market pessimism, many investors are tempted to sell all of their stocks, regardless of quality, in hopes of getting back in at lower prices.

However, selling to sidestep a market downturn rarely works out as neatly or as profitably as sellers hope. First, some stocks hold steady or rise during a downturn — these are often the strongest stocks in the subsequent upturn. And sometimes the downturn ends much more quickly than you expected, and you wind up buying back in months or even years later, at much higher prices.

Other times, the market moves up, the seller buys back in, and the real downturn begins. That can leave you down 20% or more on a 10% market downturn.

If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.

How “in-the-limelight” stocks can hurt your portfolio

Even well-established large cap stocks (or shares of larger-sized companies) can stumble. That’s especially true when they’re in what we call the broker/public relations limelight. Investors can build up unrealistic expectations when stocks spend time in that limelight. When broker/public-relations favourites fail to live up to those expectations, they drop much further than they would have if they had been less widely followed.

Toyota (symbol TM on New York) provides an example. The large cap stock’s shares have fallen roughly 19% since mid-January. That’s when the company announced a recall of 8.5 million cars to fix problems that could lead to sudden acceleration.

The cars’ gas pedals could get stuck in the downward position, or their floor mats could get trapped under their gas pedals. Toyota is also recalling hybrid cars for brake problems.

The company estimates that the gas-pedal recall will cost it up to $2 billion. To put this figure in context, Toyota earned $1.7 billion in its third quarter, which ended December 31, 2009.

Prior to the recall, Toyota was an example of what we would call a “priced-to-perfection” stock. The company was frequently the subject of positive news articles about its hybrid technology, positive labour relations and so on. For these reasons, Toyota shares were priced as though the company did not face any of the same challenges as other automakers, such as GM and Chrysler.

In Wall Street Stock Forecaster, you get an investment advisory that's 100% focused on U.S. value stocks identified by my ValuVesting System™. In a year that saw the Dow Jones Industrials fall 33.8%, I told my subscribers about winners like Arkansas Best, which gained 37.2% and Anheuser-Busch, with a 33.7% gain. Click here to learn how Wall Street Stock Forecaster can help you tap into high-quality opportunities in the U.S. stock markets.

We’ll keep you up to date on the road ahead for Toyota

We’ve been following Toyota’s troubles closely, and keeping our subscribers up to date on the stock in our Wall Street Stock Forecaster issues and hotlines.

The U.S. Congress is now investigating the large cap stock’s response to the safety concerns surrounding its vehicles. It’s possible that the U.S. government will issue stricter safety rules in response to the recalls.

The recalls have caused significant problems for Toyota. And of course, the company would have to comply with any new safety regulations from the U.S. government. However, these new measures would also apply to other carmakers.

Our three-part program helps protect you from volatility

Toyota is far from the only “in the limelight” stock that could suffer on negative news. Companies like Apple Inc. (symbol AAPL on Nasdaq) or Research in Motion (symbol RIM on Toronto) are also leaders in their industries, but their place in the broker/public relations limelight does leave them vulnerable to sharp declines when they run into trouble. But if you stick with our three-part program, these stocks will only make up a small part of your overall holdings.

We take a close look at Toyota’s competitive position and its options for dealing with the recall in the current Wall Street Stock Forecaster. This issue also gives you all the information you need to respond to the situation, and gives you our clear buy/sell/hold advice on the stock.

Best of all, you can get this issue of Wall Street Stock Forecaster absolutely free. Click here to learn how.

Typically, you calculate p/e’s using a stock’s current price and its earnings for the previous 12 months. The general rule is that the lower a stock’s p/e, the better. And a p/e of less than, say, 10, represents excellent value. A low p/e implies more profit for every dollar you invest.

There’s no doubt that p/e ratios are an important part of many investors’ decision making. These financial ratios are published regularly on the Internet and in newspapers, and are widely followed.

Financial ratios: p/e’s are just one measure of value

P/e financial ratios are a good starting point for researching a stock you’re considering buying (or selling). But relying too heavily on these financial ratios can expose you to serious risk.

Successful investors treat p/e’s as just one of many tools, and not a deciding factor. This is the approach we follow when we use these financial ratios to evaluate stocks for one of our newsletters, including Stock Pickers Digest, our publication for aggressive investing.

Here are 4 risks of relying too heavily on p/e ratios. All can seriously hurt your portfolio’s long-term returns:

1. P/e’s can give you a misleading picture of a company’s earnings: Make sure you factor out low p/e’s that arise if a company sells off assets or subsidiaries and records a large one-time gain. That inflates the p/e, and is not representative of the company’s true ongoing operating earnings. Similarly, you should add back any one-time write-offs so you don’t miss any stocks that have low p/e’s on an ongoing basis.

For a limited time only, sign up to get Pat McKeough's specific answers to your personal investment questions. Pat's proven expertise is available to guide the investment decisions of only a few new Inner Circle members. Click here to learn more about how you can benefit from membership in Pat McKeough's Inner Circle.

2. Beware of suspiciously low p/e’s: It pays to be wary of stocks that trade at suspiciously low p/e’s. Low p/e’s may come about because well-informed investors are selling the stock and pushing the price down, regardless of earnings. In other words, unusually low p/e’s can be a sign of danger rather than a clue to a bargain.

Some companies, especially in the cyclical manufacturing and resources sectors, go through periodic booms and busts that can balloon their earnings in the space of a few quarters, then deflate them overnight. If earnings are high and p/e’s are low on a company or industry, it usually means investors expect a profit setback. These stocks could easily plunge when growth turns down. Often the riskiest time to buy stocks in these industries is when p/e’s are at their lowest.

3. Don’t discount stocks with high p/e’s: You should expect to pay high p/e’s for stocks with lots of growth potential. As well, you may want to buy shares of high-p/e firms that report earnings even in bad times. This shows a high-quality company. This is true even if a company stays marginally profitable, or avoids eye-catching losses, in bad times.

You’ll also pay more for companies with a long-term earnings pattern. However, few are worth more than 20 to 25 times normal earnings in the midst of an economic cycle. So you should avoid loading your portfolio up with high-p/e stocks. Should the market go into a broad setback, these stocks are particularly vulnerable.

4. P/e ratios can mask hidden value: When we’re researching a company for Stock Pickers Digest and our other newsletters and investment services, we also look closely at its financial statements to spot hidden value that’s not shown in p/e’s.

For example, companies write off research and development costs against earnings in the year they spend the money, though benefits may come years later. Attention to research spending has guided us to some of our biggest winners. Because these companies spend heavily on research, they are more profitable and less risky than you’d guess from looking at their high p/e’s alone.

For our latest aggressive investing strategies and clear buy/sell/hold advice on dozens of aggressive stocks, be sure to consult the latest Stock Pickers Digest. Click here to learn how you can get one month free when you subscribe today.