Aug 24 2011
Stock Picking For Beginners
A lot of discussions have been devoted towards finding fair value of an investment. Admittedly, this is the hardest part of investing. First thing that comes out of my mind is Certificate of Deposit (CD). You are guaranteed certain return (interest rate), if you can hold for a certain pre-determined time frame. You would never lose your principal at the end of the time frame.
The next higher risk investment is buying common stock.
What does it means for a stock to give investor a return of 6%? It never really say it, doesn’t it? You are partly right.
All we need to do is find the share price of a common stock and the profit per share (also known as earning per share) of that particular stock. Let’s use an example to illustrate my point. Will Magna continue to give investors a 9.5 % return year after year? It depends. If the stock price rises, Magna will return less than 9.5 % annually. What else? Well, Magna might not constantly produce the same amount of profit year after year. It might even produce a loss! So, you see, stock investing is inherently risky because there are two moving part in the equation.Price of the common stock and the profits produced by the company itself.
Recently, treasury bond can give us a 4 % return. Therefore, the fair value of Magna common stock is when it can give me a return of 6% So, what is the fair value of Magna common stock in this case? For a profit of $ 6.95 per share, the fair value of Magna common stock is $115.80 per share. That’s right. At $ 115.80 per share, Magna common stock will return investors 6% annually. Having said that, we should never buy a common stock at fair value. Why? Because our investing purpose is to make money. If we buy stocks at fair value, then when do we profit from it? Do we expect to sell it when it is overvalued? Sure, it would be nice if we can do that all the time. But to be conservative, let’s not bank on our stocks reaching overvalued level.
It is not in any way an endorsement to buy Magna common stock. You should do your own calculation to verify that number. Get your investing idea for free at http://www.noviceinvesting.com . Just visit our commentary section regularly.
——————————————————–
The stock market does have it risks but if you invest small it can be worth your effort: search engine optimization services
No related posts.