## Saturday, 25 January 2014

### When evaluating the price, look at the potential return and the risk you must take to get that return.

When it comes to evaluating the price of a stock, you're really interested in just 2 things:

1.  The potential return, and
2.  The risk you must take to get that return.

If the potential return is worth the risk, the price is right.

If it is not, you can simply wait until it is.

As volatile as the stock market is, most stocks will sell at a favourable price sometime during the year.

To estimate the potential return, you will have to come up with a reasonable forecast of how high the price might go.  Knowing the hypothetical potential high price, you can estimate the potential return.

To evaluate risk, you will need to conservatively estimate the stock's potential lowest price.  If your potential gain is at least three times as much as you risk losing, your stock is probably selling at a fair price.

For example:

Stock TUW

Potential high price = \$20
Potential low price = \$10
Market price = \$12

Potential gain = \$20 - \$12 = \$18
Potential loss = \$ \$12 - \$10 = \$2
Therefore, potential gain : potential loss = \$8 : \$2 = 4 : 1

As the potential gain is at least 3x as much as you risk losing, the stock is probably selling at a fair price.