Saturday, 30 May 2015

Insist on value when you buy (Buy when EXTREMELY undervalued and Sell when EXTREMELY overvalued; with good resons)

A stock has three prices. It has:

  1. a market price, 
  2. a book value and 
  3. an intrinsic value.

The market price is easy to understand. It is the last traded price at the end of a trading day. 

The book value is simply the net tangible asset (NTA) as shown in its balance sheet. 

The intrinsic value is the most difficult to calculate. I do not know of any formula for this. At most, it is only an estimation. 

You have to factor in many metrics such as barrier of entry, calibre of management, earnings potentials (present and future) growth prospects, patents, etc.

So, what should we do? 

For me, I make it simply. I look at the track record relative to its earnings, earnings growth and dividend yields. The higher these are, the higher the value. 

Buying a stock at high earnings per share (PE) is risky. Unless the forward PE is  expected be much lower, avoid stocks trading with high PE. (A PE of over 16 is too high for me.) 

To value a stock, here are some metrics or key ratios to consider: 

  • EPS( earnings per share); 
  • D/Y (dividend yield); 
  • NTA (net tangible assets); 
  • PEG (price to earnings growth); 
  • NPM (net profit margin); 
  • ROE (return on equity); 
  • D/E (debt to equity ratio) 
  • C/R (current ratio); 
  • PCF (price to cash flow). 

One other thing to carefully consider is the core business of the company. Here, you need to think about barrier of entry, patents and competition.

When is the best time to sell a stock

Close to 100% of all stocks will at one time or another be selling at extremely high valuation that they should be sold. 

At other times, they will be selling at overly undervalued prices that they should be bought. 

We want to sell a stock when it is very much overvalued.

Understanding the value of a stock is crucial in this respect, and with the help of technical analysis, you have the advantage of the competitive edge.

Control your emotion

Taking action for action sake is a weakness that many people fail to control. Some people need to move in and out of the market often enough to overcome boredom.

They forget that transaction costs eat into their earnings.

Buy and sell with good reasons and not simply with intuition and the need for action.

Following the guidelines mention above will go a long way to help you to invest intelligently

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