Sunday, 23 July 2017

How to value shares (checklist)

Here is a checklist to remind me of the process when valuing shares:

1.  Value the companies using an estimate of their cash profits.
  • What is the cash yield a company is offering at the current share price?
  • Is it high enough?
2.  Calculate the company's earnings power value (EPV).
  • How much of a company's share price is explained by its current profits?
  • How much is dependent on future profits growth
  • If more than half of the current share price is dependent on future profits growth, do not buy these shares.
3.  What is the maximum price you will pay for a share.
  • You should try and buy shares for less than this value.  
  • Apply a discount of at least 15%.
  • The interest rate applied to calculate the maximum price should be at least 3% more than the rate of inflation.
4.  To pay a price at or beyond the valuations above, you must be confident in the company's ability of continuing future profits growth (quality growth companies).
  • The higher the price paid for profits/turnover/growth, the more risk you are taking with your investment.
  • If profits stop growing, then paying an expensive price for a share can lead to substantial losses.

Additional notes:

Investing using checklists is a very powerful method.

It focuses your thinking and guides you in the investing process.

If you are to be a successful investor in shares, you need to pay particular attention to the price you for for them.

  • The biggest risk you face is paying too much.
  • It is important to remember that no matter how good a company is, its shares are not a buy at any price.

Paying the right price is just as important as finding a high quality and safe company.

  • Overpaying for a share makes your investment less safe and exposes you to the risk of losing money.

Also, do not be too mean with the price you are prepared to pay for a share.

  • Obviously you want to buy a share as cheaply as possible, but you should also realise that you usually have to pay up for quality.
  • Waiting to buy quality shares for very cheap prices may mean that you end up missing out on some very good investments.
  • Some shares can take years to become cheap and many never do.

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