Setting a maximum price and buying price for Company X shares
Current cash profit per share 11.6 sen
Divide by interest rate [inflation +3%] 4.4%
Maximum price (cash profit / interest rate) $2.636
Current price $3.20
Ideal price at 15% discount $2.24
Cash yield at ideal price (cash profit/ideal price) 5.18%
ANALYSIS:
This approach is saying that Company X shares are currently too expensive to buy.
The most (maximum price) you should pay is $2.63 per share, compared with a current share price of $3.20.
If you want even more of a buffer (margin of safety) compared with the maximum price - a good rule of thumb is 15% - you will only want to pay $2.24.
Additional notes:
You might be waiting a long time for a share to reach your target price and it might never do so.
However, it is far better to wait or even risk missing out on the few shares that are too expensive than to risk paying too much and lose money.
When to sell?
This kind of analysis can also give you some guidance of when to sell a share.
If a share that you own reaches a maximum price, it doesn't mean that you should automatically sell it. Shares can and do go beyond and below their fair valuations.
In the above example, Company X, one would not sell at $2.63 but if the share price exceeded this (maximum price) by 25% ($3.29), you might sell and then look for something cheaper to buy.
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