Evaluating Quality first, then Price. Fair price is one associated with adequate return at acceptable risk.

1.   The most important task in buying a stock is to determine that the company is a good company in which to own stock for the long term.  (QUALITY)

2.  However, no matter how good the company, if the price of its stock is too high, it is not going to be a good investment.

3.  A stock price must pass two tests to be considered reasonable:
(i)  The hypothetical total return from the investment must be adequate - enough to contribute to a portfolio average of around 15% - sufficient to double its value every 5 years.  (REWARD).
(ii)  The potential gain should be at least 3x the potential loss.  (RISK)

4.  To complete these tasks, you have to have learned how to do the following:
(i)  Estimate future sales and earnings growth.
(ii)  Estimate future earnings.
(iii)  Analyze past PEs (Check the current PE with the average past PEs)
(iv)  Estimate future PEs.
(v)  Forecast the potential high and low prices.
(vi)  Calculate the potential return.
(vii)  Calculate the potential risk.
(viii)  Calculate a fair price.

5.  If you take each of these steps in 4(i) to 4(viii), cautiously and shun excesses, your actual results is likely to be as good or better than the forecast at least four out of the five times.

6.  And you will have a track record to rival any professional.

That's all folks!

To Buy or Not to Buy: Quality first, then Potential Return at an Acceptable Risk.

To buy or not to buy - the bottom line is the potential reward and the amount of risk that you must accept to achieve it.

Always assuming you have done your due diligence concerning the quality issues, look to see if the hypothetical total return is sufficient to warrant adding the stock to your portfolio.  If the stock appears to be capable of doubling its value in five years, it's probably a good buy.

If you have been cautious enough in your estimates of earnings growth and future PEs, and if the potential reward is at least 3x the risk of loss, you'll have no qualms about buying the stock.



Use Your Common Sense

Investing is far from a precise science.

What you lose in accuracy because you are building one estimate upon another, you gain by being conservative in your estimates.

If you are careful to take the more cautious choice at every opportunity, you are rarely going to be disappointed at the outcome.

A small difference - a 1% difference in the risk would translate into only a small difference in the share price - is not enough to warrant waiting for the price to be just right.

If the price is more than just a little too high for the value parameters to satisfy you, however, you'll want to complete your study and wait for the price to come down to a more reasonable figure.



Summary:

1.  Always the Quality criteria must be met first
2.  Then look at the Total Return - this must be >15% per year.
3.  Only buy when the Risk is acceptable, that is, the potential reward must be at least 3x the risk of loss.
4.  Don't squabble over pennies when you are buying.

REMEMBER:  Prices can fluctuate by as much as 50% on either side of their averages during the course of the year; so you might be pleasantly surprised when a price you thought beyond hope just happens to materialize one day.

How to make money in a down market?

Here is an example of making money in a down market.

At the end of 2007, an investor was enthusiastic about a stock ABC.  Then the severe bear market of 2008/2009 intervened.  Here were the investor's transactions in stock ABC.

1.11.2007  Bought 1000 units  @  $6.00          Purchase value  $6,000
6.11.2007  Bought 1000 units  @ $ 6.75          Purchase value  $6,750
15.9.2009  Bought rights 800 units @ $ 2.80    Purchase value  $2,240
!5.9.2009   Bought 5,500 units  @ $ 3.51         Purchase value  19.305

Total bought 8,300 units
Purchase value  $34,295
Average price per unit $ 4.13

Current price per unit  $ 5.51
Current value of these 8,300 units is $ 45.733.

This is a total gain of $ 11,438 or total positive return of 33.4% on the invested capital, excluding dividends, received for the investing period..


Lessons:
1.  Investing is most profitable when it is business like.
2.  Stick to companies of the highest quality and management that you can trust..
3.  Stay within your circle of competence.
4.  Invest for the long term.
5.  Generally, hope to profit from the rise in the share price.
5.  At times, the share price becomes cheap for various reasons # - be brave to dollar cost average down, provided no permanent deterioration in the fundamentals of the company..


# Severe bear market of 2008/2009.

Smart Investing: Don’t Lose Money!

We’ve all been told that in order to create wealth we must take risks and invest, invest, invest. Between stocks, bonds, mutual funds, 401(k)’s, IRA’s and so forth, people are feeling the pressure to invest because they have been taught that it’s the only way to wealth. The problem is many people are losing money. And, though some recover from losses (and some never do), losing money has a much greater negative impact on your wealth than gains do. Let me explain.

Impact of Losses vs. Gains

First, some basic math. I want to show you how losses hurt much more than gains help. Many people are under the impression that if they have a 20 percent loss one year and a 20 percent gain the next, then everything is okay and they’re back to their original investment. Unfortunately, this isn’t true.

Let’s say you invest $100,000. The first year, you lose 20 percent. You’re left with $80,000. The next year you make a 20 percent gain. How much do you have? Remember the “gain” must be calculated from the current value of $80,000, so a 20 percent gain on $80,000 would take your value up to $96,000. You’ve still lost money.

But what if you had a gain first and then a loss, would that make any difference? Let’s see: Again, you start with $100,000. Only, this time, you gains 20 percent off the bat. Now you have $120,000. The next year you lose 20 percent, leaving you with $96,000. There is no difference whether you gain first or lose first; the loss can happen at any point and will still have a greater impact than the gain.

Don’t Lose Money!

Remember the most important rule in
creating wealth, “don’t lose money.” 

In the end, no matter how you choose to invest your money, make informed decisions and look at all your opportunities.

Dan Thompson is a 25+ year financial expert and author of “Discovering Hidden Treasures.” He specializes in wealth creation and retirement planning.

OCTOBER 5, 2010

http://www.quizzle.com/blog/2010/10/smart-investing-dont-lose-money/

The margin of safety related to the Upside-Downside Ratio

Building in Room for Error
Related to the Upside-Downside Ratio

by Michael Maiello
12.3.2008


The margin of safety is one of Benjamin Graham and David Dodd’s most enduring contributions to the world of investing. The two coined the term in Security Analysis in 1934, and Graham expanded on the concept in The Intelligent Investor in 1949. The gist of it is that no matter how careful an analyst is, so many variables are involved in calculating a company’s intrinsic value and future sales and earnings that mistakes are inevitable. So buy a stock worth $12 at $10 instead of $11.50, because the wider the gap between the stock’s price and its intrinsic value, the bigger the margin of safety.


How much safety is warranted depends on the company’s quality. A speculative com-pany that’s losing money, carrying a lot of debt or operating in a shrinking industry reasonably demands a larger margin of safety than a profitable company that leads a growing industry and has a solid balance sheet. Graham and Dodd typically looked for a 50-percent margin of safety on speculative companies but would require a margin of only 10 percent for a high-quality issue.

All investors employ the margin of safety differently, since it’s tied both to intrinsic value analysis and an individual’s risk tolerance. BetterInvesting expresses the risk-reward tradeoff as the upside-downside ratio. The goal here is to evaluate the risk and reward potential of a stock over five years, assuming one boom and one recession. This analysis says nothing about the probability of a stock reaching any particular price. Instead, it expresses what a stock’s potential is. BetterInvesting recommends buying a stock only when the upside is at least three times that of the downside.

In calculating the ratio, you first find the extreme upside. For a company with growing earnings, estimate the stock’s highest price-earnings ratio over the next five years. This will represent “as good as it gets.” Then determine the company’s highest earnings per share over this period. Multiply them and that’s your extreme high.

Now do the same on the low end. Multiplying your estimated low P/E by the expected low earnings is a common way to do this. If the stock is already trading below your low forecast, you’ll want to revisit your assumptions.

Finally, take the forecast high and subtract the current price. Then divide that by the current price minus the forecast low. The result is the upside-downside ratio. Anything above 3:1 offers a reasonable margin of safety for growth stocks.

Some investors also like a margin of safety for selling stocks. The upside-downside ratio for existing holdings should be updated to see whether price appreciation has outpaced potential.

The analysts at Morningstar do something similar. They give a “fair value” estimate for every stock. For Wachovia, it’s currently $53. The stock recently traded at $34.60. Morningstar says to consider buying it at any price below $39.80, which is 75 percent of what Morningstar thinks the stock is worth.

If you buy the stock, Morningstar says not to consider selling it until it reaches $68.90. In other words, Morningstar believes Wachovia’s stock could increase by 30 percent beyond what it now considers the stock’s fair value. The answer to the selling conundrum in this case is that if Wachovia reaches its fair value, the investor has to analyze the stock again to see whether there’s room left for the stock to run.

BetterInvesting’s Online Tools

The Stock Selection Guide, the primary stock study tool of BetterInvesting members, helps you identify stocks that are reasonably priced. Our new online tool will walk you through evaluating a company using the SSG. Click on the Online Tools & Software link under the Tools & Resources menu on the BetterInvesting homepage. Your membership may already include access to the tool; if not, you can upgrade your membership to use it.



Michael Maiello, who wrote "Fly With the Fundamentals" for the January 2006 issue, is the author of Buy the Rumor, Sell the Fact (McGraw-Hill, 2004).


http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0408fundamentalpublic.htm

Investment merit at a given PRICE but not at another

Investment Policies (Based on Benjamin Graham)

PRICE: is frequently an essential element, so that a stock (and even a bond) may have investment merit at one price level but not at another.

______________________________________

Having selected the company to invest based on various parameters, the next consideration will be the price we are willing to pay for owning part of its business.

Price is always an important consideration in investing. At a certain price, the company can be acquired at a bargain, at a fair price or at a high price. Each scenario will impact on our investment returns.

We should ALWAYS buy a good quality company at a BARGAIN PRICE (margin of safety). This allows us to lock in our potential gains at the time of buying at a favourable reward/risk ratio. This maybe when the upside gain: downside loss is at least 3:1.

There maybe FEW exceptional occasions when we may be willing to pay a FAIR PRICE for a good quality company. This is often the case when a good quality company is fancied by many investors and is often quoted in normal time at a high price.

However, we should NEVER (NEVER, NEVER) buy a good quality company at HIGH PRICE, whatever its earnings and growth prospects maybe. To do so will not only diminishes our potential investment returns, but may even results in a loss of our capital due to the unfavourable reward/risk ratio.

Don't time the market, it is difficult. However, there will be time when the market is on sale and the prices of stocks are at a bargain and there will be time when the market is exuberant and the prices of stocks are high or very high.

The market will always be there and we should choose when to buy and when to sell. We should only buy a stock when the PRICE IS RIGHT FOR US and sell a stock when the PRICE IS RIGHT FOR US.


(What is market timing? Timing is a term that refers to investing by buying everything or selling everything on the basis of the (faulty) assumption that one can predict the market's next move. Attempts to time are common, but academicians and practitioners have concluded that success happens through luck only on occasions that are quickly reversed and very costly.)