If you want to make money in stock you have to buy them when they're cheap and sell them when their expensive. It's as simple as that. There is nothing else you need to know in the world of investing. The only problem is that it can be pretty difficult to actually figure out when a stock is cheap or when it's expensive. Does the price even matter when trying to assess value?
Some investors will tell you to look at the Price Earnings ratio and if the PE is low then you would deduce that the stock is cheap because the company has high earnings relative to its price. Other investors will focus on the Return on Equity metric and tell you that the ROE needs to be over 10%. Low levels of debt and a high rate of sales are also good qualities for companies to have. The question to answer is really what should the actual price that a stock is trading at actually be?
The answer to that is that you have to figure out the intrinsic value of the stock. That is not always a straight forward thing to do, but there are discounted cash flow models that help with those calculations. The premise of a DCF model is that the intrinsic value of the stock is equal to all of the company's discounted future cash flows. There are a couple of things that go into figuring that metric out, but when you've come up with an estimated value you can then compare it to the actual stock price and make a decision on whether to proceed or not.
The other metrics that go into figuring out the Intrinsic Stock Values include determining the projected free cash flow for the company, which can usually be deduced by looking at the company's recent free cash flow and estimating a future value. That type of information can be obtained from the company's Cash Flow Statements by subtracting Capital Expenditures from Cash from Operating Activities.
Another metric is the FCF growth rate. That value represents the rate that you believe the FCF for the company is going to grow at. Anything below 0% is not a good idea to look at because you're saying that the company 's best days are behind it, while anything above 10% paints too rosy of a picture that can not realistically be maintained in the long term.
The discount rate is important because it allows you to factor in risk into the equation. A 9% discount rate is considered low risk for a company, and a discount rate of 15% or higher would mean that the company is a fairly risky one to invest in. The last rate to keep track of is the perpetuity growth rate which fluctuates between 2% and 3% depending on whether there is a rising or falling market.
With all of these metrics you can arrive at an intrinsic value for a stock. The next piece of the puzzle is figuring out what your margin for error is. This is determined through the assessment of the margin of safety. If the margin of safety is below 30%, your margin for error is probably smaller than it should be for you to seriously consider making the investment. Low values would mean that you must be spot on with all of your assumptions to not lose any of your initial investment, and you shouldn't operate in an environment where you might lose your capital.
To ensure that you haven't made errors in your login, you must go in a review the annual reports for the company, including 10k reports and financial statements. Doing so will enable you to validate that you have made correct assumptions in your calculations for intrinsic value.
Some investors will tell you to look at the Price Earnings ratio and if the PE is low then you would deduce that the stock is cheap because the company has high earnings relative to its price. Other investors will focus on the Return on Equity metric and tell you that the ROE needs to be over 10%. Low levels of debt and a high rate of sales are also good qualities for companies to have. The question to answer is really what should the actual price that a stock is trading at actually be?
The answer to that is that you have to figure out the intrinsic value of the stock. That is not always a straight forward thing to do, but there are discounted cash flow models that help with those calculations. The premise of a DCF model is that the intrinsic value of the stock is equal to all of the company's discounted future cash flows. There are a couple of things that go into figuring that metric out, but when you've come up with an estimated value you can then compare it to the actual stock price and make a decision on whether to proceed or not.
The other metrics that go into figuring out the Intrinsic Stock Values include determining the projected free cash flow for the company, which can usually be deduced by looking at the company's recent free cash flow and estimating a future value. That type of information can be obtained from the company's Cash Flow Statements by subtracting Capital Expenditures from Cash from Operating Activities.
Another metric is the FCF growth rate. That value represents the rate that you believe the FCF for the company is going to grow at. Anything below 0% is not a good idea to look at because you're saying that the company 's best days are behind it, while anything above 10% paints too rosy of a picture that can not realistically be maintained in the long term.
The discount rate is important because it allows you to factor in risk into the equation. A 9% discount rate is considered low risk for a company, and a discount rate of 15% or higher would mean that the company is a fairly risky one to invest in. The last rate to keep track of is the perpetuity growth rate which fluctuates between 2% and 3% depending on whether there is a rising or falling market.
With all of these metrics you can arrive at an intrinsic value for a stock. The next piece of the puzzle is figuring out what your margin for error is. This is determined through the assessment of the margin of safety. If the margin of safety is below 30%, your margin for error is probably smaller than it should be for you to seriously consider making the investment. Low values would mean that you must be spot on with all of your assumptions to not lose any of your initial investment, and you shouldn't operate in an environment where you might lose your capital.
To ensure that you haven't made errors in your login, you must go in a review the annual reports for the company, including 10k reports and financial statements. Doing so will enable you to validate that you have made correct assumptions in your calculations for intrinsic value.
About the Author:
Wining as a Value Investor in associated with doing solid research and making good assumptions. The Value Investor Headquarters website has good resources to help you achieve those results.
