What possibly went wrong with your purchase?
It happens mostly when you buy a stock at wrong price. This may had happened because you were unable to determine the correct stock price of your chosen stock. It caused you trouble because you were either influenced by some advisors or market forces or experts. This may happen when you watch and trust media channels and believe in what the experts â€œthe so called expertsâ€ are saying about the prospects of a stock. They induce urgency and give you some macro market logic to buy the stock urgently.
Make sure you have chosen a value stock
But remember, investing in stock market is about patience and careful research of value stocks. It would be better if you develop a habit of looking at the darker picture before you invest in a company stock.
What I mean to say that actually your decision was not based on data and strong market value calculations that you had done. You believed them because you thought they were better than you and understand markets better. But believe me, most of the time, these experts are paid for influencing people around or have a self vested interest.
Ultimately, you are the one who make or lose money by investing and so called experts are not responsible for any act of advice in your behalf.
So, the crux of the matter is that, start believing in your abilities and devise your own way of investing in the market.
The best way to effectively and reliably find the right buying price point is the one which comes from current market scenario.
Find Current Business Value
The simplest technique I used to find out the right buying price for my stock was to figure out the current business value and not the current market value.
Analogy with Banking Investment
Everyone has a bank account and deposits without realizing that this is a real investment. So, I decided to explain investment in stocks as if this is an investment of a bank deposit. Imagine you have invested $1000 in your fixed deposit bank account. In the current market situation, the bank gives you 7% of return over your investment on an annualized basis. This means at the maturity of your investment, you are going to get $1070 realizing $70 as profit. I am assuming that the profit on this investment is tax exempted.
Now, read the above investment in other way round. To get $70 as an annual profit your current value should be $1000. Or in other words, your value is worth 14.3 times of the return you get. You could safely say that, if you earn $70 an year, your current net worth is $1000.Now, based on the above scenario, use a realistic investment of a stock in stock market. Say, Company â€œABC Public Limitedâ€ is 15 year old company and is consistently achieving a net profit and increasing profits by 10% year on year. In the current year, the company realized PAT of $10,000,000. (PAT i.e. profit after tax). The above statement proved that the company is stable and improving its performance year on year.
Now, based on our calculations above, we can easily calculate the current business value of â€œABC Public Limitedâ€ by using the formula ($10,000,000 X 14.3) and it comes out to be $14,300,0000.
Now collect the facts from the stock exchange or other sources about the total public shares issued by this company over a period of time. Imagine that this company has raised money from the market by issuing 100,000 shares to public. I am assuming that it includes the promoters and preferential shares and convertible debentures.
Now, calculate the business value per share by dividing business value with total number of shares issued i.e. $14,300,000/100,000 = $1430 per share.
The example above illustrates the simplified way to find the current business value of a company and a stock. Actually, the stock price of a good consistent performing company can be more than this calculated business value per share or it could be less for a less consistent company.
The stock price of a company is not traded on the business value. In this example, it only forms a base for your calculations. It depends on a lot of other important factors like its business type, promoterâ€™s profile, sector or industry the company is associated with, its growth potential, its dividend yield, government directed macro-economic indicators etc and many more such factors.
Determine Fair Market Value as a function of Business Value
You have to consider PE ratio before you opt to buy a stock and determine its fair stock price. All those factors mentioned above affect the PE (Price Earning) multiples of a share. Every industry or business sector in a market enjoy a certain range of PE multiples. What this means is that if a stock is trading at $100 while having its business value of $25 enjoys PE of 4; a ratio of trading price and business values of 1 of its share. Alternatively it says the amount of trust traders throws behind a particular stock. This can vary for consistent and non-consistent companies. Consistent and companies with strong balance sheet may attract more PE than the non-consistent companies. The actual stock price of the company therefore depends on the perception of the company and its market growth potential. But yes, you could safely imagine 1 PE as business value per share.
For example and more clarity, say IT industry is given 18 PE typically in Indian stock market. Then, if â€œABC Public Limitedâ€ is a company operating purely in IT industry, listing in India will fetch the company a market value of $1430*18 = $25740 per share. Most likely, the companyâ€™s stocks will be evaluated and traded on the said price.
Determine Right Stock Price
With the above price discovery methodology, you can trust yourself and just not blindly follow the expert advice or daily tips on investment. Please do understand that the price ponit thay you have just discovered is analaogous to MRP of a stock i.e. it is a selling price. Now, if you want a profit of 30% over a period of time, wait for the price to dip, so that you buy it at a discount. Suppose, you want to invest in a stock for 2 years and you want 50% ROI. Your estimate is that the stock will grow 10% per year. Then, you have to wait for prices to come down at a discount of 30% from current market price.
It is also needed to understand that all these calculations and advises are to be used for long term investment only. This shall not be used for trading purposes because trading follows trends and not the value. With long term investment, I mean it could be anywhere between 2-5 years.
Assumptions and Caution
Small and medium investors are more risk prone when they buy some stock at wrong entry price since they have low risk appetite and lack of advisers. Although, the calculations demonstrated above are good enough and is based on logic, facts and market condition, you may not end up getting your prices for the stocks you wanted. In these situations, buying stocks at right price require a lot of patience to let the prices dive down to your level of comfort. Also, remember that investment in stocks is not about haste. There will be lots of buying opportunities coming your way, if you research in the stocks of your interest in advance. Right price to buy a stock is different for people with different risk profile. People with low risk profile need to be more patient than people with higher risk profile. Just keep your buying prices ready and liquidity available. Then wait patiently for your price and keep monitoring the market. Also make sure that you have a selling price in your mind and take profits partially or wholly when it is available. Remember, selling is as important as buying. If you do not sell, you will never realize your profits.