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Home | Getting Started | Personal Finance | Q & A | Sample Portfolio | Glossary | About Us |
| Date: Tuesday 16th 2010f March 2010 07:08:37 AM |
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Q & A - Fair Value For A Stock - 03/19/2009 |
| By: Hari Wibowo |
| Name: UDEME |
| Website: N/A |
| Date posted: Thur, March 19, 2009 |
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Question:
how do i
arrive at a fair value for a stock, and how do i apply DCF to arrive at the fair value of a stock. |
| Answer: |
| To calculate fair value, we need to compare our stock yield with the rate of return of 10 year treasury bond (currently yielding 2.79% ). Taking some risk with our stock investment, we would want our stock to yield higher than the 10 year treasury bond. The higher generally is the better. However, investors will find less stocks that match this criteria. For example, we have decided to draw a threshold of 3% above 10 year treasury yield as our cut off point. This means, stock needs to yield 2.79% + 3% = 5.79% to match our criteria. If we invert yield, we get what we normally call Price to Earning (P/E) ratio. For 5.79%, fair P/E value of a stock is 17.27. Thus, if a company is earning $ 1 per share year in and year out, the fair value of its share price is $ 17.27 per share in this case. |
| Our approach of deriving the fair value of a stock is a fairly simplistic method. We do not use DCF to account for a stock's future earning. As with bond that gives out constant coupon, we treat stock the same way. While this may sound like a careless approach in valuing stocks, we try to minimize the uncertainty by buying stocks at 50% below its fair value, instead of at fair value. That would take care of any inflationary impact or the change in treasury yield over the specific period. |
| Hari - Novice Investing |
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| Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding any securities. |
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