Buy Cheap Sell Expensive.

Warren Buffet www.pigems.in

 

Stock market is the most popular investment principle. But how do you know when a stock is cheap?

Sutra: Compare a stock price with its actual value.

What is the difference between the stock price and its real value?


  •  At any time, the price that the market is willing to pay for the share is the share price. It changes frequently.

  • The value of a share means the business contained in it. It is stable and is associated with the functioning and fate of the company.

Buy when price is lower than price

Assuming the actual value of a share is Rs 150 and the market price is Rs 125, then you are getting this share for less than Rs 25. It is not a guarantee that the stock price will not go below 125.

How to find the share price?

First read the financial statement and understand the specifics of the stock. Warren Buffett can also use the tried method:
  • Look at the net liquid asset per share.

Net liquid asset per share = current asset (cash, debtors, liquid investment) - liabilities
Number of shares

Rule: Warren Buffet does not pay more than two-thirds of the price for any such share



  • Let us now look at the PE (valuation) growth ratio.

PE and Growth Ratio = Market Price / EPS
                                     Annual EPS growth

Annual EPS Growth = Current Year EPS - Previous Year EPS x 100
                                                           Last year's EPS

Rule: If the PE growth ratio is one, it indicates that the share is the true value. If it is less than one, the stock is undervalued. There is an overvalue if there is more than one.

PE: margin of safety indication

Suppose you buy a share for Rs 550, whose EPS is Rs 50. In a year you earn 50 rupees on an investment of 550 rupees. This is a return of around 9%.

Now you can earn 8-9% risk-free returns on bank deposits too. In this case the margin of safety is zero. If we want to keep the risk low, then the difference should be kept high.

Rule: Warren Buffet recommends that this difference should be 1.25–1.5 per cent.

Last word: In fast, investors pay more for every share. At that time the margin of safety is not met. It is good in recession.