Yesterday's dog, tomorrow's darling
- Date: 2007-07-23 - Word Count: 463
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The market's expectations about a stock swing around much more wildly than its underlying value.
In the first instalment of this value investing series back in issue 197/Apr 06, we noted that 'for some, [value investing is] all about buying shares on low PERs; for others it's about buying tangible assets for less than their book value; while still others claim that a stock like Cochlear can offer value, despite a PER of 36 and a price to tangible book value of 9'. This prompted us to ask: 'What's the theory that can tie up all these loose ends?' Now, in the eighth instalment, we're finally going to attempt to answer that question.
The short answer is that value investing isn't about buying stocks on any particular PER or any particular price-to-book ratio, it's just about buying stocks for less than they're intrinsically worth, and PERs, price-to-book ratios, and all the other measures are just tools to help us find them. As we explain in this issue's cover story, the idea is not to come up with a precise valuation for every stock on the market; we just want some signposts to point us towards a few stocks that we're confident are priced well below their intrinsic value.
Before we can get started, though, we need to decide what overall rate of return we're going to target from our investments. For this, history is as good a starting point as any, and it shows that, over the whole of the 20th Century, Australian shares made an average return of 7.5% per year after inflation (a figure you can find on the consumer section of the ASIC website). We don't think it's unreasonable to expect something similar in future.
With inflation currently trotting along at about 3% a year, and expected to carry on that way judging by government bond yields, that gives us a target of 10.5%, but we'll round it off to 10% to keep things simple. Of course, we'll actually be hoping to do a bit better than this, by buying undervalued stocks, but this serves as our estimate of what we can generally expect the average stock to achieve.
On this basis, all other things being equal, we'd be looking for an earnings yield from a share investment of 10% or more, and that translates (by dividing 1 by the yield) into a PER of 10 or below (as we saw in issue 202/Jun 06). Alternatively, as we saw last issue, we'd be aiming for a stock's dividend yield plus its rate of dividend growth to add up to 10% or more. We'd then aim to check these figures off against a company's cash flow.
Visit The Intelligent Investor for the rest of this article on share market to find out more on investment information.
In the first instalment of this value investing series back in issue 197/Apr 06, we noted that 'for some, [value investing is] all about buying shares on low PERs; for others it's about buying tangible assets for less than their book value; while still others claim that a stock like Cochlear can offer value, despite a PER of 36 and a price to tangible book value of 9'. This prompted us to ask: 'What's the theory that can tie up all these loose ends?' Now, in the eighth instalment, we're finally going to attempt to answer that question.
The short answer is that value investing isn't about buying stocks on any particular PER or any particular price-to-book ratio, it's just about buying stocks for less than they're intrinsically worth, and PERs, price-to-book ratios, and all the other measures are just tools to help us find them. As we explain in this issue's cover story, the idea is not to come up with a precise valuation for every stock on the market; we just want some signposts to point us towards a few stocks that we're confident are priced well below their intrinsic value.
Before we can get started, though, we need to decide what overall rate of return we're going to target from our investments. For this, history is as good a starting point as any, and it shows that, over the whole of the 20th Century, Australian shares made an average return of 7.5% per year after inflation (a figure you can find on the consumer section of the ASIC website). We don't think it's unreasonable to expect something similar in future.
With inflation currently trotting along at about 3% a year, and expected to carry on that way judging by government bond yields, that gives us a target of 10.5%, but we'll round it off to 10% to keep things simple. Of course, we'll actually be hoping to do a bit better than this, by buying undervalued stocks, but this serves as our estimate of what we can generally expect the average stock to achieve.
On this basis, all other things being equal, we'd be looking for an earnings yield from a share investment of 10% or more, and that translates (by dividing 1 by the yield) into a PER of 10 or below (as we saw in issue 202/Jun 06). Alternatively, as we saw last issue, we'd be aiming for a stock's dividend yield plus its rate of dividend growth to add up to 10% or more. We'd then aim to check these figures off against a company's cash flow.
Visit The Intelligent Investor for the rest of this article on share market to find out more on investment information.
Related Tags: share trading, value investing, share dividends
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