Subscribe to RSS feed
posted on 17 Aug 2015  -  23,443 views
Recently, I read a book,
A Random Walk Down Wall Street by Burton G. Malkiel. In the book, he discussed two ways to valuate a stock - The firm-foundation theory and the castle-in-the-air theory.
The firm-foundation theory assumes that each stock has a true value which is equal to the
present value of all its future dividends. It is likely that you have heard something similar because this approach is somewhat similar to Warren Buffett's style of "buying securities whose prices are below the true value, and selling those with prices are above the true value".
Of course, the challenge is in determining the true value, which can be broken down into two parts.
1) Forecasting of future dividends of that stock, and
2) Estimating the (current and future) market interest rate.
The castle-in-the-air theory is also known as the "greater fool" theory. It does not matter how much you pay for any stock as long as you are able to find a "greater fool" who is willing to pay more for it. A story mentioned in the book is that stock investment is like entering a newspaper beauty-judging contest where one must vote for the prettiest face out of a hundred photos, and the prettiest face is determined by the largest number of votes. It is basically saying that the true value of a stock does not matter as much as its
perceived value by investors.
The way I translate these two theories to practical strategies to support my stock-buying decisions is as follows:
1) I favor stocks that are likely to have good future dividends (I will
forecast this using a simple approach until I find better and more reliable approaches).
2) I try to avoid being the "greater fool" by shunning all stocks with high P/E (using STI's P/E as a gauge).
- We should always use The firm-foundation theory.
15 Jun 2016 09:03:17
Next Article >
< Previous Article
How to retire?
A Simple Trend Analysis of Dividends
List All Articles
Other articles by evankoh
Portfolio Sharing 2.0
Initially, the portfolio sharing feature was added with the intention to allow SGXcafe users to easily share their portfolios on their own blogs as I saw many financial bloggers in Singapore sharing their well-crafted portfolios but in a technically-inefficient way (e.g. copy and paste from excel sheet to html). Interestingly, this feature is gaining popularity in SGXcafe itself, especially after the ...
Growing Dividends - Does Debt-to-equity Ratio and Operating Cashflow Matter?
I believe there are many investors like me who love to invest in companies that pay dividends. Naturally, we hope that companies we invest in would have growing dividends. So, the question is "How can we differentiate companies that will have growing dividends from others?" In an attempt to find an answer to this question, I will perform a series of analyses in this and upcoming articles. Today, I ...
Now Available: United States Stock Exchange Information!
After months of planning, sourcing, and coding, I am happy to announce that US data is now available in StocksCafe! It is not completely integrated yet, but some of the most popular features are already available. 1) Add to Portfolio or Watchlist: You can now add your US market transactions! You can also add US stocks to your watchlists. 2) Stock Page: Some basic information including dividends and ...