Fair Value of a common heritage

A lot of discussions have been devoted towards finding fair value of an investment. The goal of every investor is to find undervalued investment and sell when it reaches fair value. Of course, this is the hardest part of investing. So, what is the fair value? The fair value is a point where the price of an investment reflects its earning power.

The fair value is relative and depends on other factors beyond the control of investors. Here, we discuss the calculation of fair value within our own border control. In short, the calculation of the fair value of an investment depends on the expected rate of return and the risk taken to achieve that return. A higher risk requires higher reward. It's pretty simple.

So, what capital investments are low risk? We can only compare. The first thing that comes out of my mind is Certificate of Deposit (CDs). You are guaranteed certain return (interest rate), if you can hold for a certain pre-determined period of time. You would never lose the principal at the end of time.

The next investment is a low-risk Treasury Bond. This is a bond issued by the U.S. government, which is believed to be the safest in the world. There are certain risks associated with fluctuations smaller the share price. However, if you hold the bond until maturity, you are guaranteed certain rate of return. Your rate of return depends to some extent on the price you bought the bond.

The next higher investment risk is to purchase ordinary shares. This is what we are going to focus more here. It 's considered a greater risk than the two previously mentioned types of investments because it has a higher probability of losing money on your investments. Previously, we determined that a higher risk requires higher reward. Therefore, the equity investment requires a greater reward.

So, what does this have to do with fair value? Quite simply, the price of a common heritage that gives us is to purchase a higher annual return than bonds or CDs. For example, if a CD gives you a yield of 3%, Treasury will give you a 4% return, then you would want your stock gives you a higher return of perhaps 6%.

What does it mean for a stock to give the investor a yield of 6%? It's never really say, is not it? You are partly right. Although not explicitly stated, you can do some 'digging and find out what the return on equity investment would be. For example, if the Certificate of Deposit (CD) gives you a yield of 2% per annum for a $ 100 investment, you earn $ 2 every year. Suppose you want your stock to give a yield of 6%, which is higher than CD or Treasury bonds. This means for every $ 100 invested in common stocks, they need to give us a return of $ 6 per year.

Where can we find this information? You can get on Yahoo! Finance or other financial publications. All we have to do is find the price of the shares of a common heritage and the profit per share (also known as earnings per share) of that particular action. We use an example to illustrate my point. Magna International Inc. (MGA) is expected to record a profit of $ 6.95 per share for fiscal year 2005. Recently, the share is trading at $ 73.00. The annual return of buying Magna shares is therefore $ 6.95 divided by the share price of $ 73.00. This gives us a yield of 9.5%.

Magna will continue to give investors a yield of 9.5% year after year? It depends. If the stock price rises, Magna will return less than 9.5% per annum. What else? Well, Magna may not consistently produce the same amount of years of profit after year. It could also cause a loss! So you see, the equity investment is inherently risky because there are two moving parts in the equation. Price of ordinary shares and profits of the company. This is why investors need to aim for a higher return when choosing their equity investment.

All right. Then, we move on to something important to invest in common stocks. What is the fair value of Magna shares assuming a constant gain of $ 6.95 per share? Personally, assign the fair value of a common heritage to be at least 2% above the rate of Treasury bonds. Please note that I'm using the constraint 10 years here. Recently, Treasury Bond can give us a return of 4%. Therefore, the fair value of Magna common stock is when I can give a yield of 6%

So, what is the fair value of Magna common stock in this case? For a profit of $ 6.95 per share, the fair value of Magna common stock is $ 115.80 per share. That's right. A $ 115.80 per share, Magna common stock investors will return 6% annually. That said, we should never buy a common title at fair value. Why? Because our goal is to invest to make money. If we buy shares at fair value, then when we profit from it? We expect to sell when it is overvalued? Sure, it would be nice if we can do it all the time. But to be conservative, let's not bank on our escorts to reach the level overrated.

There you go. I explained how to calculate the fair value in a common stock. Of course, the profit margin of $ 6.95 per share is the expectation of profit compiled by Yahoo! Finance. It is in no way constitutes an endorsement of Magna to buy common shares. You should do the calculation to see that very issue .......