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  1. #1
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    Default Young fullah on board

    Hey team,

    I'm a young student doing engineering up in Auckland (20 years old, two years down and 2 more to go!) and I've recently become interested in investing. I have a mere couple thousand I've been saving over the course of the summer doing my engineering internship so rather than being ready to invest I'm more looking to build knowledge of how the market works, reacts and changes so I can start to make some decisions on where to put my money for a more comfortable future.

    I've been looking around the site daily to follow some stocks and keep updated with how they're moving until I finally made an account in the hopes to start asking questions and further build some know how. I haven't formally learnt anything to do with business, economics or accounting (didn't even take a year of any at school) but I like to think I'm relatively clued up and find maths simple enough (I've done enough in school and engineering to become relatively comfortable with it). I started reading Ben Graham's intelligent investor which seems to be a highly recommended book around here in terms of the emotional side behind investing and I'm quickly getting knees deep into that.

    So with that info out of the way I have a couple of questions that may have some elaborate answers

    - If the share price is fundamentally controlled by the bidding of investors, why (theoretically) should the share price change to converge with the theoretical value of the share? Especially if dividends don't come into that equation

    - How would one start to get a good idea of valuing a company?

    - is a couple grand too small to start in the market? I understand that brokerage will kill my earnings unless the stock really jumps up but is there anything I may be missing in the venture to build up on my small capital?

    With those questions I hope I haven't sounded to mislead on the market situation but aside from that, happy to be here and hope I learn a bunch

    Cheers
    Sam

  2. #2
    born2invest
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    - If the share price is fundamentally controlled by the bidding of investors, why (theoretically) should the share price change to converge with the theoretical value of the share? Especially if dividends don't come into that equation
    If you read further into the Intelligent Investor you will answer you own question. Over the short term, the share price can swing wildly away from the "true" value of the business. Over the long term the share price will roughly follow the growing or declining value of the business.

    This happens because short term the price is controlled by everyday people like you and me buying the shares. Perhaps I have to sell my shares to buy a new car and need to sell $5000 of the stock. I need the money today and not tomorrow or in a few weeks time when the price might be better. Therefore, if someone is only willing to buy the stock today for 2-3% less than the current price, I have to sell to them if I want to sell them today. Hence these wild swings for no apparent reason. Or perhaps there is a recession and the whole stock market is declining. I get nervous because I don't want to lose any more money, so I sell regardless of the price because I just want out today. Or on the other hand, if investing in a hot popular growth company is a sure thing and it is going to make me rich quick, I'll buy today for what ever price, because I got a hot tip from the NZ Herald that the stock price is going to go up 50% this year.

    Over the longer term the price follows the value of the company because say something that was making $10 million profit in 2004, I may pay $100-150 million for the whole company. If in 2014 the company makes $100 million, I would pay $1-1.5 billion for the whole company. So over the long term it seems to follow it.

    - How would one start to get a good idea of valuing a company?
    There are several business like ways to value a business that someone could look into. There are other ways that I cannot understand how to value a business (such as how to value a company like Xero which doesn't make a profit, I stay clear of these companies because I cannot understand how to value them).

    The business like methods are:

    - Liquidation value/book value
    This is where you add up all the assets and minus the liabilities and get a figure. Take for example a house. The house costs $500,000. I have a mortgage of $400,000. The liquidation/book value (net worth) of the company/house is $100,000

    - Discounted cash flow
    This is where you estimate how much "cashflow" the business will provide over its useful life and discount it back to the present value. This sounds a bit complicated, but once you read up on it (a Google search or look through Investopedia will explain) then you can value this back. This uses the simple fact that people would be better off taking $100 today rather than $100 next year as inflation makes $100 next year less worthwhile.

    - Discount dividend model/gordon growth
    I personally use this method to value companies. It is similar to discounted cashflow but uses the dividends that the company pays out. A search on this in Google will provide more info also.

    I suggest getting a book on pure company valuation (which will be very accounting based) to understand these better.

    - is a couple grand too small to start in the market? I understand that brokerage will kill my earnings unless the stock really jumps up but is there anything I may be missing in the venture to build up on my small capital?
    If you have $2000, the brokerage to buy is $30 which is 1.5% of the purchase price. You won't get rich investing $2000 but the skills you will learn from being in the market will be invaluable. I pretend traded a virtual portfolio for 6-12 months before I bought my first share but it wasn't until I had money on the line that I learnt valuable skills that have allowed me to make good returns over the past few years. I'm 25 and I bought my first share around 4 years ago and the lessons I learnt from that first share purchase was the best lesson I ever learned. I found I could only learn so much from reading a book, it wasn't until I put things into action, made mistakes and learnt from them that I begun to get better.

    I wouldn't rush in and buy anything but I would look to buy not only to make money but to learn also.

    With those questions I hope I haven't sounded to mislead on the market situation but aside from that, happy to be here and hope I learn a bunch
    Hope the answers help too.
    Last edited by born2invest; 10-01-2014 at 02:20 PM.

  3. #3
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    cheers for the reply born, heading away for the weekend the minute I leave work so I'll try get more into the intelligent investor in the down time and research some of those models you mentioned

    I also had that mindset with the money I've earnt that it is money that I won't need over the year at uni and it will probably be a great learning curve through the process of researching companies and making an informed decision rather than just chucking 2 grand on a stock and hoping it goes through the roof from hype.

  4. #4
    born2invest
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    Quote Originally Posted by samdaman View Post
    cheers for the reply born, heading away for the weekend the minute I leave work so I'll try get more into the intelligent investor in the down time and research some of those models you mentioned

    I also had that mindset with the money I've earnt that it is money that I won't need over the year at uni and it will probably be a great learning curve through the process of researching companies and making an informed decision rather than just chucking 2 grand on a stock and hoping it goes through the roof from hype.
    A good place to start looking for a good business to invest into would be ones you are familiar with. By that I mean that you shop there or use their services, the head office is just down the road, you have worked there, know someone who works there, you understand it with your engineering background, etc.

    An example is that I work in logistics and supply chain. I therefore think I can understand those businesses better than the average person that isn't involved in the industry as I can see trends with companies before the results show up in their annual report. E.g. I can see Mainfreight (MFT on the NZX) and Toll (TOL on the ASX) trucks come in and out everyday and speak with their employees on a daily basis.

  5. #5
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    ok so I'm back from the weekend away and a few questions have arisen.

    First one is about the value of a company, I still don't see the reason why a share price would NEED to converge around a companies value? Is it just something I'll have to accept which is caused by investors or is it due to the idea that the company could try to buy back shares at the value of a company which in turn would cause that convergence towards the real value? That or other ideas along that line or am I just making things up?

    With the models listed above how would one go about finding and calculating these figures. I had a read over each of them and get the vague idea, however without some numbers and values I feel like I can't understand these models fully.

    cheers again for the help, I appreciate all I can get

  6. #6
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    Quote Originally Posted by samdaman View Post
    First one is about the value of a company, I still don't see the reason why a share price would NEED to converge around a companies value? Is it just something I'll have to accept which is caused by investors or is it due to the idea that the company could try to buy back shares at the value of a company which in turn would cause that convergence towards the real value? That or other ideas along that line or am I just making things up?
    Lets assume there is only one true value for a company (everyone has their own opinion so this isn't the case). If it is selling below this, everyone will buy up to the true value. If it is selling above this, then current holders will sell down their holding till it reaches this value.

    At a particular point in time, it is hard to say what the true value is, but over time, the market concensus should get it about right.

    Think of an easy example that has a true value - how much would you pay for NZ$1? What would you do if you could buy for 90c or if you could sell your current holding for 110cents?

  7. #7
    born2invest
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    First one is about the value of a company, I still don't see the reason why a share price would NEED to converge around a companies value? Is it just something I'll have to accept which is caused by investors or is it due to the idea that the company could try to buy back shares at the value of a company which in turn would cause that convergence towards the real value? That or other ideas along that line or am I just making things up?
    It doesn't need to stick to it's "true value" at all. Lots of companies remain expensive or cheap for decades. Because "tru value" is just one persons opinion, you and me could use the same valuation method, but because we input different figures for growth in EPS, dividend payout ratios, return on equity, risk free rates, etc we could come up with different figures. There is really not "true value" for any investment, it is only that one persons opinion of how much the investment is worth to them as an individual.

    But generally, they hover around and over the long term tend to follow the price of the business. If it didn't and remained very cheap, people would see this and buy the company, forcing the share price upwards towards.. it's "true value". Also if it was too expensive, people would recognise this and the price would decline to meet... it's "true value". Do you understand this?

    With the models listed above how would one go about finding and calculating these figures. I had a read over each of them and get the vague idea, however without some numbers and values I feel like I can't understand these models fully.
    Google discounted dividend excel. This is the Microsoft Excel spreadsheet that it will refer to. Look up any company, say Port of Tauranga. From it's annual reports over the past few years you can get the EPS each year and the growth year on year. How much dividends it pays out, it's return on equity, etc. From there, you can put a spreadsheet together to value this.

    It is hard to explain through a few short sentances. I highly recommend you go to the university library or the public library in town and type in the search engine "business valuation" and there will be whole books dedicated to these valuation methods.

    I use a pretty basic excel spreadsheet to put together my valuations for discount dividend models. I've copied across my valuation for Port of Tauranga below. I've assumed a 7 year timeframe (Google Juglar cycle on why I use 7 years), I've assumed 6% growth in EPS over those 7 years. I've asumed 55% dividend payout ratio will remain and I've assumed at the end of 7 years, a P/E ratio of 17 is reasonable. I want to achieve a 15% return after tax on my share investments, otherwise I keep my money in an online savings account and be patient. My calculations are below. As you can see, the price I want to buy at or below is $9.74. The current stock price is $13.73 so obviously I'm not buying any shares at the moment.
    17
    1.15
    1.06
    year eps div price+div price sum div compounding
    0 83.60 45.98 1467.18 1421.20 45.98 974.00 1 11.65
    1 88.62 48.74 1601.19 1506.47 94.72 1120.10 1
    2 93.93 51.66 1743.24 1596.86 146.38 1288.12 1
    3 99.57 54.76 1893.82 1692.67 201.14 1481.33 1
    4 105.54 58.05 2053.43 1794.23 259.19 1703.53 1
    5 111.88 61.53 2222.61 1901.89 320.73 1959.06 1
    6 118.59 65.22 2401.95 2016.00 385.95 2252.92 1
    7 125.70 69.14 2592.04 2136.96 455.09 2590.86 1
    8 133.25 73.29 2793.55 2265.18 528.37 2979.49 FALSE
    9 141.24 77.68 3007.14 2401.09 606.05 3426.41 FALSE
    10 149.71 82.34 3233.55 2545.15 688.40 3940.37 FALSE
    Buy below
    $9.74

    11.65 PE



  8. #8
    born2invest
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    Quote Originally Posted by Harvey Specter View Post
    Think of an easy example that has a true value - how much would you pay for NZ$1? What would you do if you could buy for 90c or if you could sell your current holding for 110cents?
    Excellent example.

  9. #9
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    thanks harvey and born, both posts very helpful.

    What you've both cleared up for me is that by no real reason should a share price actually converge to a theoretical value. It was just boggling my brain that the only reason it would move is because of investors expectations that a share would move up. I'm used to buying things that have a use whereas I find it hard to believe that a company that doesn't pay dividends could be appealing beyond "it may move up one day", really shows I've got lots to learn.

    I'm checking out some spreadsheets at the moment, but it might take me some time to figure these things out, wowzas it was confusing.

    thanks again though this has given me a solid base to continue further learning

  10. #10
    born2invest
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    Quote Originally Posted by samdaman View Post
    thanks harvey and born, both posts very helpful.

    What you've both cleared up for me is that by no real reason should a share price actually converge to a theoretical value. It was just boggling my brain that the only reason it would move is because of investors expectations that a share would move up. I'm used to buying things that have a use whereas I find it hard to believe that a company that doesn't pay dividends could be appealing beyond "it may move up one day", really shows I've got lots to learn.

    I'm checking out some spreadsheets at the moment, but it might take me some time to figure these things out, wowzas it was confusing.

    thanks again though this has given me a solid base to continue further learning
    Companies choose not to pay dividends for all sorts of reasons. Generally they boil down to two main reasons though.

    - First is the company is growing or thinks the shareholders will benefit more from keeping the money and investing it for the shareholder. If the company is making 20% return on its capital, I would much prefer them to keep the money and invest it for me at 20% than them to pay it out to me so I can keep it in a savings account earning 3% interest.

    - Second is the company isn't doing too well and can't afford to pay dividends because they are losing money every year and need the money so they don't go bankrupt

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