Investing In The Stock Market | Catalyst A Partners.com Blogs

A lot of discussions have been devoted towards finding fair value of an investment. Fair value is relative and it depends on other factors beyond the investors? control. In here, we will discuss on calculating fair value within our own boundary of control. In short, calculating fair value of an investment depends on the rate of return expected and the risk taken to achieve that return. Higher risk needs higher reward. First thing that comes out of my mind is Certificate of Deposit (CD). You are guaranteed certain return (interest rate), if you can hold for a certain pre-determined time frame. You would never lose your principal at the end of the time frame.

There are certain risks associated with the small fluctuation in the bond price.

So, what does this have anything to do with fair value? Quite simply, the price of a common stock that we buy must gives us a higher annual return than bonds or CD.

Magna International Inc. (MGA) is expected to post a profit of $ 6.95 per share for fiscal year 2005. Will Magna continue to give investors a 9.5 % return year after year? It depends. If the stock price rises, Magna will return less than 9.5 % annually. What else? Well, Magna might not constantly produce the same amount of profit year after year. It might even produce a loss! So, you see, stock investing is inherently risky because there are two moving part in the equation.That is the reason why investor need to aim for higher return when choosing their stock investment.

Recently, treasury bond can give us a 4 % return. Therefore, the fair value of Magna common stock is when it can give me a return 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. At $ 115.80 per share, Magna common stock will return investors 6% annually. Having said that, we should never buy a common stock at fair value. Why? Because our investing purpose is to make money. If we buy stocks at fair value, then when do we profit from it? Do we expect to sell it when it is overvalued? Sure, it would be nice if we can do that all the time. But to be conservative, let?s not bank on our stocks reaching overvalued level.

It is not in any way an endorsement to buy Magna common stock. You should do your own calculation to verify that number. Get your investing idea for free at http://www.noviceinvesting.com . Just visit our commentary section regularly.

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Source: http://catalystapartners.com/blog/investing-in-the-stock-market/

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