The Best At The Price

THE BEST AT THE PRICE Prepared By: Rajan Thakur

CONTENT The article tries to explain the valuation of stocks. • Paul Samuelson • John Burr Williams: The Theory of Investment Value • Benjamin Graham

INTRODUCTION • • • •

How is the market? Is that stock still a buy? When should I sell? Paul Samuelson and his cohorts say that stocks will sell for what they are worth. But this assumption is vulnerable • Because it holds only when a sizable number of investors, with big sums at play, know how to value stocks correctly. • Most of the time, stocks are priced close to what they are worth.

John Burr Williams The Theory of Investment Value

• Published In 1938, the most rigorous and influential method for determining intrinsic value • Investors are never convinced that they are at their fair value. They always looked for a better price.* • Williams suggest that investors should calculate the value of future flow of dividends instead of hoping somebody to buy the stock for higher price.

John Burr Williams The Theory of Investment Value • Ordinary financial formulas could be used to calculate the value of common stock by discounting the future stream of D dividends. • The formula is :k − g • D: Dividend • k: Expected Return • g: Growth Rate

Explanations about the formula • A stock was worth the present value of its future stream of dividends. • Infinite dividend stream* • k: the available return on alternative and less risky assets + uncertainty • Williams' formula works as long as the interest rate is equal or greater than the rate of growth. Otherwise, the value becomes infinitely large.

What Williams' Formula Implies • The less the difference between an investor's target return and dividend growth, the greater the stock value.

• Growth stocks are riskier than companies with less exciting prospects. • A Foggy Cash Flow. Most corporations do not make financial projections that extend more than three to five years. Even one year projections are inaccurate.

• Another problem with stock value theory is that the idea was borrowed from bond and annuity formulas • Microsoft • Two Insurmountable Barriers: • the future is unknowable • and the company is not obligated to pay anything to stock investors, even if the business is profitable.

John Graham: Security Analysis and Value Investing • 2 books: “Security Analysis(1934)” and “The intelligent Investor(1949)” • He admitted that intrinsic value is not necessarily a hard fact. • It is elusive and an approximate value would be enough. • Intrinsic value: the value justified by the facts, e.g. the assets, earnings, dividends, definite prospects.*

• Graham didn’t seek to determine exactly the intinsic value of a given security. • He determined a set of rules.

Principles of Graham: • Principle No. 1: Always Invest With a Margin of Safety. • Margin of Safety: A principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value.

• Intrinsic Value: The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors.

• To Graham, big corporation assets may have been valuable because of their stable earning power or simply because of their liquid cash value. • Principle No. 2: Expect Volatility and Profit From It • You should only buy when the price offered makes sense and sell when the price becomes too high.

• Principle No. 3: Know What Kind of Investor You Are Active Vs. Passive Investor Work=Return

Other Principles of Graham 1. Opt for Big Companies with Strong Sales 2. Choose Companies that are Paying Dividends 3. Seek Out Companies That Are in Strong Financial Shape 4. Seek Companies with Sustainable Earnings Growth

1. Know the business 2. Know who runs the business 3. Invest for profits 4. Have confidence