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How to Value Stocks

Investing in Stock Market

Guidelines to Investing in Stock Market

•     Diversify , Diversify and Diversify.

•     Follow the "Dollar Cost Averaging"  technique.

•     Do not  follow the herd. Think for yourself.

•     Never over pay for any asset you acquire.

•     Invest in what you know.

How long it takes to double your money?

    Let us say, you get an annual return of 6%. Well, you may be thinking that 6% is a nice return. But it takes 12 years to double your money at that rate.

    The formula is this: Divide 72 with your rate of return. This gives the number of years to double your money.  At a return of 8% it takes only 9 years (72 divided by 8) to double your money.

    So a measly 2% difference makes a difference of 3 long years to double your money.

What is the Beta of a stock?

    The Beta of a stock is the volatility or "risky ness" of that stock. It indicated how widely the share price is swinging. This value can be obtained from a source such as the Yahoo! Finance.

 For mature and stable companies the beta would be close to 1. An example is the Wal-Mart stock with Beta less than 1 . On the other hand, It would be high for Internet and other high technology companies. The  online book seller Amazon (AMZN) has a beta of 2.6

    Higher the beta, higher the risk. To justify the extra risk, you should expect a higher return on that stock.

How much extra return would compensate the extra risk?

It is given by this formula:

Required Rate = 

 T-Bonds Rate + (S&P Returns - Treasury Bond Interest) * BETA

So the required rate of return for AMZN can be calculated as:

                                4.34 + (7 - 4.34) * 2.6 = 4.34 + 2.66 * 2.6 = 4.34 + 6.76

                                 or around 12%

So, as of December 2003, you should buy AMZN stock only if you believe that the stock is going to return you 12% annually.