Subscribe to RSS feed
posted on 17 Aug 2015  -  4,342 views
Recently, I read a book,
A Random Walk Down Wall Street by Burton G. Malkiel. In the book, he discussed two ways to valuate a stock - The firm-foundation theory and the castle-in-the-air theory.
The firm-foundation theory assumes that each stock has a true value which is equal to the
present value of all its future dividends. It is likely that you have heard something similar because this approach is somewhat similar to Warren Buffett's style of "buying securities whose prices are below the true value, and selling those with prices are above the true value".
Of course, the challenge is in determining the true value, which can be broken down into two parts.
1) Forecasting of future dividends of that stock, and
2) Estimating the (current and future) market interest rate.
The castle-in-the-air theory is also known as the "greater fool" theory. It does not matter how much you pay for any stock as long as you are able to find a "greater fool" who is willing to pay more for it. A story mentioned in the book is that stock investment is like entering a newspaper beauty-judging contest where one must vote for the prettiest face out of a hundred photos, and the prettiest face is determined by the largest number of votes. It is basically saying that the true value of a stock does not matter as much as its
perceived value by investors.
The way I translate these two theories to practical strategies to support my stock-buying decisions is as follows:
1) I favor stocks that are likely to have good future dividends (I will
forecast this using a simple approach until I find better and more reliable approaches).
2) I try to avoid being the "greater fool" by shunning all stocks with high P/E (using STI's P/E as a gauge).
- We should always use The firm-foundation theory.
15 Jun 2016 09:03:17
Next Article >
< Previous Article
How to retire?
A Simple Trend Analysis of Dividends
List All Articles
Other articles by evankoh
SGXcafe in 2017
Review of 2016 2016 have been a year with its ups and downs for SGXcafe. At one point, it is faced with the possibility of shutting down. However, with the support of many users, it managed to march on. I truly appreciate each and every one of you for using SGXcafe especially those whom also contributed financially and/or by sharing about SGXcafe. Looking back at the articles of 2016, I realized we ...
The John Neff Screener
I regularly read articles from "The Motley Fool Singapore". One person that is frequently mentioned there is John Neff. "John Neff (born 1931) is one of the best known mutual fund investors of the past 40 years, notable for his contrarian and value investing styles as well as heading Vanguard's Windsor Fund. Windsor was the best performing mutual fund during his tenure and became the largest fund closing ...
What Can SGXcafe Do For You?
SGXcafe is constantly evolving, and as I continue to add features to SGXcafe, even I am starting to lose count of them. Therefore, I believe that many users - especially new users - might miss out on many features that SGXcafe offers. This article aims to record all the features available in SGXcafe, and this article will be updated as new features are added. I highly recommend for you to at least ...