Investment Basics II



*S T O C K F U N D A M E N T A L A N A L Y S T*	STOCK	FUNDAMENTAL	ANALYST

Y o u r I n v e s t m e n t B e g i n s W i t h F u n d a m e n t a l s !

The
Basic
Fundamentals
Start
HERE!

Investment Basics Part II

Fair Valuation

Although you may find a company of interest and are looking at placing your investment into the company found, you may have uncovered a company that has some significant value upside compared to current share price the market has placed on it. This may only be half of the story at this stage.

You can not simply go and pay whatever the market has valued this company until you have at least calculated what it's worth. By buying on market you might end up holding the shares for many more years than necessary in order to receive a decent return from your investment. At times you may also never realise a return at all.

Price does matter! Why would you consider paying 10 times earnings for a stock growing 5% or 10% a year. It may take an extremely long time for this company to generate enough wealth for you to realise a return. As a rule of thumb, the greatest criteria of a company's return in a portfolio is the price the investor paid for the stock. It is also as important to understand the quality of the investment and the company's growth moving forward within the timeline.

So it is of the utmost importance that the investor pays a fair price for the company's shares. An investor is in the business of realising profit and greater growth of the investment, buying shares with a low valuation is better than buying at premium or inflated prices, due to uncertainties in the future and by entering at the lowest valuation the investment is allowed more room for error and a better upside value on good results by the company invested in.

Safety Margin

Maybe you discovered a good investment and you think your stock valuation achieved is well worth the investment, it is absolutely imperative to realise a buy at a discount to its fair value. This in turn gives the investor adequate margin for safety and a buffer for error. There are no means of fool proofing future projections, and protecting your investment from negative events is very important and should be considered as part of any analysis should events not materialise as expected.

Companies in general share different risks. Predicting this risk is extremely difficult specially on a new floated public company, so understanding this risk factor and as the risk increases so should the margin for error be relatively increased in process. Being disciplined and conservative in calculating a fair value of a company enables that margin of risk and a buffer for error to be comfortable enough in times of volatility and uncertainty.

This is all speculative of course and understanding this speculation of the share market will ultimately render a new investor into becoming a better investor by always allowing a higher margin for error. This ultimately means spending a lot of time valuing a stock before even contemplating buying in and most importantly only buy shares that you have confidently found to be undervalued. Valuing a stock is a dedicated task not to be taken lightly, with good analysis, valuation and an intimate understanding of the sector profits and growth can be realised.

One such means of a safety margin is the use of company options, where the investment outlay for now is greatly reduced and deferred to another time frame. This buffer in investment creates reduced risk factor unlike the shares themselves. It also creates an opportunity of leverage as more shares are purchased but not yet paid for until such a time as options near expiry. Meantime as the share appreciates so does the options normally. If in doubt and unsure, options provide a second point of entry into the market at a much reduced capital hence reducing the potential risk.

First Step

Before even considering the investment itself, first and foremost look at the annual report. We must begin an intimate understanding of the company we are to invest in not forgetting the sector in question and the possible ranking the company has earned within that sector. The more we understand of the company, the more we are likely to make a sound decision.

There are also different means of entry into a company for investment. One such entry is through options if offered. Options provide a means of entry unlike the shares themselves. By using options as an entry point into an investment, you create a leverage to your advantage in most cases due to the options being valued lower than the stock itself. This enables the investor to purchase more of the stock through options which in turn is deferred to a future date. The ideal investment is one that consistently generates revenue and requires little to no further injection of capital. Easier said than done, but an established company for many years with consistent income revenues and dividend payouts to investors are thought to be ideal.

Within the investment, the more capital that must be injected in order to generate the same revenues will ultimately cause dilution of the company shares and result in lower share price and dwindling returns. Each additional funds raised through the issues of shares is normally considered as lesser return for the investor over a long period of time. On the other hand some companies have a barrier built-in due to the nature of the business and their economics, the raising of capital is attractive for the shareholder because it means a better return as well. A wise investment is where the initial outlay for say 1 Dollar of capital is in fact returning better than 1 Dollar consistently. So the entry point is crucial in order to realise the effectiveness of the initial investment.

Another side of the investment strategy is support. Support the company you are invested in by becoming part of that investment. You could easily become a customer of that company you are invested in by using their products or services and help grow that investment by being part of that growth. Ultimately this helps your investment grow as you may well see that investment already discounted to your benefit as a consumer.

The Strategy

Each individual investor has a strategy in mind and a plan to grow wealth from an investment. This strategy coupled with a plan normally associates with a timeline. Let's face it stocks do not continue to appreciate in value till infinity. The investor needs to also realise their own timeline referenced to the company invested in. A company's ability to generate high returns on capital are considered good investments, but what happens when competition springs into the equation? This competition may well become the next investment, so an investor also needs to be aware of the competition as this competition is likely to cut short an investment strategy planned from day one.

This is where fundamentals play a bigger part in the investment. New companies springing on market are not necessarily good investments. There is no history to tie with performance and the risk is unknown although due to the unknown risk an investor is more likely to place a high risk value on that investment. Comparatively, the competition should now also be investigated for it's worth and the nature of competitiveness it brings into the market. This may be a new product or service that may be seen by the public at large as being of better value that the other company we are invested in. This now creates a renewed risk factor into our investment that was never there before.

Understanding this renewed risk factor and taking the necessary steps to minimise its impact on the investment now becomes crucial and part of the fundamental analysis undertaken to gauge the impact on the company compared to previous historical time frames.