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Vital Signs of Healthy Stocks (Part 2)

24 October 2007 - Features - Editor

Vital Signs of Healthy Stocks (Part 1)

All companies swing between earnings and growth at various points of their respective cycles. RVD depends on 2 valuation disciplines: RDY or Relative Dividend Yield and RPSR or Relative Price to Sales Ratio. RDY measures dividend yield in comparison to the market, while RPSR facilitates finding the best stocks in a sector. Overall, RVD has better chances of locating stocks with superior potentials than the conventional focus on dividends in isolation.

Pre-occupation with the price to book value ratio is another drawback in modern investment decisions for stocks. Companies have options with respect to accounting for their assets and profits, which make inter-firm comparisons skewed. The situation is aggravated in cases of global stocks because accounting requirements vary so much across countries. Most trans-national corporations have internal management accounting systems for business decisions, but small investors are not privy to such sensitive information. These are some of the reasons for the most consistently successful investors choosing new paradigms for selecting and investing in stocks.

Classics in Evaluating Stocks

The best investors may not be forthcoming about their trading secrets, but professionals in the field adhere to some best practices for advising privileged clients, and for their personal portfolios as well. A great starting point is the exit price of a stock where experts decide target prices at which they will sell before they buy important stocks. This approach sets a profit target and accounts for risks in some measure as well. However, access to business plans and the ability to analyze them are essential for success, for there is no other way to set exit prices for stocks.

A holistic view of valuation is another durable way of assessing stocks. The Discounted Cash Flow method, comparisons with similar companies, and option pricing models, are the three favorites of various investors, but the optimal approach is to review investment decisions based on all these 3 parameters.

Exit price fixation and valuation methods are specific approaches to investment decisions regarding stocks, but it is also necessary to adopt an appropriate philosophy towards creating sustainable wealth through instruments of securities. Taking spot decisions on emotional impulses and extrapolating past trends in to infinity are two common and serious errors of judgment which can cause significant losses in real portfolio values. There are no substitutes for cold calculation, objective analyses, and intelligently discerning major discontinuities in time.

Vital Signs of Healthy Stocks (Part 1)

 



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