Fundamentals of Share Investing
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Fundamentals of Share Investing

What you need to know before investing in shares
3.9 (25 ratings)
Instead of using a simple lifetime average, Udemy calculates a course's star rating by considering a number of different factors such as the number of ratings, the age of ratings, and the likelihood of fraudulent ratings.
1,265 students enrolled
Last updated 10/2016
English
Price: Free
Includes:
  • 1 hour on-demand video
  • Full lifetime access
  • Access on mobile and TV
  • Certificate of Completion
What Will I Learn?
  • be prepared to invest in shares
  • be able to apply various strategies in stock investing
  • be able to use various stock appraisal and analytical tools
  • be able to apply financial ratio analysis
View Curriculum
Requirements
  • have in mind your investment objectives
  • have in mind your investment horizon
  • have in mind your risk tolerance
Description

In this module, we will consider the following points that everyone needs to know before investing in shares:

  • What you need to know before investing - Your investment objectives, risk tolerance, investment horizon, investment strategies and types of financial products.
  • Strategies in stock investing
  • Stock Appraisal & Analytical Tools
  • Financial Ratio Analysis


Disclaimer:

This module aims to help you evaluate information. It will not involve any advice in stock selection. Any mention of industries, companies or reference to products is solely for the purpose of illustration and application of concepts. You should consult a licensed financial advisor before making a decision to invest in any products.

Who is the target audience?
  • anyone interested in share/stock investing
  • this course is not meant for those looking for share/stock recommendations
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Curriculum For This Course
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Fundamentals of share investing introduction
1 Lecture 00:53

This is the introduction for the "Fundamentals of Share Investing" conducted by the Institute for Financial Literacy, Singapore.

Fundamentals of share investing introduction
00:53
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What You Need To Know Before Investing
7 Lectures 16:22

Shares refer to the unit of ownership of a company. Companies usually issue shares to raise capital for themselves. Shares are mostly traded in in lots of 100 or 1000.

 There are broadly two classes of shares – ordinary or common shares and preference or preferred shares. In this guide, we use “shares” to refer to ordinary shares.

 A shareholder is usually entitled to a share of dividends that are declared and paid; has the right to attend and vote at general or extraordinary meetings as well as stand to gain in the growth prospects of the company.

 In the event of liquidation or default, investors of ordinary shares are ranked behind all creditors before they can receive any assets not already exhausted to pay creditors. As a result, investors can stand to lose all the money they have invested in the company and the loss can be unlimited in leveraged trading.

 

What are shares ?
01:23

Share prices are driven by economic and market conditions, as well as industry and company specific conditions.

Since they can rise and fall rapidly, you should construct a sufficiently diversified portfolio of assets and not be overly concentrated in a few types of shares or asset classes. Be prepared to stay invested for long periods and weather short-term fluctuations for potentially longer term gains.

Before you invest, do ensure that you have sufficient emergency savings to cover at least 3 to 6 months of your monthly expenses and some basic insurance coverage like term life insurance and MediShield Life.

Considerations when investing in shares
01:01

Investment objectives and goals differ from person to person and will affect the way you invest and the products you choose;

Evaluate the risk of every investment. The amount of risk to take is a personal decision. Decide on the amount you can invest and be clear of how much you can afford to lose. A young person without family commitments or a housing loan may be happy to invest in a higher risk instrument whereas a middle-age investor with a family and housing loan may feel more comfortable investing in ‘less risky’ instruments, for example a mixture of stocks and bonds.

How much time do you have to invest? Have clarity on short term and long term needs of your family.

Take note of the different investment strategies you can use to manage risk, and factors that affect your investment strategies.

Take note of the various asset classes and the major types of financial products you can choose to invest in. Choosing your investment option involves striking a balance of 3 things: Liquidity, Safety and Return.

You should then set your investment objectives to support your financial goals. And so, according to your financial goals, your investment objectives should fall into one of the three following categories: Security, Income or Growth.

If you have already reached your savings goals, your investment objective may be capital preservation – to protect what you have saved (i.e. security). You may then wish to consider bonds for your portfolio.

If you have retired and need to have easy access to your retirement savings, your investment objective may be to ensure high liquidity. Liquidity here refers to the ability to convert an investment to cash quickly. You may also want your capital to generate income. In this case, you may wish to consider bonds for your portfolio.

For instance, if you are young and have just started to build your retirement savings, your investment objective may be capital growth or accumulation. You would then wish to consider ordinary shares or equities for your portfolio


What you need to know before investing
03:18

The return from an investment usually consists of two components:

Income - An interest or dividend payment in cash. When expressed as a percentage of the purchase price, it is known as the yield.

Capital gain (or loss) - The appreciation (or depreciation) of the investment’s price.

The total return of an investment is the two components added, that is:

Total Return = Income + Capital Gain (Or Loss)

Income

Examples of income include interest you earn from a bank deposit, the coupon you receive from a bond, or the dividend payment from shares or unit trusts you hold.

Capital Gain or Loss

This is the gain or loss you make if you sell an asset at a higher or lower price than the price you originally paid when you bought it. 

Net Returns

You should account for transaction costs and charges when computing your net returns, as these eat into your returns. There could be sales charges, management fees, brokerage charges and other expenses depending on the types of products you buy. There could also be financing or borrowing costs if you buy a product using margin or leverage.

 At the end of the day, it is also important for you to distinguish between expected return and actual return. When you invest, you expect a particular level of return. However, the actual return may differ from the expected return. It is therefore important that you do not have unrealistic expectations. Take caution when arriving at your expected return on an investment: was it the result of informed analysis, a “tip” from a friend or a “hunch”?

Return on investment
02:33

Risks can be classified into two broad categories – market risk and specific risk. You should understand what they mean as they have important implications for how you can manage risk.

Market Risk

The risk that cannot be diversified away and is inherent in investing.

Caused by external factors out of the firm’s or industry’s control, e.g. changes in the economy, political and sociological environments, which affect the prices of all marketable investments.

Examples of market risk: Interest rates, inflation, decline in the entire stock market

Specific Risk

The risk that can be controlled and minimised by having a well-diversified portfolio which contains assets that are negatively or not correlated with each other.

Company strategies, management errors, new product developments and market innovations that impact on a company’s earnings potential can cause variability in the earnings of the firm.

Examples of specific risk: a bond issuer defaulting on interest or principal payments, or a company having lower-than-expected earnings thus affecting its share price.

Example: What are possible market risks and specific risks for a global airline share?

Market risks would include weak global stock markets. A general market downturn will adversely affect the airline share even if the airline is doing well.

A specific risk would be the loss of lucrative flight routes to the airline. The share may then be negatively affected even though the stock market in general is rising.

When deciding on the appropriate level of risk for you, consider the following:

What is your investment horizon? Simply remember this: Do not take the risk if you do not have the time to recover from your losses.

What is your risk tolerance? How much can I afford to lose?

Be extra prudent when investing your retirement savings. 

Investment instruments can be ranked by their risk-return profile, starting with instruments that have both low expected return and low risk (cash and deposits), and moving through to those with higher expected return but, correspondingly, higher risk (stocks and shares).

The risk-return trade-off has a practical implication on investing. It is usually the case for us to put our focus on returns when considering any investment. The question to ask yourself before committing to an investment that can give potentially higher return is: “Can I afford to lose a significant amount of money?”

On the other hand, if your concern is risk, you may feel that a product that is capital-guaranteed may be suitable for you. Again, be aware of the trade-off as such products may offer lower returns. Some may not be suitable to hedge against  inflation. You will also take a longer time to build up your savings. 

Risk return trade off
04:02

Your risk-return profile and investment horizon depend on the life stage you are in; Accumulation, Savings, Pre-Retirement, and Retirement Phases.

Accumulation Phase

If you are early in your career, your priorities are building emergency savings, getting some basic life and health insurance and probably saving for children’s education. As you are young and have a very long investment horizon with a growing stream of income, you should also start saving for your retirement. You should consider building up as much savings and investments now, subject to your risk appetite.

Savings Phase

In this second phase, you are in your mid-career stage. Your family is growing and your household expenses may be high. You may also be supporting your parents. Your investment horizon is getting shorter and while your expenses are high, you need to maintain focus on building up savings. With growing commitments and liabilities, it is even more important to assess the level of risk you can afford with your investments.

Pre-Retirement Phase

In this third phase, you are in your late career stage. At this point, you may want to preserve what you have saved by shifting more of your investments into those that are less risky. You may also want to consider investing in products that can generate a flow of income for you.

Retirement Phase

If you are retired, you need to monitor how much you withdraw from your retirement savings for your expenses. You can still continue to undertake low-risk, income-generating investments, but be mindful of hedging against inflation.

Life stages and investment horizon
02:29

There are several asset classes that people can invest in.

Shares, bonds, real estate investment trusts (REITS), and exchange traded funds (ETFs) are all listed on the stock exchange and you can buy them through your stockbroker. Unit trusts can be bought through a bank or online channel. 

All these are different asset classes and should be analysed differently.

Asset allocation is the process of deciding the proportion of your investment portfolio to be invested in the different asset classes like bonds, shares/equities, ETFs, REITs and unit trusts. The aim is to achieve diversification and ultimately your desired balance of risk and return.

Next, within each asset class, i.e. bonds, equities, you might want to decide on regional or country exposure.

Then within each region/country, decide on the industry (industry allocation) and finally decide on the best stock (security allocation).

This is just one example of how to decide on asset allocation

Approaches to investing
01:36
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Strategies In Stock Investing
4 Lectures 07:18

Investors buy shares in the expectation that the share price will rise. Some may also buy shares as a hedge against inflation or for dividend income.

Shareholders earn returns when they receive dividends and if they decide to sell their shares when the price of the shares has gained in value. Dividends are paid out of the company’s profits. It is possible that not all the profits will be distributed. Companies may choose to re-invest profits generated from their operations into their business. A company’s share price reflects, amongst others, its growth prospects and future earning potential. 

Why invest in shares
00:46

Open a CDP Account. CDP acts as your custodian that facilitates the payments and depository services both in the shares market and of fixed income assets i.e bonds.

Open a brokerage account with a Brokerage firm. A brokerage account allows you to buy and sell shares,

either through online trading or making phone calls to Dealer/Remisier. Brokers will charge a commission fee each time you buy or sell shares

Fill in the required forms, choosing the desired form of payment for settling of trades.

Shares are traded on a stock exchange. Other products like bonds and ETFs are also listed on SGX

Getting started
00:52

When assessing the price performance of the stock you are tracking, it is useful to have something to benchmark against.

Stock indexes give a rough gauge of how the entire stock market is faring so you can get a sense of market sentiment and how your shares are doing relative to other shares. In other words, stock indexes act as proxies to help us judge the performance of the overall market. There are several ways that indexes are calculated. 

An example of a Price-Weighted Index is the Dow Jones Industrial Average (DJIA). The DJIA value is the sum of the prices of the 30 stocks included in it divided by a divisor. The purpose of the divisor is to adjust for any stock splits, company changes or other events that have occurred over time. The disadvantage of this index is that higher-priced stocks tend to affect the index more than lower-priced stocks.

An example of a Value-Weighted Index or market capitalisation weighted index is the Straits Times Index. This index is influenced by the value or market capitalisation of a company rather than its price. The market capitalisation is the market price of the stock multiplied by the number of shares outstanding.

Therefore, larger companies have a greater influence when it is part of a value-weighted index. The advantage of value-weighted index is that the index need not be retrospectively adjusted for stock splits. 

An Equal-Weighted Index assigns the same weights to all the underlying stocks regardless of the price or market value of the stocks. In other words, every stock on the index has an equal influence on the index value.

In the example, each stock is equally weighted at 33.3% of the index.


Stock market indexes
02:19

Here are some commonly used strategies when it comes to stock investing.

Active or passive.

Under active, strategies include:

  • growth and value
  • cyclical vs defensive


Passive Strategy -  The aim is to invest in high-quality stocks that offer attractive current income and/or capital appreciation and hold them for extended periods – perhaps as long as 10 to 15 years. Investing in index-tracking unit trusts or ETFs is an example of adopting a passive strategy. Passive investors perceive the market is efficient and that it is not possible to outperform the market through active stock selection and analysis. They adopt a buy and hold strategy for investments that they believe have the potential to produce good results over the long term.

Active Strategy - Active investors hope to outperform the market through active stock selection. They may use valuation models and are constantly analysing the economy, industry and individual companies. Active investors may search out investments with potential for growth or value. Some may also look for cyclical or defensive stocks. The rest of this module will focus on the active strategy. It will cover basic stock analysis for people who want to pick their own stocks. 

Growth managers seek above average earnings growth. They are willing to pay a higher price-earnings ratio for growth stocks. They believe that as long as the company continues to have a high earnings growth rate, the company’s share price will increase as well.

Value managers believe that there is a price to everything. A good stock is a “sell” at expensive valuations and a bad stock is a “buy” at cheap valuations. They are contrarian investors, selling when everyone is buying at sky high valuations, and buying when everyone is dumping stocks even at cheap valuations.

Cyclical vs Defensive

This refers to a class of stocks that is correlated to the economic cycle and is favoured by investors who want to integrate economic scenarios into their investment decisions. A cyclical stock is a stock that highly correlates to economic activity. When the economy is in recession, the profits of a cyclical company tend to drop and vice versa. For example, the airline industry will likely hit a downturn when there are less leisure and business travellers.

A defensive stock is a stock whose price has a very low correlation to economic activity, the earnings and cash flows of the company remains fairly stable; examples are telecommunications, healthcare and personal care stocks. 



Strategies In Stock Investing
03:21
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Stock Appraisal & Analytical Tools
4 Lectures 10:49

Fundamental analysis is the study of a company’s financial strength and the use of financial tools such as ratios, to identify risk levels, assess its value and potential for future growth. 

However, the numbers do not tell the whole story; it is just a starting point to help investors narrow down their search among the many viable stocks to a few preferred  ones. Fundamental analysis is more than just analysing the numbers, there are the non-financial aspects to consider such as the quality of management and industry competitiveness. Economic changes that can influence the numbers and trends they represent should also be considered.

Do also note that it is not enough to draw a conclusion by just looking at financial statements and reports because past performance does not reflect future performance. Also remember to consider your own personal risk preference before making a decision. 

Economic and Current Events

Includes background and forecast data related to economic, political and social trends on local and global scales

Industry and Company

Investors use such information to assess the outlook for a given industry or a specific company.

Information on Other Investment Choices

Includes background and forecast data on real estate, private equity or commodities.

Price Information

Includes price quotation on investment securities and recent price behaviour of the security. 

Information on Personal Investment Strategies

This information tends to be educational or analytical rather than descriptive.

To determine the value of a company, the following data are taken into consideration, Economic Analysis, Industry Analysis & Company Analysis

Stock prices are heavily influenced by the state of the economy and by economic events. Generally, stock prices tend to move up when the economy is strong and they move down when the economy starts to weaken. 

Economic analysis consists of a general study of the prevailing economic environment on a global and domestic basis. Such analysis is meant to help investors gain insight into the underlying conditions of the economy and the potential impact it might have on the behaviour of stock prices.

Leading indicators change direction in advance of turning points and are useful for forecasting. While they predict direction, leading indicators do not predict the magnitude of upturns or downturns.

Coincident indicators move approximately with the business cycle while lagging indicators change direction after turning points, suggesting that they help confirm (rather than predict) those turning points.



Fundamental analysis
03:28

Industry analysis sets the stage for a more thorough analysis of individual companies and securities. Clearly, if the outlook is good for the industry, then the prospects are likely to be favourable for many of the companies that make up that industry. Moreover, industry analysis also helps the investor assess the riskiness of a company and therefore define the appropriate risk-adjusted rate of return to use in setting a value on the company’s stock.

In industry analysis, the first step is to establish the competitive position of a particular industry in relation to others and the second step is to identify companies within the industry that holds particular promise.

Normally, an investor can gain valuable insight about an industry by seeking answers to the following questions:-

What is the nature of the industry?

How significant are technological developments?

What role does labour play in the industry?

Which economic forces are especially significant to the industry?

What are the significant financial and operating considerations?

Rivalry among existing competitors

The intensity of rivalry influences prices, product development, advertising, workers and etc. The rivalry is more intense when there are many companies of relatively equal size competing in the industry. Slow economic growth will cause competitors to fight for market share.

Threat of new entrants

The threat of entry places a limit on prices and shapes the investment required to deter new entrants. High barriers to entry include low current prices relative to costs, large capital expenditures, substantial economies of scale or the need for extensive distribution channels to compete. In addition, government policy can limit the number of competitors by imposing licensing requirements or limiting access to materials. For example, the stringent requirements to obtain a banking license or the expensive infrastructure required to provide telecommunication services.

Threat of substitute products

Substitute products limit the profit potential of an industry because they limit the prices companies in an industry can charge. An example if the air fare from Singapore to Kuala Lumpur is expected to be lower in view of the proposed high speed train connecting the two cities.

Bargaining power of buyers

Buyers can influence the profitability of an industry due to the fact that they can price it down or demand higher quality or more services by bargaining among competitors. Buyers have more bargaining power when they purchase a large volume relative to the sale of the supplier. For example, travel agencies have to price their tour packages competitively as consumers tend to compare for the best deal. Companies will have to constantly design new itineraries, explore new attractions or offer unique services to remain profitable.

Bargaining power of suppliers

Suppliers can also alter future industry returns if they increase prices or the quality or services they provide. Suppliers have more bargaining power if there are few or if they are more concentrated than the industry to which they sell to or if suppliers provide critical inputs to several industries for which few if any substitute exists. For example, oil and coal companies.



Fundamental analysis 2
04:15

Company Analysis - involves studying the financial statements of a company to learn how financial numbers are generated. The investor uses financial ratios to learn how the company is faring. The financial statements reveal the hard facts about a company’s operating performance and financial position. 

There are three parts to a company’s financial statements, and they are typically presented in this order: (i) the Income Statement (or Profit and Loss Statement) (ii) the Balance Sheet and (iii) the Cash Flow Statement.

The Profit & Loss Statement (Income Statement measures  the company’s Revenue, Expenses and Profit over a period of time.

The Balance Sheet presents a company’s financial position at the end of a specified date. It’s a “snapshot” of the company’s financial position at a point in time. It summarises a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by shareholders

The Cashflow Statement shows how funds (cash) were raised and used. Cash flow is the lifeblood of the company. For a healthy company, the primary source of cash flow is earnings. The balance sheet and profit and loss statement are normally based on the accrual method of accounting, in which the revenues and expenses are recognised as they occur rather than when cash actually changes hand. The main advantage of accrual method of accounting is that it allows the matching of revenues and expenses in the period in which a sale occurred to appropriately measure profit but the disadvantage is that no adequate attention is directed to the actual cash flow position of the company.

The cash flow statement addresses these issues by translating profit and loss statement and balance sheet data into cash flow information. The 3 primary sections of the cash flow statement are Cash flow from operating activities, Cash flow from investing activities & Cashflow from Financing Activities.




Fundamental analysis 3
02:38

Although both companies register the same net cash increase, Company X generated its cash mainly from operations while Company Y generated its “strong” bottom line cash position from selling assets and borrowing. Hence Company X is considered to have a stronger financial position.

Case study 1
00:28
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Financial Ratio Analysis
6 Lectures 15:55

Why evaluate financial statements?

It helps management evaluate performance, work out compensation and comparison between divisions,  look for troubled spots and plan for the future as well as guide in estimating future cash flows

It help investors and creditor assess credit worthiness, evaluation competitors and identify potential target companies for acquisition.

Comparing ratios will aid management to make financial decision especially in areas where there is a significant deviation from the planned results.

Market data should be used whenever available and should take precedence over accounting data.


Why evaluate financial statements
00:48

Ratio analysis is the study of the relationships between various financial statement accounts. Each measure relates an item on the balance sheet or profit and loss statement to another or a balance sheet item to profit and loss statement item. 

When using historical standards, investors compare the company’s ratios from one year to the next. When using industry standards, investors compare a particular company’s ratios to those of other companies in the same line of business.

Liquidity ratios provide information about a firm’s short-term solvency. The primary concern is the firm’s ability to pay its bills over the short-run without undue stress. These ratios focus on current assets and current liabilities. However, these ratios can change rapidly so today’s value may not be a reliable guide to the future.

Financial Leverage Ratios 

Financial leverage ratios indicate the amount of debt being used to support the resources and operations of the company. The amount of indebtedness within the financial structure and the ability of the company to service its debt are major concerns to potential investors. The two widely used leverage ratios are debt to equity ratios and interest coverage ratio.

The debt to equity ratio measures the amount of debt being used by the company and a low or declining debt to equity ratio is preferable as that would suggest the company has a more reasonable debt load and therefore less exposure to financial risk. 

The interest coverage ratio measures the ability of the company to meet its fixed interest payments. The ability of the company to meet its interest payments like bond coupon payments in a timely fashion is an important consideration in evaluating the company’s risk exposure. As a rule, a ratio 8 to 10 times earnings is considered strong i.e. a higher figure would indicate a strong company. 

Operating Efficiency Ratios 

These are used to evaluate how efficiently or intensively a firm uses its assets to generate sales. They are sometimes called asset utilisation ratios.


Financial ratios 1
02:38

Profitability Ratios 

Profitability is a relative measure of success. Three widely used profitability ratios are net profit margin, return on assets and return on equity. Each one relates the profits of a company to its sales, assets or equity respectively. Generally speaking, a healthier company would reflect a higher or rising figure for the three ratios mentioned. 

Net profit margins are expressed as a percentage that measures how much out of every dollar of sales a company actually keeps in earnings. A 30% profit margin means the company has a net income of $0.30 for each dollar of total revenue earned. It is calculated as net income divided by revenue or net profits divided by sales.

Return on assets (ROA) shows management’s effectiveness in generating profits from the assets it has available and is perhaps the single most important measure of return. The higher the ROA, the more profitable the company.

Return on equity (ROE) is closely watched by investors due to its direct link to the profits, growth and dividends of the company. It measures the return to the firm’s stockholders by relating profits to shareholder’s equity.

Market Value Ratios

 Market value ratios show investors exactly what portion of total profits, dividends and equity is allocated to each share of stock. The popular market ratios are earnings per share, price/earnings ratio and book value per share.

Earnings per share (EPS) translates the company’s aggregate profits into profits on a per share basis. EPS provides a convenient measure of the amount of earnings available to shareholders. 

Price/earnings ratio (PER) relates the company’s earnings per share (EPS) to the market price of the stock. Other things being equal, you would like to find stocks with rising PER ratios, because higher PER multiples usually translate into higher future stock prices and better returns to stockholders. However, an investor needs to watch out for PER ratios that have become too high relative either to the market or to what the stock has done in the past.

 Book value per share ratio is another term for equity or net worth. It represents the difference between total assets and total liabilities i.e. common stockholder’s equity = total equity less preferred stocks. Usually a company should sell for more than its book value.

Financial statement analysis is a complex process.

Many large brokerage firms publish analyst reports which include financial ratios for various companies. Importantly these reports relieve investors of the chore of computing the financial ratios themselves.
Investors using these financial reports can analyse it in 2 ways: Historical standards or Industry Standards

Historical Standards – Various financial ratios and measures are tracked for a period of 3 to 5 years. This is to assess and uncover developing trends in the company’s operations and financial conditions i.e. whether the financial ratios are improving or deteriorating, and where are the financial strengths and weakness lie.

Industry Standards – Investors use industry standards to discover the relative strength of the company compared with similar companies or with the average results of the industry as a whole.

By evaluating these ratios, an investor should be able to derive some basic conclusions about the financial condition, operating results and general financial health of the company.

The investor will also be able to gauge if the stock is overvalued or undervalued compared with its own historical valuations, or compared with other companies in the same sector. 

Financial ratios 2
04:31

An alternative to comparative trend analysis is Intrinsic Value analysis. One key advantage is that this method does not require investors to look for other companies similar in terms of industry and size. 

The aim of this analysis is to determine the intrinsic value, or the underlying worth of a particular stock. Investors attempt to resolve the question of whether and to what extent a stock is under- or over-valued by comparing its current market price to its intrinsic value. Investors will look out for stocks trading at lower market prices than the intrinsic values (i.e. stocks trading at a discount to the intrinsic value).

It requires the future cashflows, timing of the cashflows and the application of a proper discount rate.
However, the intrinsic value of a particular company can vary widely when the analysis is done by different investors. One big reason is the discount rate.

Discount Rate

In calculating the intrinsic value, investors often use a discount rate to estimate the risk of the product.

The higher the perceived risk of an investment, the higher the discount rate, and in turn the lower the intrinsic value calculated. Conversely, if the risk is lower, the discount rate will be lower as well and the intrinsic value will be higher. The rationale behind this is that a stock should be valued higher if it is a lower-risk investment.

The choice of the discount rate has a substantial impact on the stock’s intrinsic value. Investors can have different views of the risk for the same investment, and as such different investors can use different discount rates for the same stock. This will result in different calculations for the intrinsic value.

 Ultimately this shows that calculations of intrinsic value are subjective and are as much an art as a science.  

The two widely used methods to calculate the intrinsic value of stock are

Dividend Discount Method.

Price Ratio Method.

If you determine intrinsic value to be $4, and market price is $6, you will rather wait.


Intrinsic value
03:28

The intrinsic value of the stock is equal to the present value of the future dividends it is expected to provide over an infinite time horizon. Thus, just as the current value of a stock is a function of future dividends, the future price of the stock is a function of future dividends. With this in mind, the future price of the stock will rise or fall as the outlook for dividends (and the required rate of return) changes. Many investors set the discount rate as the required rate of return. A lower discount rate (and required rate of return) will lead to a higher valuation for the stock.

The Dividend Discount Model holds that the value of a stock is a function of its future dividends and there are 2 versions of the dividend discount model. 

Zero Growth Model assumes that the stock has a fixed stream of dividends. Under such circumstances, the value of the zero growth stock is to divide the annual dividends by the required rate of return.

Constant Growth Model has the following assumptions:-

Dividends grow at a constant rate

The constant growth rate will continue for an infinite period

The required rate of return is greater than the infinite growth rate

By increasing the cash flow though dividend or growth rate  and/or decreasing the required rate of return (k), value of the stock will increase.

Constant Growth Dividend Discount Model is best suited to the valuation of mature, dividend paying companies that hold established market positions.

The discounted dividend model is not able to solve the problem of high-growth stocks because they normally don’t pay dividends.

Projections and calculations of dividends are subject to errors that are magnified over time.

As mentioned before different investors can use different discount rates for the same stock. This will result in different calculations for the intrinsic value.



Dividend discount model
02:49

Using the P/E ratio to estimate Intrinsic Value

   P0  = P/E ratio x Estimated earnings 

  = P/E x E1   

A brokerage estimated Company P’s earnings at $0.10 per share. Using a P/E ratio of 15 (derived from past earnings), the intrinsic value is $1.50. If Company P was trading at $1.60 at the time, is it a good buy?

A common method to calculate intrinsic value using the PER ratio is to use estimated earnings for the next 12 months. In the example, Company P’s intrinsic value is estimated at $1.50 (P = 15 X $0.10). Since this is lower than its current stock price, Company P is not a good buy.

A better way is to use projected earnings to determine the estimated P/E ratio and decide if it is high or low when compared with the company’s growth prospects.

Interest rates, growth prospects, debt-equity ratios, dividend payout policies.

Earnings can be affected by creative accounting, unusual gains or losses.

Valuing stocks with PE ratio
01:41
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Conclusion
1 Lecture 00:52

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Conclusion
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Unbiased Financial Education Courses

The MoneySENSE-Singapore Polytechnic Institute for Financial Literacy is a collaboration between MoneySENSE, the national financial education programme in Singapore and Singapore Polytechnic.

MoneySENSE is spearheaded by the public-sector Financial Education Steering Committee which comprises representatives from the Ministry of Health, Ministry of Social and Family Development, Ministry of Education, Ministry of Manpower, Central Provident Fund Board, Monetary Authority of Singapore, National Library Board and People’s Association.

Our financial education courses cover basic money management, financial planning and investment know-how.

May Ng
4.3 Average rating
40 Reviews
1,825 Students
2 Courses

May has 25 years’ experience in the banking industry. She has managed retail banking branches offering deposits, investments, insurance, loans and card products in a local bank, overseeing operations, ensuring compliance and good customer service delivery to banking clients.

Prior to joining the Institute, May was working in the preschool education sector by providing management leadership to a cluster of preschool centres.
May holds a Bachelor of Science (Hons) Economics degree, specialising in Banking & Finance.