How is a share price calculated?
- Although they are various ways of doing this, the most common is by the use of EPS or Earnings per Share. The owner of a company will decide that he would like to have to invite an additional 1000 owners or shareholders into his company, who will therefore be getting a share of the company’s profits. If the profits are also a 1000, then the share price would Earnings (profits) divided by the number of shares i.e. 1. However, the owner will also add a premium to the share price in lieu of future profits from the company, but also a discount to attract potential investors.
What should I consider when deciding what stock to invest in?
Your investment strategy should be driven by the following but by no means exhaustive list of variables;
- Your time horizon i.e. how long do you want to keep your money in a particular stock and also how long are you prepared to wait before you can reap your desired return on that share. Most investors will have 4 time horizons; speculative, short-term (up to 6 months); medium-term (up to 2years) and long-term (2+ years)
- Your risk appetite: Quite simply, how much of the amount you’ve spent on the share can you afford to lose? Unlike the majority of investments, share prices to go up as well as down.
- Financials: Look at the company’s profits, cash flow, market share, and financial ratios (e.g. P/E, Interest cover but specifically its EPS) and how all have changed over the last 5 or so years. You should rarely invest in a company unless you have seen audited financial data. However, please remember that this data will be a reflection of the company’s past performance and not necessarily of its future performance. Hence, lookout for forecasts for the coming year or over the next few years (for IPOs).
Company’s environment: What market share does the company hold and is it a growing or decreasing one? Are their any legal issues outstanding? In other words, do a SWOT analysis so that you encompass issues such as the economy, rivals, politics and government policy. The last one is especially important at the NSE as the government has a holding in a substantial number of companies.
- Company’s management/shareholders: A well managed company with reputable MD/CEO will mean that good performances won’t be far behind. Some companies have majority shareholders i.e. an individual or a fund or an investment company may have a controlling shareholding of 50%+. In which case, try to understand how they operate. Transcentury Ltd, the Agan Khan are examples of majority shareholders in EA Cables and NMG respectively and are known for being performing companies. Sometimes, government-owned companies may come with political baggage of the wrong kind.
- Do you like the company’s products: If you don’t or have no idea what the company sells, chances are that not many other customers do and hence its not a growth company. However, some new companies will have products/service ideas that are new to the market, in which case ask yourself do you understand the potential.
- Avoid herd mentality: Unless you buy the same shoes, clothes, electronics as your pals; don’t buy a share just because everybody else is. Typically, when everybody else is buying a share, you may end paying too much for it and if its prices rises too fast, its difficult to judge the right point to buy into it and similarly it will be just as difficult to judge when to exit.
- Finally, buyer beware: shares to go up as well done, past performance is not a predictor of future performance. Hence set yourself limits in terms of how much you invest, when you invest and when you sell. And invest in a company you understand.