The fair value is relative and depends on other factors beyond the investors’ control. Here, we discuss the calculation of fair value, within the confines of our control. In short, the calculation of the fair value of an investment depends on the rate of expected return and risk to achieve that return. Demand higher risk higher reward. It ‘very simple.

So, what constitutes a low risk business investment? We can only compare. The first thing that comes out of my mind is a certificate of deposit (CDs). You are guaranteed some return (interest rate), if you can keep for a certain pre-determined period of time. You would never lose the primary to the end of the period of time.

The next low-risk investment is the Treasury Bond. This is the bond issued by the U.S. Government, which are considered to be safest in the world. There are some risks associated with small fluctuations in the price of bonds. However, if you held to maturity bonds, you are guaranteed some rate of return. Your rate of return depends to some extent, the price that you bought the bond a.

The next higher investment risk is to purchase ordinary shares. This is what we are going to focus more here. It is considered a higher risk compared to the two types of investments, including before, because it has a higher probability of losing money on your investment. Previously, we established that a higher risk needs higher reward. Therefore, stock to invest a greater reward.

So, what does this have anything to do with fair value? Very simply, the price of a common stock that you buy should give us an annual return greater than bonds or CDs. For example, if a CD is a 3% return, treasury bonds give you a 4% return, then you want the stock offers a yield greater than 6%, maybe.

What does it mean for a stock to give investors a return of 6%? It ‘never say no? You are right. Although not explicitly stated, it is possible to do some ‘digging and find out what the return of your investment would be in stock. For example, if the certificate of deposit (CD) offers an annual return of 2% to $ 100 investment, you should earn $ 2 every year. Suppose that you want the store to give you a yield of 6% which is higher than CD or Treasury bond. This implies for every $ 100 invested in equities, he needs us to give a return of $ 6 annually.

Where can I get this information? You can do it on Yahoo! Finance or other financial publications. We all need to do is find the price of common stock and profit per share (also known as earnings per share) of that particular situation. We use an example to illustrate my point. Magna International Inc. (MGA) is expected to post a profit of $ 6.95 per share for fiscal year 2005. Recently, the share is trading at $ 73.00. The annual purchase Magna stock is then divided by $ 6.95 a share price of $ 73.00. This gives us a yield of 9.5%.

Magna will continue to give investors a return of 9.5% year on year? Depends. Increases if the stock price, Magna will return less than 9.5% per year. What else? Well, Magna could not consistently produce the same amount of profit, year after year. It could even produce a loss! So, you see, equity investments are inherently risky, because there are two moving part of the equation. Price of the Common Stock and the profits produced by the company. This is why investors should focus on higher return, when their choice of investments.

All right. So, let’s go ahead for the most important thing in investing in common shares. What is the fair value of stock Magna assuming a constant profit of $ 6.95 per share? Personally, assign a fair value of common stock, must be at least 2% above the rate of Treasury bonds. Please note that I am using the link here 10 years. Recently, treasury bond can give us a 4% return. Therefore, the fair value of Magna common stock is when you can give me a return of 6%

So, what is the fair value of Magna common stock in this case? For a profit of $ 6.95 per share, the fair value of Magna common stock is $ 115.80 per share. That’s right. A $ 115.80 per share, Magna common stock will return investors 6% per year. That said, we should never buy a common stock at fair value. Why? Because our goal is to invest to make money. If you buy stock at fair value, then when we profit from it? We do not expect to sell when it is overvalued? Sure, it would be nice if you can do all the time. But to be prudent, not to mention the non-bank stocks to reach our level overestimated.

There you go. I explained how to calculate the fair value in a common stock. Of course, the $ 6.95 per share profit is the expectation of profit made by Yahoo! Finance. Is in no way an endorsement to buy Magna common stock. You should do the calculation to verify that number.

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