How to price stocks

Stocks in 2017: Predictions Vs. “Mental Bets”

Boy, people love predictions.

Whenever I see a title like “Best Stocks for 2017” I must check it out. I never act on predictions or take what is being said at face value, but I click anyway.

In fact, half of the time I click with an attitude: “Yeah, yeah, let’s see what you have to say…” Even if there are 100 stocks on a list, I feel compelled to check them all (I guess I am a list junkie).

Most predictions go unverified – that’s how predictors get away with them year after year.

When was the last time you checked a “Best Stocks for 2017,” or “2016,” list to see how the picks panned out? We don’t care: that was then, we care about now. We just might find something useful.

Stock traders, should you act on predictions?

As a stock trader, I know how dangerous it can be to act on predictions. Even the most accurate or compelling ones often turn out wrong because they are based only on known facts – and who knows what the future holds?

Nobody can predict the unknown, not in stock trading anyway. But what we can do, especially as stock traders, is to be prepared for as many eventualities as possible. I call that “mental bets.”

If a prediction sounds plausible, I ask myself: What will happen if it does come true? What will I do? I try to develop a range of scenarios that ultimately translate into buy, sell or hold decisions. If “A” happens, I will do “B”; if “C” happens, I will do “D,” and so forth. If “A” does not happen, I don’t do anything.

But what I don’t do is act in anticipation, no matter how convincing a prediction. I wait for the market to validate it before acting.

This way I can also engage in predictions of my own: if something happens as I expect, I stand prepared to act; if it does not happen, or if it changes its course, I don’t lose any sleep over a “wrong” prediction – it was just a mental bet, no sweat, I am on to the next one.

It’s a great mental exercise to see if what you think will happen actually happens, how accurate you are. (By the way, it’s much worse if your mental bet pans out but you fail to act through lack of conviction.)

So, what are the best stocks for 2017? I have no idea. But I do know this: there will be winners and there will be losers; I will try to buy as many winners as I can because I know I can catch them as soon as they emerge.

Instead of focusing on the stock predictions, it makes sense that the traders focus on picking the right stocks.

How to Price Stocks?

If you are new to investing, than chances are that you are not clear about getting the right price when buying stocks.

Perhaps you think that a price that seems low to you means it is a good deal, but that is not the case. In fact, it couldn’t be further from the truth!

Unlike buying a sweater, when buying stocks, you are buying a part of a business, and business is based upon earning money; so when you buy stocks, you must take into consideration how much money that business is making and use that info among many other things (covered in my other articles), to forecast the potential earnings of that business.

An important point to remember is that when trading stocks you should look at both fundamentals and technicals. Using technical analysis you can ensure that you time your traders properly.

This can be done in a number of ways. You can use classic technical analysis concepts as well use some non-conventional methods such as renko trading.

When you invest in stocks, your shares represent individual interests in that company and therefore you are entitled to a portion of the earnings of that business.

For illustrative purposes: If a company makes $100 million dollars in a year (net gain after all expenses) to divide amongst their 1 million investors, dividing that $100 million by 1 million means each investor earned $100.

So, how did those investors know how much they should pay for those shares, anyway? For illustrative purposes, let’s say that “Company A” has shares available for $26 each, and “Company B” has shares priced at $30. Which is the better buy?
Company A sells Apples. Company A sells 1000 of them during the year. “Company B” across the street sells Bananas. They sell for only $1.50 a bunch. Company B sells 2,500 of them in the year.

Which company made more money? Even though Company A has a more expensive product, Company B sold more. Some simple multiplication reveals that Company A made $2,000 ($2 times 1000) compared to Company B’s $3,750 ($1.50 times 2,500).

But how does one know how much to pay for shares in these companies?

Let’s back up in time and assume that when these companies made their initial public offerings (IPOs) they first determined how much they thought their respective businesses were valued to be, and then decided how much more money they wanted to bring in.

A company determines how much stock they are offering to the public, and the total amount of those stocks multiplied by the price they are being offered at is called the Capitalization or Market Cap.

The shares available to be traded are referred to as the Outstanding Shares. Shareholders can do a simple calculation in order to gauge whether the price of a stock is expensive or not.

Actually there are several ways, but the most common is known as the “P/E Ratio’. We’ll get to that in a minute.

To continue from where we left off earlier, we need to determine how much a company earns before we can ascertain if “the price is right”. We know that Company B made more money than Company A, so it is safe to assume that their stock (B) should be worth more than (A), since we are investing in the potential interest or entitlement to future growth earnings, right?

So let’s put that knowledge to work. In the real-world, stock market earnings are shown as per share amounts. A price will be shown to go up or down by the individual share amount.

All we need to do is take the current Share Price and divide it by the listed Earnings-Per-Share. Remember that we said earlier that Company A has shares priced at $26 each and Company B has shares priced at $30? Well, if ‘A’ had earnings per share of $1.10 and ‘B’ had earnings per share of $1.25 then all we need to do is divide $26 by $1.10 and we get a P/E of 26.63 (or 26.63 times earnings) for Company A.

If we do the same for Company B, we divide $30 by $1.25 and come up with a P/E of 24 (or 24 times earnings).

Since both of these companies are in the same sector and industry, we can safely compare the two of them, and although Company A sells shares for only $26, it only makes $1.10 on each one and thus its P/E ratio is higher than Company B, which seemed higher with it’s shares priced at $30, but since they made $1.25 their P/E ratio is lower at 24 indicating that they are in fact the more discounted choice.

Now all you need to do is read about how to find the right companies to invest in, then find the “best of breed” for a given sector, then use this ratio to find the one with the best price.