Values, Values, Values

My objective in this post is to lay the ground for all those who are interested in learning about investing in Equity. It may seem overwhelming initially (it was for me), but do take the time to let it soak in, and soon you'll find yourself on the path to financial freedom.

Earning from Equity
Here we are, stepping out into the great unknown. How do we earn money off financial investments in Equity (a Publicly-listed Company's stocks)? Well, one could simply buy stocks that give out regular Dividends (Dividends are basically a portion of a company's earnings that a firm's board of directors decide to give out to the shareholders). Another way would be to buy the stock at a low price, and sell it at a higher price. Sums of money earned this way are called Capital Gains. Personally, I prefer investing in stocks that provide a greater potential for Capital Gains.

Often enough however, we are likely to see our earnings made up of both Capital Gains and Dividends. These earnings can then be simply coined Total Returns. The formula below shows the relationship:

Total Returns = Dividends + Capital Gains

Simple Formulas

With this out of the way, we know we want to make money through equity, but how do we know what a company's shares are worth? To begin, we must first realize our Required Rate of Return (Rs) for the company we want to invest in. (The Rs is simply the minimum return an investor is willing to accept for his investment, based on a host of factors like risk, etc.). In order to derive this, we have the Capital Asset Pricing Model (CAPM):

Rs = Rrf + (Rm - Rrf) * B

Rrf : Risk Free Rate (The Interest Rate of US Treasury Bills)

Rm : Expected Market Return (Yearly Historical Market Returns can be used)

B : Beta (The volatility of the share price relative to the Market; figures can be be obtained from Reuters)

Try the CAPM out! I recommend using Singtel, a telecommunications company listed on the Singapore Exchange (SGX) that pays out stable and regular Dividends (Singtel's Beta (B) is available here). For this case, try using Singapore's Treasury Bills (Rrf), and get your historical expected market returns (Rm) here!

Valuing Stocks

Here comes the exciting part! Once we have obtained our Rs, we can make use of 3 methods to derive the price.

1. The Dividend Growth Model
2. The Discounted Cash Flow Model
3. The Comparables Method

Basically, all these methods provide us with a valuation of the company's share price. Ultimately, this helps us to make our final decision on whether to buy the stock or not. Due to time constraints, I will only be talking about one of the three above. However, do leave a comment if you would like to know more about the others, and I will try my best to answer.

The Dividend Growth Model

The idea behind this model is to use the projected Dividends that will be paid in the future to calculate the present value of the Company. There are a few variations in this model based on the expected growth of Dividends, but for the sake of using Singtel as an example, we will be focusing on the formula concerning perpetual growth Dividends:

P = D / (Rs - g)

P : Price of 1 Share now
D : Expected Dividends paid per share, 1 year from now
g : Expected Annual Growth Rate of Dividends

Now consider this scenario: The minimum return we accept is 6.3%, Singtel is expected to pay a Dividend of $0.17 one year from now, and is expected grow steadily by 1.8% per year.

Using these figures, our valuation of Singtel's share price would be $3.78. This value does not necessarily reflect current market prices, but it shows what we think Singtel's shares should be worth. Intuition would then lead us to think that if the market price for Singtel's shares is now only $3.50, our potential upside (profit) would be $0.28, or 8%.

Tying this back up with the start of the post, if we buy one Singtel share at $3.50 now, and sell it one year later at $3.78 (earning $0.17 on Dividends), we are likely to see our Total Returns as something like this:

Total Returns = Dividends + Capital Gain 

= 0.17 + 0.28 

= $0.45, or 12.86% profit on our initial investment

Now, growing your money by 12.86% per year is quite an achievement, considering the interest rates (about 0.05% per year at time of writing) that local banks are providing: DBS/POSB, UOB, OCBC, and Maybank. Do note: I am not putting down banks, nor dissuading you from depositing money in banks. Bank deposits serve their purpose of keeping our money relatively safe. However, it is in my opinion that if we want to achieve financial freedom, investments in equity seem like a much better option.

At this point, I would like to congratulate you. You've made it! You survived this post, and I want to thank you for taking the time to read it through.
But it's not over just yet. We haven't actually earned any money from reading. Now is the time to practice. Go ahead and derive valuations for stocks, keep track of their market prices, and find opportunities to invest!

Good luck! And till next time.

Tick Tock, the clock doesn't stop

An Introduction
Hi!

Today marks the start of the second year (kinda. it's the 3rd week of Jan) in my journey towards financial freedom. It has been amazingly uplifting, but at times terribly frustrating as well. I will be recording my progress as I continue down this path, and I invite all those who are interested to provide their insights and comments. (Don't forget, your advice won't only help me, but all who read this blog!) For those who are just starting out as well, I warmly welcome you to draw knowledge from my experiences, and perhaps share your experiences as well. Portions of posts dedicated to you will be highlighted in blue, like this. Look out for them!

So, you may wonder, who exactly is this guy, and what does he do?

Well, my name's Joshua, and at time of writing, I'm a sophomore in Singapore Management University (SMU). I'm majoring in Business and Accountancy, and while I hope and aspire to land myself a good job in the future, I have come to the realization that earning a fixed income will not be enough to provide the shelter/education/comfort that I seek for my family in the future.

I've come to realize that there is a strong need for me to grow my money as I earn it, and thus began my foray into the world of investments. Wet behind the ears, I leaped out into the abyss, investing a good proportion of the savings I had into Equity (aka Shares of Publicly Listed Corporations) on the Singapore Exchange (SGX). Trading suddenly became a roller coaster ride of emotions, and I was struck by how easily I could be overcome by fear, or greed. However, I am glad to say that by year's end, my portfolio had doubled in value.

Moving back to the present, I recognize that some of you may think that I am a child genius/investment prodigy/Warren Buffet (it's humour, don't beat me up over it). This is not the way I see it. I largely attribute the growth of my portfolio to something along the lines of : God's help, good advice, some stroke of luck, and perhaps a few good decisions on my part.

Moving Forward
Drawing motivation from my goals in life, I am compelled to wade deeper into the sea of finance. This year, I am resolved to make more informed and better trading decisions. At the same time, I will specifically be learning more about Technical Analyses and how they can be used to improve the frequency of positive returns. For those who are just starting out, one good place to start would be Investopedia 101, a treasure trove of information about the Financial world.

With this, I conclude my first post on this blog. Till the next time.