How to Make Money through Investing in Stocks

People invest in order to save for retirement, create a rainy day fund or simply to increase their wealth. The American stock market has provided many investors with excellent returns. But in order to succeed you need to learn how to make money through investing in stocks and not simply guess at what to do and lose money in the process. In fact, one of the most famous investors, Warren Buffett, half-jokingly says that the first rule of investing is not to lose money and the second rule is not to forget the first rule! If you watch what investors like Buffet do you can make money through investing in stocks. The basis of his solid approach to investing is the concept of intrinsic value.

Playing the Market

Back in the 1920’s, the roaring twenties; playing the stock market was common. Stocks were going up and it was hard not to buy a stock and not see its value rise. Unfortunately the stock market crashed in 1929 and the overall stock market lost nearly half its value. Many stocks lost all of their value and companies went out of business. Unfortunately the tendency to play the market has not gone away. As the Chinese market rose a couple of years ago to new heights investors picked stocks based on lucky sounding names. And the Chinese market crashed. The dot com bubble and crash and the 2008 crash were likewise set up by inflated stock values as investors fought to get into what appeared to be an eternally rising market. How do you avoid playing the market? This is where the concept of intrinsic stock value comes in.

Benjamin Graham and Intrinsic Value

The intrinsic value of stock is its fundamental value based on predicted earnings. Investors compare intrinsic value to market value and when the intrinsic value of stock in a solid company is more than market value the stock is typically considered a buy. This is because the market will eventually catch up and price the stock accurately. If you are holding a stock whose intrinsic value is less than market value it is time to sell the stock before the market corrects down to the real value of the stock based on projected earnings. It was in the wake of the 1929 crash that Benjamin Graham came up with the concept of intrinsic value. And in 1949 he published a book entitled The Intelligent Investor which included his ideas.

Analyze the stock to determine its price based on predicted future income and then subtract the current stock price. Calculate expected company cash flow and then discount to current dollars. Determining intrinsic value of stock is a discounted cash flow valuation. The key to determining intrinsic value of stock is getting a clear idea of the medium and long term prospects of the business in question. Successful stock investors learn to judge how well a company will manage its assets, products, costs, R&D, and marketing. When the picture is clear an investor can make an informed decision. If the market price is less than the intrinsic value of stock it is time to buy and if one owns the stock and the prices are reversed it is time to sell.

A Formula for Calculating Intrinsic Value of Stock

Here is the original formula that Benjamin Graham suggested as modified in 1962 and again in 1974.

  • Preceding twelve months earnings per share, EPS
  • A constant of 8.5 representing an expected price to earnings ratio, P/E ratio, for a company that is not growing
  • g being an estimate of long term growth (five years)
  • A constant = 4.4, the average yield of high grade corporate bonds in the early 1960 decade
  • Y = The current yield of AAA corporate bonds
  • V = intrinsic value

The formula is as follows:
V = (EPS x (8.5 + 2g) x 4.4)/Y

How to make money through investing in stocks is to consider the intrinsic value of every stock that you want to buy and every stock that you hold.

How to Make Money through Investing in Stocks PPT

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