Sep 4, 2011

The Valuation of Shares

The primary question that comes to the mind of an investor is- ‘how to value a share?. How much can I buy it for and how much should I sell it for? Let me warn you in advance that there is no clear answer to those questions.

Shares don’t come with an MRP (Maximum Retail Price) or an MSP (Minimum Support Price). Share prices are completely market determined. So how should you go about valuing a share?

Let’s say you are an enterprising guy and you want to make some money. You go to the nearby market as you know it’s the place where goods and services are traded and the opportunity to make money exists.
You can’t go in with any pre-conceived notions of what you’re going to buy/sell and to whom you’re going to do so. You will need to spend some time observing the market. You will need to collect information as to what is happening, why it is happening, what can happen and most importantly- keep your eyes, ears and nose ready to spot an opportunity.

If the market gives you an opportunity to buy wheat and sell it later for a profit you can do so. You can use the profit to buy rice and sell it later for a profit again. If after gaining some experience and with careful valuation you feel that wheat is not your thing and you want to specialize in trading rice you can do so. 

There are always many things traded in the market. It’s not just rice or wheat, you can have mobile phones, TV’s, cars, bikes, clothes, kitchen-ware, medicines, stationary, books, gold, etc. Just about anything and everything can be traded. You can trade all of these simultaneously or specialize in one or two (or more) things. 

You should look at the stock market in exactly the same way. In simple mathematical terms- the stock market is nothing but the super set to all other markets, i.e. every other market is actually a subset of the stock market (in some way or the other). You should go about valuing shares of companies in the same way that you would look to start a business in a market. You need to spend time understanding the market and only then will you be able to profit from it.  

Now there are many ways to try and decipher the market.  Despite the numerous years of research and study by some of the most brilliant minds, nobody has yet been able to come out with a proper way of going about understanding the market and valuing shares.

Broadly speaking there are 2 ways you can go about the whole thing. One is called Fundamental Analysis. A fundamental analyst will study the economy, the GDP, the market research, the balance sheets, the credit ratings etc. The other way of valuing shares is called Technical Analysis. A technical analyst wants to play the trend. These are the guys who sit in front of graphs and try and decipher the market. Most investors use a bit of both technical and fundamental to invest.

So the answer to our earlier question as to how to value a share is quite simple actually- get reading and get involved!

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