How to Assess Stock Prices for Beginners - Defensive Investing for New Investors

I’m reluctant to write about stock investing because I believe it’s a difficult subject to deal with which I’m not an expert on. On top of that, I do not have too many experiences with stocks that investors may want to read about. But I realized that not all people are in that stage of their investing experience to want to read advanced tips on stocks. Some may just be beginning to invest and may want to hear how I started.

For those of you who may just be interested to know, I’d like to share some of the principles I found in the book “The Intelligent Investor” which I used to pick stocks to invest in. These principles were not developed by me because I’m not competent to do that. Instead these are words of wisdom from professionals who knew what they were talking about.

Philippine Stock Market

I may just have been lucky to start my stock investment in a time when the market was trending upwards. But I know that since I invested a portion of my cash in the Philippine stock market on March of this year, my investment has gained 28% in value. That’s a really good performance over a six-month period. I doubt if that’s sustainable. I think it will depend with the market condition in the future and how the companies I chose to invest in will perform.

Nevertheless, I found the tips in the book reasonable. They offer practical guidelines that were formulated from an analysis of how the stock market works and how investors normally behave. The experts know where the risks are so they are better equipped to tell us how to guard ourselves from pitfalls we would normally not see.

I believe someone who is new to stock investing should be cautious. This thing is risky so a new investor should go out of his way to lessen his exposure to unexpected events. With this in mind, I thought the tips for defensive investors were right on target. A defensive investor is the one who purposely guard against the risks with investing by taking relatively conservative steps.

Stock Price

A particular concept that I would like to focus on is the price of the stock. When you look at any stock in the stock market, you are only presented with two information. The first is the company trading initial (such as ALI for Ayala Land, Inc.) and the second is the price it is selling for. The question that should be foremost to the mind of the investor is whether the price of a stock is reasonable or not. Is it too expensive or is it cheap?

To determine if the price of a stock is worth it or not, you ought to know the value of the stock. The objective value of a stock can be determined by using some basic accounting concepts. If this is unfamiliar territory for you, don’t worry. To put it simply, you just need to know the book value of the stock and compare it with how much the stock is being sold for. Book value is an accounting concept. You may think of it as simply the amount left for business owners in the event that a business is liquidated after all debts have been paid.

If you’ve bought a company’s stocks, you own a part of that business. Of course the number of the stocks you own determines the extent of your ownership. The book value of each share of stock can be determined by dividing the amount left for owners by the total number of company stocks there are.

Price vs Book Value

If you think this is difficult to determine, worry no further. Book value as compared with the stock price is available through a metric which is called price-to-book value. This number gives you the current price of the stock divided by its book value. Finance websites such as readily has this number for everyone to see.

The author of “The Intelligent Investor”, Benjamin Graham, suggests that a defensive investor set a limit to the price of any stock he buys. That limit he said should be at 1 and a half times of the book value of the stock. This rule on top of others mentioned in the book will eliminate several stocks available in the market today. The author justifies doing so in order for the defensive investor to be on the safe side.

I’ll expound on the other parts of these investing rules for the defensive investor on the next several posts. I hope these discussions will be thorough enough for beginners to appreciate. Moreover, I wish I could relate the articles together in a cohesive manner to enable better understanding and usefulness.

But if you have questions now, go hit the comments section.

Photo Credit: 401(K) 2012 (Creative Commons)