Singapore-based financial blog that aims to educate people on personal finance, investments, retirement and their Central Provident Fund (CPF) matters.

Wednesday, 3 September 2014

Thoughts on predicting share price

I was browsing through investment blogs and for a long time, I have noticed most of them are themed on predicting future share prices. They often use many different methods which can be grouped under technical analysis. The point is that this method is usually used alone.

While this method has its own merits, I often feel that they missed out on a very important fact. Investing in a company means owning the business. This means that some form of fundamental analysis has to be present because you need to understand the company that you are going to invest in. There are several weaknesses to this method, though. One is that the company may doctor its balance sheets to make it attractive to potential investors and secondly, the balance sheet is backwards dating. Hence, it may not be extremely helpful in predicting the future of the company.

Hence, there are some ways which I think is useful in countering the weaknesses of fundamental analysis. First, is to try to predict the forward Price to Earnings ratio (PER), with accuracy. Note: it is with accuracy. What I mean is that you would want to invest in a company that has a higher chance of increasing its earnings in the future. Let's say the PER of company X is now 10. The company is engaging in food and beverage industry in Russia and is not affected by the sanctions issued by the government. This definitely translates to a earnings as now there is higher demand for its products, coupled with lesser competition. If X's share price is now $1 and the earnings increase by 20%, the share price should increase to $1.20, given that the PER remains the same. However, predicting the future is difficult, or else, impossible. The way is to predict with certainty. This is of course provided that the company is stable and sound in terms of its current financial position.

While back dated information suck big time, who else has the current up-to-date information? Well, its the business owners themselves! One way to know if the company is really doing well is to check if there are any insider movements or share buybacks. If a director or key personnel is buying up some shares, this might indicate that he/she has faith in the company, or else he/she would not even risk their own money. Otherwise, the company might think that its share price currently is trading at a discount and it might be a good time to buyback some of its shares to increase its return ratios.

While these methods do have the limitations too, I feel that they are counteract measures against fundamental analysis and should be used concurrently to improve your investment decisions. This post is also of no offense to people who believe technical analysis is accurate. I, too, use technical analysis to time my entry. But this is just my 2-cents, hence, the blog title: "Thoughts on predicting share price". Rather that: "Facts on predicting share price".

Do leave a comment and share your views.
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