When To Buy And Sell

The mechanism of buying and selling is quite simple. It is as simple as pressing a button on the front of your computer screen. The question of when investors should buy and sell warrant a more detailed analysis.

When to sell: Ideally, we sell when a stock reaches its fair value. There are nine other reasons to sell, but I will not cover here. So, what is a fair share value? I have covered this time enough. But in general, a stock reaches its fair value when it is yielding 3% above the current risk-free interest rate. I use 10 year treasury bond as a proxy for free risk-free rate. Currently, the 10-year bond yield 4.46%. Fair value of a share is therefore when it is thus 7.46%. Invert output, then we got the Price Earnings Ratio. Commonly used Yield of 7.46% corresponds to P / E ratio of 13.4

Where to buy: This is an easier question to answer. We, of course have to buy less than we sell shares. If we sell the stock at a P / E ratio of 13.4, then we need to buy when the P / E ratio is less than 13.4. How much lower? It depends on how many times you strive for. If, say, you're aiming for 50% efficiency, then your purchase price when the stock is trading at a P / E of 8.93. If you are aiming for a 34% return, then your purchase is at a P / E of 10.

In short, we have to buy at a P / E of 13.4, correct on a P / E of 8.93 and then sell? Yes, but with many pitfalls. I have those concerns addressed in five common abuse of P / E ratio. To emphasize, the P / E ratio used here is not P / E ratio backlog, do not ignore the value of cash in the balance sheet, not an event not ignore and not ignore the change in interest rates. At this point I'm ignoring earning growth simply because the calculation of the fair value for a company with 0% growth.

You might be wondering where you might find stocks that are trading at a P / E of 13, let alone 8.93. Here's a few candidates to help you get started. Seagate Technology (STX) has a forward P / E of 7.5 and $ 2.30 per share of net cash on the balance sheet. Western Digital Corporation (WDC) has a forward P / E of 9.75 to $ 2.65 per share of net cash. OmniVision Technologies Inc. (OVTI) is trading at a forward P / E of 10.3 with $ 5.30 per share in net cash. Magna International (MGA) is trading at a forward P / E of 9.72 to $ 4.58 per share in net cash.

Please note that this is not a buy / sell recommendation. You would do very well if you own homework.