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A calculation of the correct price of share.
Obviously nobody can predict a price of anything with 100% accuracy. For truth sake prices are not predictable even with 51% of trustworthy. Future is unpredictable in principle. It can be manipulated but not foreseen. This memo is about what is the reasonable mental procedure to calculate correct price of one share. The formula is: P = kr*d/I + (1- kr)* P-*(1+DP/P-) where: P - price of share, d - projected dividend per one the share; I - best bank interest you can get (not in a form of percent but part; 3% interest rate here = 0.03) ; P- - price of share year ago; DP - average change price per year; kr - coefficient of sanity (skepticism or nonconformism ) of the person who estimates a price of share. Let's do some explanation of the formula. Presume that for some long time of history all shares has more or less stable prices without obvious neither positive nor negative trend. In this case one person should expect that if he put his money into bank and then take them in one year with interest he would get the same result as if he buys a share and then in one year sell them for the same price and in addition will collect a dividend. This is a fundamental concept of free market that it self adjusts on the long run to the situation that all investment options have bring the same profit. In this case a right price of one share will be exact Pd=d/I, that is mathematical condition that for sum of money P dividends or bank interest will be the same. In case of trendy market one can believe that the tendency will continue one year more. In the history stock market had indeed long periods when such kind of presumptions happened to be correct. In this case a price of one share will be equal Pt = P-*(1+DP/P-) - just extrapolation of existing trend. Coefficient kr - is a physiological characteristic of the person making decision. Some people tend to be more conforming then others. So only in very stable situation a dividend bases price could find common agreement; in all other situations there will be distribution of opinions about real price. And investors will trade with each other moving price around "correct" level. The longer a tendency existed the more it is selfsupported. Most interesting points for discussion sake is a moment of breaking of long established trend like it was in 2000. The exponential growth of DOW about 20 years practically took out off minds of investors any thoughts about influence of dividends on price. But prices cannot grow eternally long. The natural limit is a money volume able to be used for speculations. Magic of number 10000 played its role in the setting a roof for expansion too. Break of trend establishes self accelerating trend of different direction. The only possibility for regulators to avoid non-controlled crush even below level of dividend determent prices were changing banking interest. That was done. It was diminished almost to zero that effectively increase Pd till around actual. But this regulative option is exhausted to 2004. Bank percent will be increasing that leave us only too options - dramatic fall of DOW or strong inflation. Looks like that it will be both but not great but just big. Leonid Sakharov 11/21/2004 |
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