Tuesday, July 29, 2008

Basic formula for trading in stock market used by Warren Buffet

This formula was given by Benjamin Graham.
You might wonder who Benjamin Graham is. He's the man who taught Warren Buffet, the richest man in the world who earned a lot of his wealth from stock markets around the world.

The formula is: Value= EPS (8.5+2g), where

Value = Value of the stock in rupees (if you are investing in India)
EPS = Earnings Per share in rupees (if you are investing in India)
g = Growth rate in per cent

For instance, assume that a stock like TCS' value as of today is Rs 1,240 and its EPS is Rs 57.65. Now, these two figures can help us arrive at a growth rate in terms of percentage at which the company's profits need to grow to sustain a price of Rs 1,240.
Let us calculate 'g' for TCS by substituting the assumed values in Graham's formula.
1,240 = 57.65 * (8.5 + 2*g)
Therefore, 1,240/57.65 = 8.5 + 2*g
Therefore, 21.5 = 8.5 + 2*g
Therefore, 21.5 � 8.5 = 2*g
Therefore, 13 = 2*g
Therefore, g = 13/2
Therefore, g = 6.5.

Suppose that,Tata Steel needs to grow by a mere 0.2 per cent for next 7-10 years to sustain it's price.
Do you think a huge company like Tata Steel will grow only at a mere 0.2 per cent? Of course not. It is a promising company with a sound management that can propel the company to much higher growth rate than 0.2 per cent.
Normally, a company that is expected to clock higher growth rates than 'g' is considered as a good buy. But this should not be your only tool to identify a stock could increase in value in the future.