There are a lot of reasons and fundamentals behind this method but here I will just list down the practical steps now. Explaination to follow in future posts.
Buying a stock should be EXACTLY like starting your own business !
1. find out the historical EPS ( for the past 10 years if available )
2. determine the EPS growth rate from #1
3. by using this EPS growth rate, forecast to future EPS ( ie.10 years later )
4. pick a reasonable PE for your stock
5. use PE from #4 and the future EPS from #3 to calculate the Future stock price
6. decide a return rate you want to achieve ( ie. 15% )
7. Backdate the future stock price in #5 to today's price using interest rate in #6
8. decide a safety margin ( ie. 50% ) and finally you have your target buying price !
There you go, When the stock price is lower than #8, BUY !!
example :
1. EPS is 0.28 to 1.12 in past 10 years
2. so the growth rate is about 15% ( you can use rule of 72 )
3. 10 years later, the EPS will become 4.48
4. PE = 10 from magazine/newspaper
5. stock price = PE x EPS = 10 x 4.48 = 44.80
6. 15% means doubling every 5 years or doubling twice in 10 years
7. 44.80 / 4 = 11.20 ( 11.20 double twice in 10 years becomes 44.80 )
8. 11.20 / 2 = 5.60
So if the stock price goes below 5.60, I will buy.
