# Question on the nature of the value of shares



## tothemax6 (16 November 2010)

Hi all,
I have a question which has been bugging me for a while, hoping to get some thoughts from those who know more about shares.
The question is, what actually gives a share its value? Initially, my impression (before I actually bought some shares) was that dividends were what gave the shares value. Makes sense, in the same way that interest gives a term-deposit value. However, it appears that a large number of shares have no dividend. Also, major shares which do have dividends often have negligible returns - often less than inflation.
So of course the only answer to this is 'the value of shares comes from the potential capital gains'. This I cannot understand, although it does appear to be the main reason people buy shares. When one gets capital gains, it is typically because the asset becomes more valuable. As an example, I buy an ounce of platinum, changes in industry cause increase demand for platinum raising its value. Or as another example, I buy a house, people decide to move into the neighbourhood, increasing demand for the house, raising its value.
However I cannot see the way in which a share without a dividend has any underlying value, in the same way that a house has value or a pound of rice has value. It seems that the value is purely manufactured by the bidding process, and that the only 'capital gains' that are possible come from those bidding up the price in search of capital gains (a circular process).
Please enlighten me, I am very lost 
Cheers!


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## Synergy (16 November 2010)

When you buy a share, you are buying a very small part of a company - You become a part owner of that company. The company has value, so the share also has value.


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## skc (16 November 2010)

tothemax6 said:


> Hi all,
> I have a question which has been bugging me for a while, hoping to get some thoughts from those who know more about shares.
> The question is, what actually gives a share its value? Initially, my impression (before I actually bought some shares) was that dividends were what gave the shares value. Makes sense, in the same way that interest gives a term-deposit value. However, it appears that a large number of shares have no dividend. Also, major shares which do have dividends often have negligible returns - often less than inflation.
> So of course the only answer to this is 'the value of shares comes from the potential capital gains'. This I cannot understand, although it does appear to be the main reason people buy shares. When one gets capital gains, it is typically because the asset becomes more valuable. As an example, I buy an ounce of platinum, changes in industry cause increase demand for platinum raising its value. Or as another example, I buy a house, people decide to move into the neighbourhood, increasing demand for the house, raising its value.
> ...




In theory you are correct. If a company never pays dividend or return cash to shareholders than the value of the company is zero. Since what good is $100m cash sitting in the company if you were NEVER going to be able to get your hands on it? 

In practice, company rises in value because what it owns can make more money than before. It is highly unlikely that the money will be trapped inside the company forever. And in those circumstances you will find that the market will mark down the share price (comapred to the company's assets or even cash), or some active shareholders will pressure management to give back the cash.

And in terms of "value" being manufactured by the bidding process... perception is often reality. And isn't that just the same as the house or bag of rice example you've mentioned? What is the value unless someone is willing to buy it?


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## Tanaka (16 November 2010)

I just completed reading Roger Montgomery's book 'Value Able'. The book teaches how to find the intrinsic value of a company. Most companies on the ASX and any market for that matter trade above their intrinsic value. When you buy a stock you are buying part of a company (it'ss assets, income and debt), it doesn’t matter if they don’t pay a dividend as long as they are using that money to grow at a better rate than you can find in a bank account or property. There is a thread about Roger Montgomery on in this forum. Have a look at his website rogermontgomery.com. IMO The reason most stocks trade at above their intrinsic value is that people are speculating about future performance of the company.


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## Tysonboss1 (16 November 2010)

tothemax6 said:


> Hi all,
> I have a question which has been bugging me for a while, hoping to get some thoughts from those who know more about shares.
> The question is, what actually gives a share its value? Initially, my impression (before I actually bought some shares) was that dividends were what gave the shares value. Makes sense, in the same way that interest gives a term-deposit value. However, it appears that a large number of shares have no dividend. Also, major shares which do have dividends often have negligible returns - often less than inflation.
> So of course the only answer to this is 'the value of shares comes from the potential capital gains'. This I cannot understand, although it does appear to be the main reason people buy shares. When one gets capital gains, it is typically because the asset becomes more valuable. As an example, I buy an ounce of platinum, changes in industry cause increase demand for platinum raising its value. Or as another example, I buy a house, people decide to move into the neighbourhood, increasing demand for the house, raising its value.
> ...




The value of a company is based on the value of the assets it owns and the earnings generated by these assets. A company does not have to pay a dividend to have a value, for example a company could not pay a dividend because it chooses to reinvest it's earnings back into opening more stores and generating further profits.

Picture this, You own shares in coca cola back in the 1900. they have one plant producing coke earning $50,000 / year. they can choose to pay out $50,000 per year in dividends or use the $50,000 per year to build a new plant every 3 years. 

obviously the value of the coke company will sky rocket over time as they open more plants and don't pay dividends.

If they were opening a new plant every 3 years, then they would be earning about 33% on any money left in the business, compared to about 6% interest you would get in a bank account if they paid it out to you.


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## Tysonboss1 (16 November 2010)

tothemax6 said:


> Also, major shares which do have dividends often have negligible returns - often less than inflation.




A share represents part ownership in a company that more than likely holds a large portion of it's net worth in real assets not cash, So this in itself offers some form of protection against inflation.

All things being equal, Inflation affects the buying power of cash. So the effect of inflation is higher prices. Which over time would see the prices the company charges for it's products as well as the $value of it's assets rise. 

So over time inflation will be offset by higher dividends and higher share prices.

Same with property, you may look at an investment property returning 3.8% yield and think that this is only 0.8% return after inflation, but the fact is the property price and the annual rent both increase over time with inflation.

So if you are buying real assets inflation is far less important than if you are holding cash ( cash is trash )


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## Tysonboss1 (16 November 2010)

skc said:


> In theory you are correct. If a company never pays dividend or return cash to shareholders than the value of the company is zero. Since what good is $100m cash sitting in the company if you were NEVER going to be able to get your hands on it?




Berkshire Hathaway is worth $120,000 / share and has never paid a dividend or returned a cent to investors.

The reason they are worth that much is because over 50 years warren has compounded the earnings rather than pay out dividends which has ment the asset base of the company has grown to over $200 Billion and the share price has gone from $12 to more than $120,000.


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## awg (16 November 2010)

A couple of points for the OP

* Value can be assessed by various methods

* Many investors prefer companies that pay no dividend because they believe the company will provide a greater rate of return than they themselves can attain..eg Berkshire

* Another type of company that virtually never pay dividends are emerging miners, you are paying for the commercialisation of the resource, then you might be able to sell the shares you bought for 35c for $3.50.

The potential value in these projects is assesed using models developed that are appropriate to the industry


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## skc (16 November 2010)

Tysonboss1 said:


> Berkshire Hathaway is worth $120,000 / share and has never paid a dividend or returned a cent to investors.
> 
> The reason they are worth that much is because over 50 years warren has compounded the earnings rather than pay out dividends which has ment the asset base of the company has grown to over $200 Billion and the share price has gone from $12 to more than $120,000.




I understand and Berkshire Hathaway is a great example.

What I said was theoretical...in *theory*, a stock that *never * (not 50 or 100 years, but never) pay a cent out to shareholders is worth nothing. You cannot value it any other way but zero.


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## Sdajii (16 November 2010)

skc said:


> I understand and Berkshire Hathaway is a great example.
> 
> What I said was theoretical...in *theory*, a stock that *never * (not 50 or 100 years, but never) pay a cent out to shareholders is worth nothing. You cannot value it any other way but zero.




Not exactly. Let's say Company XYZ was trading at $10 per share and had a book value of $100 per share, most of which was cash or very liquid assets. Immediately the share price would increase, or, someone with enough money would come along and buy the company, or, the shareholders would demand that the money was given to them. If the share price was too low compared to the real value of the company, it would force a situation where the shareholders directly got something out of it. The shareholders do own the company and can make any decision they want. Typically the shareholders don't kick up a massive fuss and unanimously demand particular action, because most of the time the directors are going at least a remotely decent job, so the shareholders sit back happy to leave things in capable hands.

The way I understand it, if every single shareholder (or close enough to all of them) wanted to liquidate the company and distribute the money obtained amongst themselves, it would have to happen.

Obviously, generally, things aren't so drastic (because share prices do stay higher than ridiculously low values because people understand the situation and buy them before they become so insanely undervalued), but you can see that there isn't a 'zero value' on shares in a company which never pays dividends as long as the company does have value.


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## skc (16 November 2010)

Sdajii said:


> Not exactly...
> 
> The way I understand it, if every single shareholder (or close enough to all of them) *wanted to liquidate the company and distribute the money obtained amongst themselves*, it would have to happen.
> 
> Obviously, generally, things aren't so drastic (because share prices do stay higher than ridiculously low values because people understand the situation and buy them before they become so insanely undervalued), but you can see that there isn't a 'zero value' on shares in a company which never pays dividends as long as the company does have value.




No it is zero in *theory* if *no money ever leaves a company*. What you are describing there is money leaving the company via liquidation or return of capital.

Since what I describe is theoretical there isn't really much point talking about it much further. The reason that I brought it up was that it was actually a trick question in my uni finance tutorial many years back.


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## Sdajii (16 November 2010)

skc said:


> No it is zero in *theory* if *no money ever leaves a company*. What you are describing there is money leaving the company via liquidation or return of capital.
> 
> Since what I describe is theoretical there isn't really much point talking about it much further. The reason that I brought it up was that it was actually a trick question in my uni finance tutorial many years back.




Well then, what is your point? If I buy anything, whether it's a can of beans, a tonne of gold or a screwdriver set, if I don't sell it it has no value by that line of thinking. If I considered my tonne of gold or car or tools or anything else *of value* to have *zero value* I can guarantee someone would be willing to pay me more than I thought it was worth, given the chance, and that's how things' values are determined. You don't need to actually sell something to estimate their value or consider the value to exist, and shares are constantly being bought and sold anyway, so you have a constant valuation of them. The company exists, it has value, you can buy part of it, have true ownership of it, and have a say in how it is run proportional to how much of it you own. If the shareholders all demand it, the profits of the company go to the owners rather than being reinvested, but because most shareholders do understand the way it works they often want all and often most of the profits to be directly reinvested back into the property.

Things don't need to hand you cash to have value. Heck, even paintings or the chair I'm sitting on has a value, even if never sold. 

In no sense do shares have no value, and if you see it that way you've made a pretty bizarre judgement.


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## tothemax6 (16 November 2010)

Ah I see, it is because the company may release the equity back to the shareholders at some point. 


> Another type of company that virtually never pay dividends are emerging miners, you are paying for the commercialization of the resource, then you might be able to sell the shares you bought for 35c for $3.50.



Well again, that would only be if the company was at some point liquidated and returned the equity to the shareholders (i.e. when the exploration was finished and the land was handed over to a mining company etc). Otherwise, again we have the circular issue - the $3.50 is being produced by bidding the price up only.
I suppose my sticking point was the actual link between the equity and the share value. And it seems that since companies can/do return the equity to the shareholders at times, the price is actually linked to this future return.
Although mind you, I have seen some P/B ratios of 3+. Supposedly this is because the expected future equity is likely to be much larger, according to those buying.
Cheers


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## robusta (16 November 2010)

Tysonboss1 said:


> The value of a company is based on the value of the assets it owns and the earnings generated by these assets. A company does not have to pay a dividend to have a value, for example a company could not pay a dividend because it chooses to reinvest it's earnings back into opening more stores and generating further profits.
> 
> Picture this, You own shares in coca cola back in the 1900. they have one plant producing coke earning $50,000 / year. they can choose to pay out $50,000 per year in dividends or use the $50,000 per year to build a new plant every 3 years.
> 
> ...




The above post is a perfect example of the compounding you can get within a company that has a high ROE and can retain those earnings and still earn a high ROE on those earnings.

This is how it would work with a company earning 20% ROE (return on equity) ,retaining all profits and assuming the market will only ever pay 10x earnings (PE 10)
Year 1
Equity $1.00 earnings $0.20 share price $2.00
Year 2
Equity $1.20 earnings $0.24 sp $2.40
Year 3
Equity $1.44 earnings $0.288 sp $2.88
Year 4
Equity $1.73 earnings $0.346 sp $3.46



tothemax6 said:


> Ah I see, it is because the company may release the equity back to the shareholders at some point.
> 
> Well again, that would only be if the company was at some point liquidated and returned the equity to the shareholders (i.e. when the exploration was finished and the land was handed over to a mining company etc). Otherwise, again we have the circular issue - the $3.50 is being produced by bidding the price up only.
> I suppose my sticking point was the actual link between the equity and the share value. And it seems that since companies can/do return the equity to the shareholders at times, the price is actually linked to this future return.
> ...




It is not so much the book value but the return you can get from that book value (ROE)

Let's look at two companies with a book value of $1.00, now if I told you one company was trading at book value ($1.00)and the other was trading at twice book value ($2.00) we would probably be more interested in the cheaper company.
Now if we dig a little deeper and find the first company is earning a ROE of 10% and the second is earning 30%, this changes the whole picture.
Company A ROE 10% EPS $0.10 SP $1.00 return to shareholder = 10%
Company B ROE 30% EPS $0.30 SP $2.00 return to shareholder = 15%


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## Tysonboss1 (16 November 2010)

tothemax6 said:


> the $3.50 is being produced by bidding the price up only.




Yes, That is how the share price is decided. But obviously the more value inside the company the more people would be prepared to pay.

Price is what you pay, Value is what you get (in return for the price you pay).

I think when you purchase a share you should ask the same questions as you would when you are purchasing any other business. Most likely you would be comfortable paying an amount based on a certain multiple of it's earnings.

You would probably be comfortable paying a larger multiple for a business that is expanding and a much much smaller one for a company in decline.

There are many other factors as well, but it all comes back to what you are prepared to pay for the companies businesses, based on what they are doing now and what your opinion of their future is.


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## Julia (16 November 2010)

Tothemax:  Do you feel any wiser as a result of this thread?  Does it help you make decisions about what to buy/sell?

Have you considered that all the complicated considerations of what a company is worth may mean zilch if your capital doesn't grow?
Or at the very least if you don't receive dividends and franking credits which offset any fall in the SP?

Perhaps I over-simplify things, and I understand that the view is unacceptable to fundamentalists, but essentially buying shares in a company is the same as buying e.g. a house.  It is only worth what someone is prepared to pay for it.

Take a look at QBE.  It's endlessly touted as Australia's best managed insurance company.  Financial advisers include it as an essential part of a core portfolio.  But what has the SP done (i.e. your capital) in the last several years?
It has diminished in value.  And the yield is hardly sufficient to make up for this.

Might be another way to approach your investing.  You can spend days evaluating the intrinsic worth of a company, but if the market doesn't agree, you're simply not going to make money.


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## skc (16 November 2010)

Sdajii said:


> Well then, what is your point?
> In no sense do shares have no value, and if you see it that way you've made a pretty bizarre judgement.




Everything you say is true and valid and in practice can happen - I totally agree. What you fail to see is that my argument is a *THEORY*.

The reason that I brought it up, and the reason that it was a trick question in a finance tutorial, is that it helps you understand where does value of a share come from.

Here's the logic...
The value of the share comes from future returns.
Future returns consist of dividends, capital returns and capital gains.
Capital gains comes from people in the future placing a value on the returns further into the future.
Those returns further into the future consist of dividends, captial returns and capital gains. 
And so on...

Take it to infinity, you are left with share value is nothing more than the present value sum of all future dividends and capital returns. Capital gain doesn't come into it because, at infinity, there is no more future returns. So the last capital gain term, at time = infinity, is zero. So in a situation, again in theory, where no money ever leaves the company (so dividend and capital returns = 0) the current value has to be zero.

A somewhat imperfect example - if I put a bar of gold into a safe, throw away the key and drop it into 5000m below the ocean (so that gold will see day light again), what is the value of such gold? Or how much will someone be willing to buy it off me? 

If none of this makes sense to you that's fine... but it helped me understand the underlying components in share value at the time.


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## Tysonboss1 (17 November 2010)

skc said:


> A somewhat imperfect example - if I put a bar of gold into a safe, throw away the key and drop it into 5000m below the ocean (so that gold will see day light again), what is the value of such gold? Or how much will someone be willing to buy it off me?




The Value of the gold Bar = Current gold price - cost of commercial dive contractor/submersable vehicle - cost of safe cracker - shipping fees - risk margin.

It's almost in the same league as an oil field trapped in 5000M, It would have value for those with the organisational skills to arrange for it's removal and explotation.


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## skc (17 November 2010)

Tysonboss1 said:


> The Value of the gold Bar = Current gold price - cost of commercial dive contractor/submersable vehicle - cost of safe cracker - shipping fees - risk margin.
> 
> It's almost in the same league as an oil field trapped in 5000M, It would have value for those with the organisational skills to arrange for it's removal and explotation.




This will be the last comment I make on this...

For the last time this is a theoretical situation, and the premise states that "IF no money ever leaves the company" (or IF the gold never sees daylight). Given that premise, I have showed how the value cannot be any other figure but zero. Because that is the maths of how share value is derived. It simply cannot be any other way. Period.

And I agree that you can do all sorts of things in practice to break that premise (e.g. shareholder forcing a return on capital, deepsea extraction the gold etc). But that's missing the point.

P.S. Just realise I had a typo in my post... I meant to say "So the gold bar will *not* see the daylight again". Sorry for the confusion.


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## dhukka (17 November 2010)

Julia said:


> Perhaps I over-simplify things, and I understand that the view is unacceptable to fundamentalists, but essentially buying shares in a company is the same as buying e.g. a house.  It is only worth what someone is prepared to pay for it.
> 
> Take a look at QBE.  It's endlessly touted as Australia's best managed insurance company.  Financial advisers include it as an essential part of a core portfolio.  But what has the SP done (i.e. your capital) in the last several years?
> It has diminished in value.  And the yield is hardly sufficient to make up for this.
> ...




Yep, it is definitely unacceptable to anyone practicing a form of value investing. Back in 2007, people were prepared to pay US$75 for a share in Lehman Brothers. Was Lehman Brothers worth $75 a share because that's what someone was willing to pay for it? Or was it worth something considerably less given it's leverage and exposure to toxic assets? Anyone remember what the price of Babcock and Brown stock was in early 2008? Was it really worth that much because someone paid that price?   

How about ABC learning centres, does anyone remember that one? Go back to that thread and you will see people warning of how overvalued that stock was.  How about the NASDAQ bubble? Stocks were doubling and tripling in a matter of days when they had no revenue and little assets. Were they worth those ridiculous prices because people paid them? 

There is a confusion here between price and value, the two aren't the same thing.


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## Julia (17 November 2010)

Very fair comment, dhukka.

But it's not correct to assume from what I said about a situation where a well run, stable company is nonetheless not bringing decent returns for its shareholders, that conversely it's necessarily a good investment to buy some market darling whose SP has been inflated *despite that company's fundamentals not being sound*.

I don't know if most trend followers will check fundamentals before climbing on to an uptrend.  I do.  People who were done over by holding the stocks you mention could have - even if they hadn't been watching fundamental factors - could have got out with a relatively small loss if they'd exited at the start of the downtrend.

But many of these people said, 'hell, if it was a bargain at $X, then surely it's way more of a bargain when it has lost 50% of its value", and happily bought more.

But they are two separate arguments.

My point was simply that not all 'good' companies provide their shareholders with reasonable returns.


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## dhukka (17 November 2010)

Julia said:


> Very fair comment, dhukka.
> 
> But it's not correct to assume from what I said about a situation where a well run, stable company is nonetheless not bringing decent returns for its shareholders, that conversely it's necessarily a good investment to buy some market darling whose SP has been inflated *despite that company's fundamentals not being sound*.
> 
> ...




If that was your point it wasn't clear to me, I thought you were saying that a company's shares are simply worth what someone is prepared to pay for them. I don't know why I thought that was your point, oh wait a minute, maybe it had something to do with this: 



> but essentially buying shares in a company is the same as buying e.g. a house. It is only worth what someone is prepared to pay for it.




But anyway, why would anyone buy QBE because it has been touted as a good company? CSL is one of the most innovative, successful and well run companies to come out of Australia, I doubt many would dispute that. However 2 years ago, the stock was 15% higher than it is today, does that mean it's a badly run company? hat's why you do valuation analysis. You work out a value and compare it to the price to determine if it is worth buying or not.


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## wayneL (17 November 2010)

It's good to hear from you dhukka.


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## tothemax6 (17 November 2010)

OK QBE, CSL, the tech bubble, Lehman's brothers etc are part of my question.
It seems here that there is a huge decoupling of the values of the companies and their price. So this is a good point to question.
In the case of a sack of flour, the value is coupled directly to the exercising of the use of that flour. That is to say, people can speculate all they want, but in the end the price will hover around a price based on fundamental supply and demand of the flour. However, from what I'm reading, shares seem massively speculative. That is, since there is no use value for the share at any given time (only a possible return of the backing equity at some point), the price heads into random territory.
So to use an analogy, it seems that whilst a commodity vs its value is "a ball on a flexible stick", with the ball (price) being moved (side to side) fairly rigidly by the supply/demand (hand at the stick); a share appears to be a "ball on a long bungee cord", or perhaps in some cases, "a ball in a lotto machine, the movement of the stick being irrelevant".
Does this sound fair?
Also, to try and explain myself better, another example is that somes share act like "a fictitious entity advertised on the internet as "XYZ+", and people can bid for shares in it. The price is then randomly determined by people bidding against each other, even though the entity (since it does not exist) has no exercising value".
Btw I guess I'm still confused 
Cheers


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## Trembling Hand (17 November 2010)

Commodities are more volatile than share prices. That is they undergo larger % moves of given periods than shares. (excluding to odd penny dreadful who's market is close to no existent)

As you used a bag of flour,

A monthly chart of wheat,

Basically though its the same mechanics of an on going market. Both shares and commods and other financial instruments - continual auction - very similar result. Miss price happen daily in all of them over all time periods


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## robusta (17 November 2010)

Today is the perfect day to look at the value of shares. Because of Irish debt and Chinese inflation is the combined value of listed Australian companies worth 1.6% less today than yesterday? 
Is Monadelphous worth 2.6% less, CSl 0.52% less and CBA 0.2% more? I don't think so. So it is fairly obvious that price will often vary from the value of the company. This is probably due to fear, greed and for all I know the phases of the moon. I don't bother trying to work it out (because I cannot) I just try to take advantage of it.



dhukka said:


> There is a confusion here between price and value, the two aren't the same thing.




It is simple if the price you pay is below the value you get then things generally turn out well.



Julia said:


> Have you considered that all the complicated considerations of what a company is worth may mean zilch if your capital doesn't grow?
> Or at the very least if you don't receive dividends and franking credits which offset any fall in the SP?




It bothers me a little how complicated a lot of people make out fundamental investing to be (including a lot of fundamental investors)

Here is the technique I use to find investments, before I look at the price.

1) The business must make a profit. 
Fairly simple, no profit makes it impossible for me to find a value and keeps me from speculating. 

2) The business must have little or no debt.

3) The business must have a high ROE
Return On Equity is the most important consideration in valueing a business.
Would you invest $100 if it only returned $2.00 p/a or would you rather invest $100 to return $20 p/a? I normally search for a minimum 20% ROE

Steps 1, 2 and 3 save me a heap of effort running a red line through most of the listed companies.

4) Does the business have a competitive advantage?
You know what this means, we are talking about Woolworths. any of the big 4 banks, JB Hi Fi, Navitas....

5) Work out a value for the business.
For this example we will look at a company paying out all profits as dividends. (because I will often pay a bit more for a company that can compound returns by retaining profits and earn a high ROE on those returns)

My required rate of return for investing is at least 10% to compensate me for the risk's taken.

Now the fun bit, let's "value" some companies.
Company A
Equity / share $1.00, EPS $0.20 ROE = 20%, now I would "value" this company @ $2.00, so if I pay $2.00 all things being equal I should get my 10% return if I pay more than $2.00 my returns will be less, if I pay less my returns will be more.

Company B
Equity / share $1.00, EPS $0.35 ROE = 35%, this one I would value at $3.50 

6) Now switch the stock market back on, compare the value to the price. If you have a margin of safety (price is a decent discount to value) You have found a bargain.



Julia said:


> Might be another way to approach your investing.  You can spend days evaluating the intrinsic worth of a company, but if the market doesn't agree, you're simply not going to make money.




Disagree with this, I love it when the market doesn't agree it means I have found a bargain. If I spend a hour or two looking at the few extraordinary businesses this applies to I know the market cannot ignore their performance forever.


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## prawn_86 (17 November 2010)

On the topic of value does anyone know where one can obtain a good spreadsheet setting our ROE, div yield etc? I have built my own but its not very pretty


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## dhukka (17 November 2010)

tothemax6 said:


> OK QBE, CSL, the tech bubble, Lehman's brothers etc are part of my question.
> It seems here that there is a huge decoupling of the values of the companies and their price.




Absolutely, prices can decouple significantly from their underlying value and remain so for lengthy periods of time. That's what creates the opportunity for a value investor. The price will reflect fundamentals over the long term but may trade for significant periods at prices that don't reflect the underlying value. 

Stocks are simply a claim on a long-term stream of cash flows that investors expect to be delivered over time. What are the source of those cash flows? Usually they come in the form of dividends, but can also be capital returns. Investors also attach a terminal value for the stock, or in other words, the price they expect to receive for selling the stock. 

skc's example may be 'theoretically' true but it is of absolutely no practical use in understanding how to value a stock. 




> In the case of a sack of flour, the value is coupled directly to the exercising of the use of that flour. That is to say, people can speculate all they want, but in the end the price will hover around a price based on fundamental supply and demand of the flour.




But there is no "in the end" as TH says, it is a continual process and the fact that commodities are often more volatile than stocks demonstrates that stocks are not more speculative.  



> However, from what I'm reading, shares seem massively speculative. That is, since there is no use value for the share at any given time (only a possible return of the backing equity at some point), the price heads into random territory.
> So to use an analogy, it seems that whilst a commodity vs its value is "a ball on a flexible stick", with the ball (price) being moved (side to side) fairly rigidly by the supply/demand (hand at the stick); a share appears to be a "ball on a long bungee cord", or perhaps in some cases, "a ball in a lotto machine, the movement of the stick being irrelevant".
> Does this sound fair?




No, there is no evidence that suggests stocks are more speculative, in fact if anything commodities tend to be more speculative. 




> Also, to try and explain myself better, another example is that somes share act like "a fictitious entity advertised on the internet as "XYZ+", and people can bid for shares in it. The price is then randomly determined by people bidding against each other, even though the entity (since it does not exist) has no exercising value".
> Btw I guess I'm still confused




Maybe you are over thinking it. Robusta's examples ( although if you are going to lift examples straight from Brian McNiven and/or Roger Montgomery you should probably acknowledge it) are a useful starting point. It is important to note the difference between a company that pays out all dividends as profits and one that retains all earnings. Understanding this is the key to understanding how the value of a business can increase over time. I would recommend picking up a copy of one of Brian McNiven's books, his latest being Concise Guide to Value Investing: How to Buy Wonderful Companies at a Fair Price.


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## Julia (17 November 2010)

dhukka said:


> If that was your point it wasn't clear to me, I thought you were saying that a company's shares are simply worth what someone is prepared to pay for them. I don't know why I thought that was your point, oh wait a minute, maybe it had something to do with this:



Sorry you found it necessary to resort to sarcasm, Dhukka.  
I stand by my comment above *in terms of whether you are going to make money or not*, something I'd have thought was the fundamental purpose of our involvement in the market.

Have I expressed myself so badly that you can't see my point regarding e.g. QBE, well managed company though it might be, is simply not going to grow your capital if it continues in its current downtrend?

If the market doesn't agree that it's a company worth owning, then the SP will languish as it has.  Therefore my comment that the company's shares are simply worth - in terms of making money for you - what the market is prepared to pay for it.
Nothing to do with how you 'value' a company.





> But anyway, why would anyone buy QBE because it has been touted as a good company? CSL is one of the most innovative, successful and well run companies to come out of Australia, I doubt many would dispute that. However 2 years ago, the stock was 15% higher than it is today, does that mean it's a badly run company? hat's why you do valuation analysis. You work out a value and compare it to the price to determine if it is worth buying or not.



Well, I suppose this is just where we have a total philosophical difference.
I simply don't understand why you'd want to buy a company whose shares are not going to make you any money in the foreseeable future, when there are plenty of companies out there which will.

I simply don't get why anyone would opt for the opportunity cost of holding on to a losing or passive share just because they believe in its intrinsic value, something which seems to be infiniately variable depending on who is doing the analysis.

But that's fine.   None of us is obliged to adopt what makes someone else happy.
I just really did think most people bought shares with the aim of growing their capital and maybe receiving a reasonable yield in the process.




dhukka said:


> Absolutely, prices can decouple significantly from their underlying value and remain so for lengthy periods of time. That's what creates the opportunity for a value investor. The price will reflect fundamentals over the long term but may trade for significant periods at prices that don't reflect the underlying value.



Hence opportunity cost where your funds could in the interim be invested in a company whose SP is actually rising.


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## dhukka (18 November 2010)

Julia said:


> Sorry you found it necessary to resort to sarcasm, Dhukka.
> I stand by my comment above *in terms of whether you are going to make money or not*, something I'd have thought was the fundamental purpose of our involvement in the market.




I too thought that was the purpose, I don't know anyone, nor have I ever, who invests to lose money.



> Have I expressed myself so badly that you can't see my point regarding e.g. QBE, well managed company though it might be, is simply not going to grow your capital if it continues in its current downtrend?




I understand your point now, it was not at all clear to me before. However I don't really don't understand how your point is relevant to the thread, which is afterall about the "nature of the *value* of shares" 



> If the market doesn't agree that it's a company worth owning, then the SP will languish as it has.  Therefore my comment that the company's shares are simply worth - in terms of making money for you - what the market is prepared to pay for it.




So your point is that if XYZ is trading at $3 today then it is worth $3 to the person holding it today. I'm at a loss to understand why you feel the need to state this, this is just so blindingly obvious. 

You seem to be arguing a form of EMH? That prices reflect all available information about the stock. 



> Well, I suppose this is just where we have a total philosophical difference.
> I simply don't understand why you'd want to buy a company whose shares are not going to make you any money in the foreseeable future, when there are plenty of companies out there which will.




I don't either, actually I don't know anyone who would, the whole idea seems so obviously stupid I can't understand why you feel the need to state it. 



> I simply don't get why anyone would opt for the opportunity cost of holding on to a losing or passive share just because they believe in its intrinsic value, something which seems to be infiniately variable depending on who is doing the analysis.




Because from a value investors standpoint, if you have no idea of the value of the company, then there is no basis to assess whether the price on offer is reasonable. But nor does a value investor have to hold something that is going down, he/she should be constantly reassessing the stocks prospects based on further information, there is nothing stopping a value investor changing his/her views and cutting his/her losses. 

I understand that technical traders have no need of valuation techniques to buy a stock or make money, why can't you understand that a fundamental investor doesn't need to concern himself with the trend of the price?




> I just really did think most people bought shares with the aim of growing their capital and maybe receiving a reasonable yield in the process.




So did I, again who are these people buying shares with the aim of losing money? I've just never met anyone that stupid. 




> Hence opportunity cost where your funds could in the interim be invested in a company whose SP is actually rising.




Why is there necessarily an opportunity cost? Value investors are not prohibited from buying a stock with a rising price.


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## Julia (18 November 2010)

dhukka said:


> So your point is that if XYZ is trading at $3 today then it is worth $3 to the person holding it today. I'm at a loss to understand why you feel the need to state this, this is just so blindingly obvious.



I'd have thought so.  But you asked me to say why I said the market value of a share was what someone was prepared to pay for it, so I did.



> I don't either, actually I don't know anyone who would, the whole idea seems so obviously stupid I can't understand why you feel the need to state it.



I'll ignore the sarcasm again and just ask why, then, so many people hold stocks like QBE and CSL as core p/f stocks where the value of their capital investment is falling *when that capital could be employed in rising stocks*.

I'm not suggesting you do this, but if you look at many of the recommended core p/folios, both these stocks will have been included over the whole of the downtrending period.



> Because from a value investors standpoint, if you have no idea of the value of the company, then there is no basis to assess whether the price on offer is reasonable.



Yes, of course I understand what you're saying here.  But my different approach is that I don't actually care whether that price truly reflects the intrinsic value of the company if I can make some money out of it from the start of an uptrend.

You know as well as I do that thousands of people buy stocks they believe are undervalued (as well they might be), and hold on to them into infinity, believing that one day the market will recognise how undervalued they are and they will actually make money instead of losing it.

Again, I'm not suggesting you do this.  I don't know.

Why not just let's accept that different people have different approaches, perhaps often due to their personal circumstances?   If I need to generate a living from my capital, I'm not going to do it by buying the CSL's of the market and living in hope of growing that capital one day.
But I suppose if someone has a full time job or other source of income which meets all expenses, then that person can quite afford to take the view that they can buy what they believe is an undervalued company in the belief its 'true value' will be recognised at some stage.

I have no interest in quarelling with you, dhukka.   I apologise if I had no right to offer a suggestion that considering trends can be a useful alternative approach and wish you all the best in whatever approach best serves your own philosophy and situation.


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## dhukka (18 November 2010)

Julia said:


> I'd have thought so.  But you asked me to say why I said the *market* value of a share was what someone was prepared to pay for it, so I did.




No actually, I asked about 'value' not market value, two completely different things. Market value is just the price, the intrinsic value of a business is something altogether different. 




> I'll ignore the sarcasm again and just ask why, then, so many people hold stocks like QBE and CSL as core p/f stocks where the value of their capital investment is falling *when that capital could be employed in rising stocks*.
> 
> I'm not suggesting you do this, but if you look at many of the recommended core p/folios, both these stocks will have been included over the whole of the downtrending period.




I didn't mean to be sarcastic I genuinely can't believe anyone would knowingly do this. I guess I don't buy into your premise that "so many people" are willfully doing it.  I can understand that there may me be many people who have entrusted their investments to investment managers that invest in such stocks as QBE and CSL. But I suspect they have no clue why their managers are buying these stocks or even if they know what stocks are in their portfolio. 

Remember a lot of these managers are just shadow indexes only they do worse than the index because of transaction costs. I'm not making excuses for them, I think it's a horrible idea just to hold stocks because they are in an index and a true value investor wouldn't do it. 

A value investor who buys CSL or QBE today is doing so because he thinks it's undervalued, he may or may not be right, I personally haven't looked at either for some time. I thought CSL was overvalued when looking at it in 2007 but that would have cost me money in 2007 but saved me some in 2008 and  2009. Personally I'm not interested in stocks of this size, the time to invest in CSL was in the early 1990's, I'm interested in finding the next CSL. 





> Yes, of course I understand what you're saying here.  But my different approach is that I don't actually care whether that price truly reflects the intrinsic value of the company if I can make some money out of it from the start of an uptrend.




And I understand what you're saying, people can make money without worrying about intrinsic value, and more power to them. I thought the poster that started this thread wanted to understand what gives shares value, and what drives their price, I don't know how telling him that XYZ is worth $3 because that's what it is trading at right now, helps him.



> You know as well as I do that thousands of people buy stocks they believe are undervalued (as well they might be), and hold on to them into infinity, believing that one day the market will recognise how undervalued they are and they will actually make money instead of losing it.
> 
> Again, I'm not suggesting you do this. I don't know.




There may well be thousands of people doing this, but you are mistaking a poor psychological approach to investing for a fault of fundamental or value investing. My mother is a perfect example, I've told her time and time again, if the reason you bought the stock has changed and there is no evidence for it being undervalued anymore, then it's time to get out, however she just says "oh I'll just hold it and see what happens, it might go up again", this is a woman who has no business investing in stocks as far as I'm concerned. She clearly doesn't understand what she's doing. She is also not following any disciplined approach based on fundamental or value investing. She is simply speculating. 




> Why not just let's accept that different people have different approaches, perhaps often due to their personal circumstances?




I do accept that, I have doubts that you do though. I don't think your really understand what a fundamental or value investing approach is all about. You seem to think it's about buying a stock that is out of favour or in a downtrend and hoping it will turn around. Your comments on opportunity cost seem to confirm this. 



> If I need to generate a living from my capital, I'm not going to do it by buying the CSL's of the market and living in hope of growing that capital one day.




Maybe not, but what has that got to do with the opening poster's questions about value? 



> But I suppose if someone has a full time job or other source of income which meets all expenses, then that person can quite afford to take the view that they can buy what they believe is an undervalued company in the belief its 'true value' will be recognised at some stage.




I think the veiled sarcasm here underlies your beliefs, I don't think you actually believe in the concept of intrinsic value. You think value and price are the same thing. If that is the case it is unfortunate because you can never understand a value investing approach. 



> I have no interest in quarelling with you, dhukka.   I apologise if I had no right to offer a suggestion that considering trends can be a useful alternative approach and wish you all the best in whatever approach best serves your own philosophy and situation.




I didn't think we were quarrelling, I call it debate, considering trends may be useful, I agree, but it doesn't help with questions of value.


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## robusta (18 November 2010)

dhukka said:


> Robusta's examples ( although if you are going to lift examples straight from Brian McNiven and/or Roger Montgomery you should probably acknowledge it) are a useful starting point. It is important to note the difference between a company that pays out all dividends as profits and one that retains all earnings. Understanding this is the key to understanding how the value of a business can increase over time. I would recommend picking up a copy of one of Brian McNiven's books, his latest being Concise Guide to Value Investing: How to Buy Wonderful Companies at a Fair Price.




Just for the record the examples were my own, but the theory came from Roger Montgomery's Valeable. To learn about the value of shares reading anything by Benjamin Graham, Brian McNiven and Roger Montgomery would be a good start.


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## Julia (18 November 2010)

dhukka said:


> I think the veiled sarcasm here underlies your beliefs, I don't think you actually believe in the concept of intrinsic value. You think value and price are the same thing. If that is the case it is unfortunate because you can never understand a value investing approach.



No, quite obviously I don't really believe in the whole 'value investing' approach.  
Any more than you believe in trend following.

I have already suggested in my last post a conciliatory approach of 'each to his own' but you seem determined to maintain an argument.

I frankly don't have either the energy or the interest to pursue what has become a pointless discussion.  I've tried to be polite and draw the discussion to a reasonably amicable conclusion, wishing you all the best in your endeavours.
I now give up.


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## dhukka (18 November 2010)

Julia said:


> No, quite obviously I don't really believe in the whole 'value investing' approach.
> Any more than you believe in trend following.
> 
> I have already suggested in my last post a conciliatory approach of 'each to his own' but you seem determined to maintain an argument.
> ...




But I do believe in trend following, I believe people can and do make consistent money from it. I also have taken the time to understand it. 

I've tried to address your misconceptions about fundamental investing but you aren't interested in discussing it, it is clear you have made up your mind without an attempt to even find out what it is you don't believe in. Here is a simple question, do you think the price of a stock is equal to it's underlying value?


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## tothemax6 (19 November 2010)

> Maybe you are over thinking it. Robusta's examples ( although if you are going to lift examples straight from Brian McNiven and/or Roger Montgomery you should probably acknowledge it) are a useful starting point. It is important to note the difference between a company that pays out all dividends as profits and one that retains all earnings. Understanding this is the key to understanding how the value of a business can increase over time.



I think over things more than others, I agree, but that's my thing I guess. I totally understand all the talk about how the value of a company is determined. My problem is purely with the link between the equity of a company and its share price. 
To try and illustrate my point better, what is the difference between a piece of paper saying "You own this official piece of paper printed by XYZ Co", and a share, if the company never actually pays out from the equity? If it doesn't then there is no link between the equity and the shares - it is all fictional. The other end of the spectrum would be a share which gives you full exercising rights over the underlying equity - i.e., you can withdraw that equity in exchange for the share at any time.


> Stocks are simply a claim on a long-term stream of cash flows that investors expect to be delivered over time. What are the source of those cash flows? Usually they come in the form of dividends, but can also be capital returns. Investors also attach a terminal value for the stock, or in other words, the price they expect to receive for selling the stock.



You aren't understanding what I am saying - yes the stream of cash flow gives the share a value (just like a term-deposit). But if there is no cash flow (nil-dividend stock), the capital return is detached from any value other than itself. You could just as soon create "fakecomsec" dot com, with imaginary shares, and then people do the trading thing as usual. 


> Today is the perfect day to look at the value of shares. Because of Irish debt and Chinese inflation is the combined value of listed Australian companies worth 1.6% less today than yesterday?



Well yes. In a news event, information that was not previously known (and thus had a lesser effect on the share price) becomes know - increasing its effect on the share price. Chinese inflation could result in less purchasing power of the Yuan (although it is their fault, tying it to the inflating dollar and all), which could result in them purchasing less Aussie commodities. Investors, who had not known this before, now know it, and the new risk-knowledge reduces the value of the shares commensurately.
That is, if the equities underlying the shares is actually connected to the shares.
Cheers


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## dhukka (19 November 2010)

tothemax6 said:


> My problem is purely with the link between the equity of a company and its share price.
> To try and illustrate my point better, what is the difference between a piece of paper saying "You own this official piece of paper printed by XYZ Co", and a share, if the company never actually pays out from the equity? If it doesn't then there is no link between the equity and the shares - it is all fictional.




No it's not fictional at all, you have completely misunderstood both 'shares' and 'equity'. You need to go back to basics. What is a share? What is Equity?

Take your example, if you have a piece of paper that says "You own this official piece of paper printed by XYZ Co" then what do you have? You have a piece of paper with some ink on it. What is that worth? I doubt it's worth anything, try selling it and find out what you can get for it.

Now imagine that you bought a share of XYZ company on the stock exchange, let's say XYZ is a food retailer like Woolies. Your share is not just a piece of paper. You are a part owner of XYZ, that means you partly own a share in all the assets and liabilities of that company, land supermarkets etc. What is it worth? Even if it doesn't pay a dividend? Well that's dependent on the kinds of returns the company generates. If you want to realise your investment right now, you can go straight to your broker and sell your share for a price, that's the function of the stock exchange. The price, may or may not reflect the underlying value of the company. 



> The other end of the spectrum would be a share which gives you full exercising rights over the underlying equity - i.e., you can withdraw that equity in exchange for the share at any time.




You are making a distinction that doesn't exist, shares are equity, that's why shares are commonly referred to as 'equities', if you own a share you own an equity stake in the company. You can withdraw your equity stake at any time by selling your shares on the stock exchange. (assuming there is a liquid market for your shares/equity)



> You aren't understanding what I am saying - yes the stream of cash flow gives the share a value (just like a term-deposit). But if there is no cash flow (nil-dividend stock), the capital return is detached from any value other than itself. You could just as soon create "fakecomsec" dot com, with imaginary shares, and then people do the trading thing as usual.





It's not only dividends that give a company it's value, just because a company doesn't pay dividends doesn't mean it's value becomes 'detached'. The equity has a value that can be calculated by taking into account the company's return on equity. 

How can you trade imaginary shares? It's impossible.


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## Dreadweave (19 November 2010)

I look at it very simply, there is no other way really.


A share has value because someone is willing to pay for it.  the fact that you even buy the share in the first place is evidence of this,  and that someone like you in the future may do the same thing and buy the shares from you.

shares have value in alot of cases simply because they can be traded.

in a perfect world shares would not be traded, people would only buy a share if the company paid a dividend.  Human nature itself, greed, crowd phychology and understanding how this works adds the value to a share.  Simply, because it can be traded, and that people will most likely buy it from you somewhere later on.

Because the share is actually a part of a company, there is some security or a feeling of safety that in some case one day if the company had to liquidate you might at lease get some of your money back. imho that is the only reason that people trade real shares and not fake shares.


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## tothemax6 (19 November 2010)

> It's not only dividends that give a company it's value, just because a company doesn't pay dividends doesn't mean it's value becomes 'detached'. The equity has a value that can be calculated by taking into account the company's return on equity.
> How can you trade imaginary shares? It's impossible.



It is not impossible, you simply have an identical copy of comsec, but without the term 'actual own a share of the company' involved, and none of the listed companies have dividends. Then it is exactly the same, and people can trade their shares in the imaginary companies. After all, what is the difference in terms of the price action against the equity? You can have all the news about the companies, what they are doing etc, and people can use this information to decide the value of the shares - but like real share it is their trading decisions alone which actually set the price of the share.
Another example - we sell shares in "Sweden" - yes the actual country. We then say 'you own a part of all the assets and liabilities of Sweden'. And people then trade these shares, based on their opinions of what would value Sweden, since it is all fictitious any way and there is no way to retrieve the equity of Sweden promised by the share directly.
However, the one thing I can think of which might give a share real value (tying it to its equity) is the fact that the men with lots of the shares CAN exercise control over the company via voting, thus the minor holdings of shares by many are linked to the major holdings, and thus to those who can do as they wish with the equity.


> A share has value because someone is willing to pay for it. the fact that you even buy the share in the first place is evidence of this, and that someone like you in the future may do the same thing and buy the shares from you.
> shares have value in alot of cases simply because they can be traded.



Well the share I bought does in fact have a dividend, albeit tiny. But yes you see my point - it has value mostly because it is traded rather than the equity behind it, kind of like fiat money.
Cheers


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## dhukka (19 November 2010)

tothemax6 said:


> It is not impossible, you simply have an identical copy of comsec, but without the term 'actual own a share of the company' involved, and none of the listed companies have dividends. Then it is exactly the same, and people can trade their shares in the imaginary companies. After all, what is the difference in terms of the price action against the equity? You can have all the news about the companies, what they are doing etc, and people can use this information to decide the value of the shares - but like real share it is their trading decisions alone which actually set the price of the share.
> Another example - we sell shares in "Sweden" - yes the actual country. We then say 'you own a part of all the assets and liabilities of Sweden'. And people then trade these shares, based on their opinions of what would value Sweden, since it is all fictitious any way and there is no way to retrieve the equity of Sweden promised by the share directly.
> However, the one thing I can think of which might give a share real value (tying it to its equity) is the fact that the men with lots of the shares CAN exercise control over the company via voting, thus the minor holdings of shares by many are linked to the major holdings, and thus to those who can do as they wish with the equity.




tothemax, it would be a good idea for you to sell any shares you have and forget about the stockmarket. You are clearly very confused. If your comments were intended as a wind-up they would make much more sense.


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## robusta (19 November 2010)

tothemax6 said:


> It is not impossible, you simply have an identical copy of comsec, but without the term 'actual own a share of the company' involved, and none of the listed companies have dividends. Then it is exactly the same, and people can trade their shares in the imaginary companies.



Or we could all invest is fairy dust, sounds great to me.


tothemax6 said:


> After all, what is the difference in terms of the price action against the equity? You can have all the news about the companies, what they are doing etc, and people can use this information to decide the value of the shares - but like real share it is their trading decisions alone which actually set the price of the share.




I like to call this a "market" where the price I get is what someone else is prepared to buy or sell the share. This is based on trading decisions.



tothemax6 said:


> Another example - we sell shares in "Sweden" - yes the actual country. We then say 'you own a part of all the assets and liabilities of Sweden'. And people then trade these shares, based on their opinions of what would value Sweden, since it is all fictitious any way and there is no way to retrieve the equity of Sweden promised by the share directly.




I don't know a lot about it but are currency and bond markets a reflection of a country's value?
Maybe you are trying to make a point about speculation, you could probably sell mining rights on Mars, or Tulip futures but are they a good investment?



tothemax6 said:


> However, the one thing I can think of which might give a share real value (tying it to its equity) is the fact that the men with lots of the shares CAN exercise control over the company via voting, thus the minor holdings of shares by many are linked to the major holdings, and thus to those who can do as they wish with the equity.




Or maybe a share (or part ownership) in a good company that makes a profit and has a better than fair chance of making more profit's in the future could be worth something.



tothemax6 said:


> Well the share I bought does in fact have a dividend, albeit tiny. But yes you see my point - it has value mostly because it is traded rather than the equity behind it, kind of like fiat money.
> Cheers




Hey we all live with fiat money. Do not discount the human desire to gamble and speculate.
The first rule I look at for a company for my investments is it must make a profit. That does not stop a heap of stocks that are engaged in drilling holes in the ground, developing new drugs... from trading on the ASX. A lot of people make money on these stocks, for me I call them speculative and value them at $0.00 This does not mean they are worthless it just means I cannot find a logical way to value them. 

On the subject of fiat money how do you value one good old Australian dollar?
We could argue it is worth next to nothing or it could save your life.


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## So_Cynical (19 November 2010)

XYZ goes up XYZ goes down...the price of XYZ changes at any measurement of time, often ending up at the same price at different moments in time and all the time not reflecting the real "value" of XYZ just the price XYZ is trading at, at that particular moment in time.

How well we exploit the price differences in XYZ over time determines how successful we are as traders and investors....this is how it works and any need of deeper understanding is simply over complicating the simplicity of perception, sentiment and reality.


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## robusta (20 November 2010)

So_Cynical said:


> XYZ goes up XYZ goes down...the price of XYZ changes at any measurement of time, often ending up at the same price at different moments in time and all the time not reflecting the real "value" of XYZ just the price XYZ is trading at, at that particular moment in time.




In the short term this is correct, but over the long term the price will reflect the value of the company.



So_Cynical said:


> How well we exploit the price differences in XYZ over time determines how successful we are as traders and investors....this is how it works and any need of deeper understanding is simply over complicating the simplicity of perception, sentiment and reality.




I find it really difficult to work out perception and sentiment but easy to work out the reality of a profitable business.


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## tothemax6 (20 November 2010)

dhukka said:


> tothemax, it would be a good idea for you to sell any shares you have and forget about the stockmarket. You are clearly very confused. If your comments were intended as a wind-up they would make much more sense.



And you have done nothing to address my post, only criticize its existence. Thanks for nothing. My assumption is that logically, there must be a link between the equity and the shares, but I question the extent to which this link exists, and the extent to which the price action is determined randomly by bidding actions rather than the past/future valuation of the equity.


> Or we could all invest is fairy dust, sounds great to me.



But this is exactly my point, you could list 'fairy dust' as a share, and people who buy and sell it in the same way as a no-dividend, no-equity-return, share, since in neither case can the shareholder exercise the use of the equity. Fairy dust can no more be exercised (it doesn't exist) than the equity underlying a share can.


> Or maybe a share (or part ownership) in a good company that makes a profit and has a better than fair chance of making more profit's in the future could be worth something.



Why? You don't have access the the profits. In the case of a 1 owner company, the owner can do as he wishes with the profits, so they are worth something to him. To the 1/10000th part owner, he can't use the profits, so again, we return the issue of the link between share and equity.


> On the subject of fiat money how do you value one good old Australian dollar?
> We could argue it is worth next to nothing or it could save your life.



Well I value it by the fact that it is the means of exchange, and is thus the most marketable product, and hence it is high value (even though its just bits of plastic). Again, the only issues it has are the same as always - there is nothing to stop its volume increasing except the morality of men. But thats another topic 
Cheers


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## robusta (20 November 2010)

tothemax6 said:


> My assumption is that logically, there must be a link between the equity and the shares, but I question the extent to which this link exists, and the extent to which the price action is determined randomly by bidding actions rather than the past/future valuation of the equity.




Are you asking about the difference between investing and speculating? To me when valuing shares if a company makes no money then I classify it a speculative and value it at $0.
With companies making a profit there is a definite link between eqiuty and the share price over the long term. Compare JB Hi Fi and Clive Peters for example. (before Clive Peters went bust)



tothemax6 said:


> But this is exactly my point, you could list 'fairy dust' as a share, and people who buy and sell it in the same way as a no-dividend, no-equity-return, share, since in neither case can the shareholder exercise the use of the equity. Fairy dust can no more be exercised (it doesn't exist) than the equity underlying a share can.




I actually have to agree with you here. There are a whole heap of companies on the ASX that are speculative and as a value investor I can't find a value for. This however helps me as I get to draw a red line through these shares and move on to something that will give me a RETURN on my equity.

Maybe a example would help:
_Company XYZ, a explorer recently listed with 10 million shares @ $1.00 a share. We have a few pegs in the ground out the back of Oodnadatta and we are going to drill some holes and find something._

Now what is XYZ worth?

Some would say $1.00 a share as this is the equity per share. But I would value at $0 because they are going to spend that $1.00 drilling holes in the ground.

Some would say they have a 20% chance of finding something but to me this is speculation and remember I require a Return on my equity so to me still worth $0.

_One year later the rumour mill cranks up XYZ have found something bigger than BHP's Olympic Dam, trading volume quadruples and the sp goes from $0.50 to $1.85 _

Now what is XYZ worth?

Nothing has changed it is all still speculation I still get $0.00

We could go on but you get my point. Until a resource is found and we know how much is there and the cost of extracting it the value of XYZ is pure speculation.
This goes for the new whiz bang technology or the latest biotech stock, until the product makes it to market we are speculating.




tothemax6 said:


> You don't have access the the profits. In the case of a 1 owner company, the owner can do as he wishes with the profits, so they are worth something to him. To the 1/10000th part owner, he can't use the profits, so again, we return the issue of the link between share and equity.




Now I must disagree with you. Take a look back at Woolworths, JB Hi Fi and The Reject Shop and you will find a direct link between the equity, the ROE and the share price over any decent period. (say ten years). Now compare these to the also rans, Coles Myer group, Clive Peters, Qantas.
The share price follows the profits on the equity left in the businesses by the owners (shareholders).

Try this example of a company retaining all profits. (this is fairly rare in Australia but plenty have a low payout ratio when in growth phase.)

_Company UVW, a retailer based in Tasmania with 15 stores, we are a giftware store looking to expand on the mainland we have a competitive advantage (cheapest, best service/product range) we earn a constant 40% ROE and we are listing 10 million shares @$3.00 / share, after listing the equity per share will be $0.50_

Now what is UVW worth?

At first glance paying $3.00 to get $0.50 equity does not sound like a good deal. But the chance to earn 40% compounded is too good to pass up.

Using one Roger Montgomery's formula I would be happy to pay up to $6.00 for UVW so let's see how we go.

Year 1
Equity $0.50 profit $0.20 fair value with 10% required return $6.05
Year 2
Equity $0.70 profit $0.28 fair value with 10% required return $8.48
Year 3
Equity $0.98 profit $0.392 fair value with 10% required return $11.88
Year 4
Equity $1.372 profit $0.55 fair value with 10% required return $16.63
Year 5
Equity $1.92 profit $0.38 fair value with 10% required return $23.28

Now the owner has been doing exactly what I would want to do with the profits, reinvesting them and earning 40% compounded. Sound extreme? Take a look at JB Hi Fi and the Reject shop in the first ten years after listing.

What about the price? Well it has probably fluctuated all over the place depending on sentiment and whatever. But the market cannot ignore that profit growth forever and over any meaningful period of time I would bet sp would end up fairly close to that fair value.

Sooner or later UVW will have opened all the stores they can and start to pay a dividend but believe it or not this makes UVW less value to me.

Year 6
Equity $2.30 profit $0.92 dividend $0.92 fair value with 10% required return $9.20
Look at it the other way, pay $9.20/ share to earn $0.92 dividend equals 10%return.


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## robusta (20 November 2010)

If the above post sound like rubbish to you let's try a experiment.
Pick any listed company you like.
Don't tell me the company name, the only thing I ask is it must make a profit every year.
Get the annual report or look on your online broker financials screen and give me:
Earnings per share, Dividends per share, ROE, book value or equity per share, payout ratio and shares on issue for a period of at least five years preferably ten and we will see how close my value for the company comes to the actual share price.


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## dhukka (21 November 2010)

tothemax6 said:


> And you have done nothing to address my post, only criticize its existence. Thanks for nothing.




Actually I've tried to address your questions numerous times, you are clearly very confused.  But lets try again.



> My assumption is that logically, there must be a link between the equity and the shares but I question the extent to which this link exists, and the extent to which the price action is determined randomly by bidding actions rather than the past/future valuation of the equity.




As Robusta suggests, companies that are purely speculative, i.e that don't earn profits or even have any revenues such as a mining company with a few holes in the ground or a biotechnology company with just an idea. These type of companies will almost always show no correlation between the equity in the company and the share price.

However companies such as JB Hi-Fi or the Reject Shop that have a clear track record of increasing profits and equity per share show a clear correlation with their share price and it has nothing to do with the fact that they pay some earnings out as dividends. The same phenomenon can be seen with the likes of AAPL, a company that doesn't pay any dividends.



> But this is exactly my point, you could list 'fairy dust' as a share, and people who buy and sell it in the same way as a no-dividend, no-equity-return, share, since in neither case can the shareholder exercise the use of the equity. Fairy dust can no more be exercised (it doesn't exist) than the equity underlying a share can.




This is just completely false. When you own a share you own a share of the equity of the company. If, as in the case of APPL, the company continues to reap high returns on that equity and doesn't pay any dividends the stock market will assign a higher price to the shares over the long term. Sure the price may fluctuate up and down day to day, week to week but over the long term the price will reflect the increasing equity per share. 

 If somebody decided to list a company called fairy dust that did nothing (that is it had no business), if there were actually people stupid enough to buy the stock they may be able to bid the price up in the short term, but eventually (and I imagine in the case of a company that has no business it would be relatively quickly) it would soon be realized that the company was worthless because it does nothing. You are saying that APPL, a company that pays no dividends but makes and sells leading technology products (iphones, ipads, macs etc.) is the same. Surely you can see this is ridiculous. A share in APPL is a share in a company with high revenue generating products, valuable assets and IP. The fairy dust company has nothing, it's equity is worth nothing, whereas APPL's equity is getting more and more valuable every quarter. 

When shareholders in APPL want to realize the value of their equity they will get a price commensurate with what investors are willing to pay at that time, and given the stellar returns the business has been generating in recent years that price will continue to increase (short-term price fluctuations notwithstanding). Shareholders in fairy dust limited will get nothing because the company is worthless except in the very unlikely case that someone would be stupid enough to offer a price for it. 





> Why? You don't have access the the profits. In the case of a 1 owner company, the owner can do as he wishes with the profits, so they are worth something to him. To the 1/10000th part owner, he can't use the profits, so again, we return the issue of the link between share and equity.




The 1/10000th part owner may not be able to use the profits but he owns a share of them, those profits are worth something, people are willing to pay for them as evidenced by APPL, they won't be willing to pay for something that doesn't exit.


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## tothemax6 (23 November 2010)

> This is just completely false. When you own a share you own a share of the equity of the company. If, as in the case of APPL, the company continues to reap high returns on that equity and doesn't pay any dividends the stock market will assign a higher price to the shares over the long term. Sure the price may fluctuate up and down day to day, week to week but over the long term the price will reflect the increasing equity per share.



OK my question is still _why_ is this the case. It is all very well saying "X is Y", but it is never an answer to "Why is X Y?". I have no problem with the factors that modify the value of the equity (present and future), and I understand all the factors you are mentioning. But you have avoided the question by using a gap, specifically in this case "the stock market will assign". Why will it do it? You are speaking of a constant state of "should" arbitrage, in which all values are determined by what traders think "should" be the case. There must be a link between the "should" and "is", or it is all false.
In the case of a bag of wheat, the "should" is all very well, but the "is" comes from the real act of people producing and consuming wheat. The "should" cannot but help be connected to the "is". To try again to explain why I think the link can be missing in the case of equities:
Imagine a bus. The original bus owner issues 1000 shares in the bus, keeping another 1001 for himself. The shares 'title the owner to a share in the bus'. However, these share holders cannot ride the bus at a discount, they cannot hire out the bus, they cannot collect any profits created by the bus, they cannot sell any part of the bus, they cannot make any modifications to the bus, etc, etc, etc. In what way is the equity in the bus then connected to the share price? Purely by "should" arbitrage. In reality, even if it trades at $10, the share is worth $0. Yes or No?
PS, I am not having a go at you or anything, I am just determined to get to the bottom of this 


> If the above post sound like rubbish to you let's try a experiment.
> Pick any listed company you like.
> Don't tell me the company name, the only thing I ask is it must make a profit every year.
> Get the annual report or look on your online broker financials screen and give me:
> Earnings per share, Dividends per share, ROE, book value or equity per share, payout ratio and shares on issue for a period of at least five years preferably ten and we will see how close my value for the company comes to the actual share price.



No, 'twas a good post . I am having difficulty deducing these values from the information in the financial screen. Is there a particular book you would recommend for learning about this 'value investing', since I am more inclined towards a 'buy and hold' investment strategy than a day-trading (shudder) strategy (for time/stress/being able to concentrate on other things reasons). 
Cheers


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## ducati916 (23 November 2010)

*et al*

I would actually second robusta's suggestion in that you pick a company, and several people who use fundamental analysis to value stocks, can undertake an analysis of said company and provide a valuation.

For myself, I would need the name of the company so that I could undertake an analysis of the financial statements.

Should make for a robust discussion, and clarify many of the abstract issues that have already been raised.

jog on
duc


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## dhukka (23 November 2010)

tothemax6 said:


> OK my question is still _why_ is this the case. It is all very well saying "X is Y", but it is never an answer to "Why is X Y?". I have no problem with the factors that modify the value of the equity (present and future), and I understand all the factors you are mentioning. But you have avoided the question by using a gap, specifically in this case "the stock market will assign". Why will it do it? You are speaking of a constant state of "should" arbitrage, in which all values are determined by what traders think "should" be the case. There must be a link between the "should" and "is", or it is all false.




If you understand all the factors that effect the value of the equity then how can you not understand how these same factors affect prices? In the case of AAPL the value of the business is increasing, so investors are willing to pay more for it, what is confusing here?

Remember that a lot of all traders are not concerned with value, they couldn't care less what the underlying or intrinsic value of a stock is, they may be purely momentum players following a trend and therefore equity 'values' have no meaning to them. 




> To try again to explain why I think the link can be missing in the case of equities:
> 
> Imagine a bus. The original bus owner issues 1000 shares in the bus, keeping another 1001 for himself. The shares 'title the owner to a share in the bus'. However, these share holders cannot ride the bus at a discount, they cannot hire out the bus, they cannot collect any profits created by the bus, they cannot sell any part of the bus, they cannot make any modifications to the bus, etc, etc, etc. In what way is the equity in the bus then connected to the share price? Purely by "should" arbitrage. In reality, even if it trades at $10, the share is worth $0. Yes or No?




It's hard to know what the value of the 'bus' is, does it make any money?  Or does the bus just sit idle in someone's driveway? How old is it? Does it work? Even if the bus does nothing the shares are probably worth something because there will be a liquidation value for the bus and all the shareholders will get a piece. 

You seem to have trouble understanding what a shareholding actually is. Regardless of whether the stock pays a dividend or not, a share entitles the owner to a claim on the profits (or losses) of the company. Paying dividends doesn't affect this relationship. Whether you have the ability to tell management what to do with the profits is irrelevant.


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## Knobby22 (23 November 2010)

ducati916 said:


> *et al*
> 
> I would actually second robusta's suggestion in that you pick a company, and several people who use fundamental analysis to value stocks, can undertake an analysis of said company and provide a valuation.
> 
> ...





I'll be in that. Pick a company and we shall all value it in our own way.


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## Tysonboss1 (23 November 2010)

tothemax6 said:


> . Is there a particular book you would recommend for learning about this 'value investing', since I am more inclined towards a 'buy and hold' investment strategy than a day-trading (shudder) strategy (for time/stress/being able to concentrate on other things reasons).
> Cheers




The intelligent investor, By ben graham.

Ben is the father of value investing.

Here is a link to a video series with the audio of the first couple of chapters.
listen to atleast the first few videos and you will gain a wealth of infomation.

http://www.youtube.com/watch?v=02_kWrNOAQk


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## ducati916 (23 November 2010)

Knobby22 said:


> I'll be in that. Pick a company and we shall all value it in our own way.




There is obviously a wide variety to choose from: a resource company like BHP, a retailer like WOW, a biotech like CST, each have their own distinct analysis style [for want of a better word]

It would be quite fascinating to choose 1 [not necessarily any of these] and have the various styles of individual analysis.

I think we're waiting on *tothemax6* to pick a company.
jog on
duc


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## tothemax6 (23 November 2010)

Very well, I nominate the company Nufarm (NUF).


> It's hard to know what the value of the 'bus' is, does it make any money? Or does the bus just sit idle in someone's driveway? How old is it? Does it work? Even if the bus does nothing the shares are probably worth something because there will be a liquidation value for the bus and all the shareholders will get a piece.



The bus is new and in use. And yes this is what I am getting at, liquidation is a link between the equity and the shares. Is there an example of a company recently being liquidated, resulting in the shareholders realizing a profit from the returns?
Cheers


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## So_Cynical (23 November 2010)

tothemax6 said:


> Very well, I nominate the company Nufarm (NUF).




Good choice, NUF has been thru the ringer lately, lots of issues so should throw up some interesting analysis, personalty i added NUF to a watchlist back in July 09 at $9.10 ~ watched with interest and completely made a mess of my bottom call in the NUF thread so have lost all confidence in my ability's (re NUF) to offer any analysis with confidence.....other than to say that i have put NUF in my too hard basket and prefer to look elsewhere for new entry's.


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## robusta (23 November 2010)

tothemax6 said:


> Very well, I nominate the company Nufarm (NUF).
> 
> The bus is new and in use. And yes this is what I am getting at, liquidation is a link between the equity and the shares. Is there an example of a company recently being liquidated, resulting in the shareholders realizing a profit from the returns?
> Cheers




Think I understand the confusion now. IMO it is not so much the equity but the return on that equity that gives the shares value.
This makes NUF a good example.

First glance tells me I will never invest in this company. NUF seems to be in the business of destroying shareholder value.

Shares on issue have gone from 162m to 261m form 2003 until now. This tells me either shareholders have been asked to put in more money or this business has been on the takeover trail.
Profit has gone from 77m up to 149m to a loss of 34m over the same period.
ROE is terrible @ 3.2%. Long term debt of 807m!!!
This is not a business it is a money pit where owners throw more and more money in and occasionally get some out.
Things may improve for NUF but why bother punting on that chance?
Better to look at a business that is allready building shareholder value and has a better than even chance of maintaining that momentum.

OK having said all that what would I value NUF at if it could maintain the status quo and halt the down hill slide?

$2.87

Yes that's right about 1/2 the equity per share.

Yet I am happy to hold JBH @ $18.68 when equity per share is about $2.71 (that is almost 7 times the equity per share) because they can generate a 40% return on that $2.71


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## tothemax6 (24 November 2010)

OK thanks guys, this thread has been useful to me. I will get a copy of "The intelligent investor, By ben graham" and read up. I was interested in NUF since it is a big fertilizer producer, I foresee increased food demand from Asia, and its downward trend had ceased. However if the company is a bit of a sick dog, I should probably look at its competition.
Btw does anyone know a good way to get full listings of ASX companies by what they produce (roughly)? I saw one website (http://www.australian-economy.com/) has full listings of companies and codes, but only shows the financial figures for each.
Cheers


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## ducati916 (24 November 2010)

*tothemax6*

NUF it is then.

jog on
duc


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## ducati916 (24 November 2010)

*et al*

If anyone can provide a link to their financial statements, that would be appreciated. Every google search takes me to a virus etc.

jog on
duc


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## Whiskers (24 November 2010)

ducati916 said:


> *et al*
> 
> If anyone can provide a link to their financial statements, that would be appreciated. Every google search takes me to a virus etc.
> 
> ...




Will this do the job, duc? 

http://www.asx.net.au/asxpdf/20100928/pdf/31srstn8f4jxwh.pdf


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## ducati916 (24 November 2010)

Whiskers said:


> Will this do the job, duc?
> 
> http://www.asx.net.au/asxpdf/20100928/pdf/31srstn8f4jxwh.pdf




Yes they will, ta!
Can you link also to some earlier years, as I need the comparison from earlier years also. In your own time, no big rush, much appreciated.

jog on
duc


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## Whiskers (24 November 2010)

ducati916 said:


> Yes they will, ta!
> Can you link also to some earlier years, as I need the comparison from earlier years also. In your own time, no big rush, much appreciated.
> 
> jog on
> duc




If you can paste this into your address bar they go back quite awhile. http://www.nufarm.com/AnnualReports


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## robusta (24 November 2010)

tothemax6 said:


> OK thanks guys, this thread has been useful to me. I will get a copy of "The intelligent investor, By ben graham" and read up. I was interested in NUF since it is a big fertilizer producer, I foresee increased food demand from Asia, and its downward trend had ceased. However if the company is a bit of a sick dog, I should probably look at its competition.
> Btw does anyone know a good way to get full listings of ASX companies by what they produce (roughly)? I saw one website (http://www.australian-economy.com/) has full listings of companies and codes, but only shows the financial figures for each.
> Cheers




Please do your own research. My post is only my own opinion.


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## tothemax6 (24 November 2010)

robusta said:


> Please do your own research. My post is only my own opinion.



I know, what I mean is if I had a listing of companies and what they do, I would be able to compare them. Is there an efficient way by which you go about looking through companies (and categorizing them by what they do)? It would take years to go through each ASX listed company through comsec. 
Cheers


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## So_Cynical (24 November 2010)

tothemax6 said:


> I know, what I mean is if I had a listing of companies and what they do, I would be able to compare them. Is there an efficient way by which you go about looking through companies (and categorizing them by what they do)? It would take years to go through each ASX listed company through comsec.
> Cheers




Lots of lists and tables here 

http://www.afrsmartinvestor.com.au/tables.aspx

and stocks by sector here

http://markets.smh.com.au/apps/mkt/industrylisting.ac


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## ducati916 (25 November 2010)

Whiskers said:


> If you can paste this into your address bar they go back quite awhile. http://www.nufarm.com/AnnualReports




Perfect. Ta.

jog on
duc


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