How to get rich(4)- Mr Market and Stock evaluation basis

If you are a stock (or share or securities) investor,  what do you hope tomorrow market direction to be?

Most investor will hope the market will go up forever, so that tomorrow (stock) price will be higher than today, and their net worth will increase everyday. In fact, if every market participant hopes that way, they are hoping for someone to always pay for the higher price. But one would wonder, if the musical chair somehow stops, who will end up with the stocks when market is turning tide?  And how do you know when the musical chair will end? 

Thus, you should only hope the market go up forever, when you plan to sell, or stop buying in the future. 

An intelligent investor according to Benjamin Graham or Warren Buffet, which plan on keep buying in the future, will pray for the market to stay flat or even going down tomorrow, so that they can keep buying the stock at bargain price. In that case, they are not hoping to profit from capital gain, they are hoping to profit through underlying cash flow derived from the stock. 

How do you determined if the stock is underpriced? 

One simple way, is to find the implied rate of return using Present Value formula, 

P = D/ ( r - g) 

Where P is current price, 

D is amount of dividend, 

r is the implied rate of return,

g is the growth rate , equal to ROE * retention ratio

Retention ratio = amount of earning that is not pay out = (1 - D/E)

Using public bank as an example (stock code 1295) With Price = RM 15.64, Dividend per share of 48 sen, average ROE of 25.4%. and retention ratio of 0.52 for last year, 

g = .52 * 25.4% = 13.2%

r = D/P + g = 3.07 + 13.2 = 16.27%. 

Seem a good buy as implied rate of return is 16%! 

However , an investor should noted that, a large portion on the rate depends on the growth component, 

And it seemed that current earning growth for public bank have slowed to 10%. 

In other way, given the price is highly above its tangible asset (RM 4.83) , an investor can only recoup his principle from the dividend income. A dividend of 48 sen with 10% growth will repay the nominal principle in 15 years, which roughly translated into 6.6%  implied rate of return in 15 years.