Stocks and Lottery Tickets

 

lottery ticket

I guess this week is a big one for lottery players… something about Powerball? Okay, so you can probably tell that I don’t play the lottery. In fact I never have other than buying raffle tickets at events. I have nothing against playing the lottery, I have several friends who will buy tickets, I just never got into it.

I have a friend who once said that buying stocks was the same as buying a lottery ticket. Even Efficient Market Hypothesis supports this belief. EMH states that the market is so efficient that you cannot beat the market unless you take on more risk. I have mentioned before in blog posts and videos that there is a difference between speculating and investing.

If you buy a stock purely on a whim, or because somebody told you it was a good idea, then that would be speculating and it is the equivalent of buying a lottery ticket. If you buy a stock because you have studied it and looked closely at it’s fundamentals and you believe the stock is undervalued by the market, then that would be investing.

One of the key things I look at is the company’s earning per share (EPS) and how much the experts are predicting it to grow. I use a 15% expected return (meaning that is the target return that I hope to get on the stock) and I use the company’s expected growth to calculate what the company’s EPS will be in the future. For example, if the analysts’ think a company will grow by 20% over the next 5 years, I will take 1.2 multiplied by its current EPS to the fifth power.

Ex. 20% expected growth, $3 current EPS

$3 x 1.2 x 1.2 x 1.2 x 1.2 x 1.2= $7.46

I next take the industry average PE for that company and multiply it by the projected 5 year EPS.

Ex. PE for industry is 15x

$7.46 x 15= $111.9

Now,  I need to bring this back to today’s price since this is a 5 year projection. This is where my 15% expected return comes into play. If I expect it to grow 15% annually, then mathematically that means it would double in 5 years.

So the $111.90 5 year projection would mean it should be $55.95 today ($111.90 divided by 2). 

So if the stock is significantly below $55, I know I may have found a bargain. How much below? I would like to see it be 50%-75% of that price.

Of course from here I am going to look at many more factors. I need to know this company and their story so I can know if I even think it’s possible they can grow EPS.

So as you can see, I am too busy running these numbers to stop and buy a lottery ticket, but to those of you who have, GOOD LUCK and if you win big remember to put some of that money towards your retirement 🙂