CAPITAL ALLOCATION: STOCK MARKET BUDGETING

One of the basic concepts of personal finance is having a budget, and you should have one. Budgeting is more than allocating your monthly salary to expense items, it is also a control measure. It helps you monitor whether you are already living beyond your means and helps you keep track of expense items that you spend so much. This discipline works well with stock investing, too. By effectively allocating your capital into your stocks, you will be able to maximize your returns and manage the risks. Use the scenario below as guide to effective capital allocation process.

Imagine you have P 50,000 as buying power in your trading account. After doing thorough research and financial statement analysis, you’ve identified five stocks that met your criteria:

#1: Intrinsic Value

After identifying the stocks you want to purchase, compare the current market price with the computed intrinsic value. Intrinsic value is defined as the amount of which a businessman is willing to pay for the whole business divided by the number of shares. Intrinsic value is more of a range of value rather than an exact one. This concept will be discussed in detail in another article.

Luckily, all five stocks are selling below their low intrinsic value. This would mean that even after applying margin of safety, the current market price offered still provides allowance in case your valuation is wrong.

#2: Probability of Return

Given that all five stocks met the criteria for purchase, you set to identify the probability of return for each stock. By using the high intrinsic value as selling price, you can compute the % return for each stock. To simplify the computation, we disregarded the impact of trading fees.

Based on the foregoing data, EFG posted the highest possible return of 71%.

#3: Setting weights for each stock

By looking at the probability of return which you can use as guide in allocating your capital, you can now set weights for each stock. This process is subjective and will depend on your familiarity with the company and its industry, experienced and risk appetite.

Please note that we do not recommend purchasing all these stocks in one transaction however, as long as you can maintain your average purchase price below the low intrinsic value, the probability of incurring real losses is low. You can adjust your weights based on factors that are unavailable to you

during your initial analysis. Assuming your calculations prove to be correct after two years, your portfolio would have generated 52.6% return or compounding annual growth rate of 23.5% which is beyond the acceptable return.