This is part III of the article DCF Analysis continued – I. Please read the article from the first part before continuing with this one
Third part: Let’s increase the investment horizon as well. Initially, we were having a 3 year investment horizon 1-jan-2005 to 31-Dec-2007. Now, let’s make it 31-Dec-2008 and all the investment from year 2 onwards are shifted a year further (as follows):
| Start Date | 01-Jan-05 | Investment Period | 4 years | | | |
| End Date | 31-Dec-08 | Interest Rate | 9% | Present Value of | ||
| A | B | C | D | E | F | G |
| Date | Stock | Buy | Sold | Annualized time | PV-Buy | PV-Sold |
| 01-Jan-05 | Microsoft | (1,000.00) | | - | (1,000.00) | - |
| 03-Mar-05 | GS | (200.00) | | 0.17 | (197.14) | - |
| 01-Dec-05 | Google | (4,000.00) | | 0.92 | (3,696.68) | - |
| 10-Feb-07 | Microsoft | | 1,200.00 | 2.11 | - | 1,000.52 |
| 11-Jul-07 | Exxon | (5,000.00) | | 2.52 | (4,022.83) | - |
| 13-Sep-07 | Amazon | (2,000.00) | | 2.70 | (1,585.00) | - |
| 19-Sep-07 | AMX | (3,000.00) | | 2.72 | (2,374.14) | - |
| 28-Dec-07 | GS | | 600.00 | 2.99 | - | 463.75 |
| 05-Jan-08 | AMX | | 3,600.00 | 3.01 | - | 2,777.24 |
| 09-Jun-08 | Google | (5,000.00) | | 3.44 | (3,717.79) | - |
| 10-Oct-08 | Google | | 12,000.00 | 3.78 | - | 8,667.29 |
| 11-Oct-08 | Exxon | | 5,500.00 | 3.78 | - | 3,971.57 |
| 31-Dec-08 | Amazon | | 2,100.00 | 4.00 | - | 1,487.69 |
| | | | | | | |
| Total | | (20,200.00) | 25,000.00 | | (16,593.58) | 18,368.06 |
| Net (Sold-Buy) | | | 4,800.00 | | | 1,774.48 |
| Net % Return | | | 23.76% | | | 10.69% |
| Annualized % Return | | 5.47% | | | 2.57% | |
Everything else is same except for the trading activities from 2nd year onwards have been shifted down a year further, so that the effective investment horizon is 4 years.
As we can see, the effective annualized rate of return has come down to just 2.57% as compared to 4.3% with our initial figure. Hence increasing the horizon also reduces the effective net return.
Then, what is the point in telling that we only look at the amount of money we get on our investment (and forget about the time value of money)? Increase the investment horizon to 5, 6 years and beyond, the same return value will come to negative.
If you have to forget the time value of money, then why not consider the bank accounts in which the money is doubled in 7, 8 or 9 years that too risk-free? Why are we playing around in the risky stock markets for speedy returns if we have to ignore the time value of money?
The fact is that investments or trading should be analyzed in real perspective. You cannot ignore the effective annual rate of return and time value of money.
Have questions, please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
4 comments:
Hi Shobhit
as I said, I have these numbers with me, please tell me if i am wrong.
6-Jun-07 I bought 2 Bhel@1350=2700
3-Oct-2007 i Sold them @2025=4050
Net Return is 50%
Annualized Return is 45.84%
I used the same formula given in your article annual returns@9%
Thanks
Aniruddha
Andy,
You are absolutely correct - but only to the extent of calculations! THe mathematics is correct that 45.84% return is calculated in DCF model.
But are you sure these are your exact and all the numbers??
I dont want to dampen your spirits, but the following the sequence of comments that you've left on the previous articles, these numbers seem to be impractical and incomplete to me.
1) You said that you've taken a loan for trading. Where is that 6000 Rs. EMI repayment? Shouldn't there be 5 EMI payments made for your investment period of June to Oct?
2) Is BHEL the only stock you purchased and sold over the 5 month period from June to October?
3) The buy price of 1350 and sell price of 2025 - do they include brokerage charges? It doesn't look like that
4) Have you considered the Demat charges that you paid for 2 quarters (June to OCt)?
Please note that DCF is an absolute model - it does not worry about the source of money. It only needs the amount of money coming in and going out.
It hardly matters whether you purchased BHEL or Reliance. It hardly matters whether you paid brokerage or received money. All it needs is the correct figures of cash in and cash out.
Consider all your cash in and cash out amounts. Dont just pick up your "BEST TRADES" to prove that you've made enormous % returns. Anyways, if you've made only BHEL trades over the past 5 months, then I would say what's the point in taking a loan for trading and paying 6K each month, amounting to 30K for 5 months.
Hi Shobhit
Thanks for your kind reply, this is boosting my moral. Yes i did this trade for Bhel(prices including brokerage) and apart from BHEL I hold a 35 stock portfolio, (avg life of that is 3 months as i have monthly targets for EMI payment) and 9 Mutual funds (couple of sectorial and rest Equity diversified which i am holding since 2 yrs). After re-reading your all blogs about DCF i am energized to know that where i stand. so thinking to do this analysis from 1 Apr 07 onwards. Started printing trading book, brokerage paid reports and monthly statements... Seems to be exciting.
I can't hold long term(6-12-24 months) because no one knows what will happen at the end of that period. so whatever profit (usually 6-12% weekly by simple calculation) is there i book it and move on..
Anyways, i will surely let you know about my dig work...
Thanks again dear
Aniruddha
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