Due to speculative nature of stock prices, it is nearly impossible to predict stock prices. Even experts of stocks does not have a clear formula of how to predict stock prices. Stock prices are mainly run by investor perception about company’s future performance and expected growth. But this assumption about growth is not scientific, they are based on assumptions. Technical analysts do a detailed tracking of stock price in order to predict stock prices. But again this is not scientific and lot of information is left to assumptions. Fundamental analysts like Warren Buffett also predict stock prices, but there is difference between Warren Buffett and technical analysts. Where Buffett predict stock price based on inherent strengths of underlying business, while technical analysts study just price movements.

Compound Annual Growth Rate (CAGR) Calculator

In the process of prediction of stock prices what investors try to forecast is CAGR of a stock. In order to learn how to predict stock prices, first we have to know what is CAGR. We Suppose you bought a stock at $5 ten years back. Today the same stock is priced in market at $15. What CAGR you made from this stock? The CAGR is 11.6% per annum. You can use the above CAGR calculator to calculate the CAGR of this example:

Starting Value: $5

Time: 10 Years

CAGR: 11.6%

Relationship between stock price and its fundamentals

Warren Buffett predict stock prices on basis of fundamental analysis of a company. In simple terms you can say Warren Buffett tries to establish a relationship between the market price of stock and its financial performance. Fundamental analysis helps to predict stock prices in long term perspective only. If one will try to predict stock prices in short term using companies fundamentals, it will not work. For short term technical analysis is more suitable. When I say long term it means time span of 7-15 years. Lets see how to predict stock price using fundamental analysis. When we are linking market price of stocks with companies’ financial performance we must understand that it takes time for companies to deliver financial results. If we buy stocks today and in next one year we want our stock price to get doubled then it’s not possible. Stock investment are not lotteries. Companies needs time to show results. Suppose a company’s stock is $10 today and its management decided to invest $1million dollar to expand and modernize its facilities. This modernization and expansion projects is envisaged to increase turnover and profit margin of company. The duration in which this project (say 5 years) is executed, there will be no increase in turnover and profit. Instead companies profitability will go down as company must have taken loan to fund its projects. In these 5 years we cannot assume any appreciation of stock prices. But as soon as the project is complete and company begins to experience increase its sales and profitability, it will reflect in the stock prices. But why the market price of stocks appreciates after expansion and modernization of business? The answer is simple, expansion and modernization of business strengthens the fundamentals of business (higher Sales/share, Earning/share etc). If we want to understand a patters on CAGR for a particular stock, best is to note its price fives years back and compare it with todays market price. Lets take example of Reliance Industries, five years back in June08 its market price was Rs1100. Today the market price of Reliance is Rs 862. If we will use the CAGR calculator we will see that growth rate is negative.

Ending Value: Rs862

Starting Value: Rs1100

Time: 5 Years

CAGR: -4.7%

When we say strengthening of fundamentals we mean increasing the following business performance parameters.

1. Sales / share (SPS)
2. Earnings or net profit  / share (EPS)
3. Net worth – depreciation / share (NWPS)