In a previous column, we discussed why you should maximize first on the stock with the greatest rate of return. However, our example only
showed two stocks in the same period. If your choice is between a 10% return in one week, or a 100% return in ten weeks, what should you do? To answer that, we need to understand the Time Value of Money.

All else being equal, it is better to have money sooner than later, since if you have money now, you can do things with it. For instance, if forced to choose between $100 today or $100 next year, you would (if you are sensible) prefer $100 today since at the very least you can invest in a one year CD and have $104 next year. Its the same thing with HSX stocks. The above stock with a 10% return will give you money sooner, which can be reinvested in other stocks, possibly including the second stock. This is the miracle of compounded interest. But just because you get it sooner doesn’t necessarily make it better.

So, how do you compare stocks over time? It so happens, there is a nice formula that does just this. (see my short sellingcolumn for how to use
this formula when shorting a stock).

If you want to know a stock’s TRUE rate of return, accounting for time difference, use the following
formula:

True Daily Rate of Return = (EDP/CP)^(1/t)-1.
EDP = Estimated Delist or Adjustment Price (I use adjustment price until after the adjustment, when I recalc based on EDP)
CP = Current Price
t = number of days til the price is adjusted or the stock
is delisted (whatever number you used for EDP)

Once you do the math, you see that the 10% return-in-one-week stock has a daily Return on Investment of 1.37%. The 100% return-in-twn-weeks stock offers you a 1.00% return. The former is the better buy.

There is also a simple formula you can use. It is (Delist (or adjust) price/Current Price)/(# days). The advantage of this formula is that you might be able to do it in your head, and you can use it if you don’t have a scientific calculator handy (necessary to do the exponential function the previous formula uses). The problem is that the further off into the future that you get, the more inaccurate this simpler formula becomes. For time spans under a month, the difference isn’t great, but it will yield wildy inaccurate results over a time span such as a year.
Tom Miller