This post was originally published here.
It’s easy to assume that a company’s stock value correlates with its price, but this isn’t always the case. There’s an important distinction between the two. When considering any investment, investors should carry out due diligence to understand the difference between the two and know exactly why it matters. A company’s stock price can be determined with a simple Google search to find it’s current trading rate. But it’s more complicated to calculate the intrinsic value of a share.
Who to Believe?
While there’s no 100% accurate way to find a stock’s true value, there are some figures and trends to watch out for as you’re trying to make a decision in the market. These are some of the most common factors experienced investors pay attention to:
- Price to earnings ratio
- Price to book ratio
- Free cash flow
- Competitors (both current and potential)
This information is typically easy to find and widely available on analyst reports, making them seem like a good starting point for any potential market analysis. But these can be heavily weighted in the determination of its trading price according to the report’s bias for or against a company. While the Securities and Exchange Commission has implemented guidelines to minimize any potential conflicts of interest, there really are no amount of laws and regulations that can fully eliminate analyst bias. (Don’t forget to check out my post Equity Analysis: Art or Science? too.)
To Trendwatching We Will Go Then
When more people are selling a stock than buying it, the price falls, and vice versa. Being aware of these trends can help you make the right decisions with your own portfolio. But it’s important to only take note these trends and build an informed opinion based on your own company homework. Which is where learned valuation experience can help you gain an edge in the stock market. Learning how to value a company based on the above factors provides quantifiable metrics to make better-informed investing decisions.
Depending on your personal outlook, you may be more interested in short- or long-term trends. Some people look to make money on short-term fluctuations in stocks by simply monitoring the price and attempting to predict sudden changes. On the other side of the coin are long-term investors who are more interested in the hidden factors which determine the intrinsic value of a company (on the assumption that the price will eventually move to represent the value). And these tools are not just for the likes of Warren Buffett and John C. Bogle. They’re within everyone’s grasp.
Given how hard it is to accurately find a stock’s value, there’s almost never a consensus as to which stocks should be bought and sold at a given time. There is too much conflicting information, difference in investing philosophies, and too many hidden factors for everyone to simply agree on a consensus about a stock’s value. This means that the market is often inefficient—that stock value and stock price don’t match up. And every investor’s main goal is to identify stocks with prices that don’t necessarily represent the real value. We’re all looking for undervalued companies that others haven’t cottoned onto yet.
All investors would love to be able to identify every market inefficiency, but of course, you can’t always be on the right side. Sometimes, you’ll still often find yourself making decisions that turn out poorly. This will predominantly happen if these decisions are based on emotion and trendwatching rather than research and fact-finding though. Equipping yourself with the tools to accurately assess and value a company is the mark of a savvy investor. No emotional biases and crowd-following for you!
One Size Doesn’t Fit All
It would be great to believe you can simply accept the expertise of online market analysts and so-called financial experts who have a lot to say about this stock and that one. But everyone has their own individual bias as well as his or her own idea of what to look for when determining the difference between a company’s stock value and its stock price. When it gets down to the nitty-gritty, dial out the white noise and complete your own expert analysis before making any investment.
Good investors are those who adapt to changes in the market and use them to their advantage by adjusting their investment outlook. Great investors are those who take the time to carry out their own due diligence and don’t just watch what the rest of the market is doing.
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Article by Andrew Stotz, Become A Better Investor