Value versus Price - Two Perspectives on Worth

Value versus Price

Two Perspectives on Worth

	VALUATION	PRICING
End	truth -- intrinsic value	illusion -- marginal opinion
Means	method of appraisal *	auction mechanism
Terms	case-by-case	standardized
Institution	private contracts	public exchanges
Approach	rational, logical	arational, emotional
Knowledge	economics	psychology, sociology
Principle	theory of investment	ad hoc, empirical
Result	value range	single price
Precision	highly imprecise	highly precise
Accuracy	within value range	outside value range
Investment	real assets	claims on assets
Units	operating enterprise	common stock issue
Data Source	company reports	market-generated
Measurement	absolute	relative, comparative
Analysis Type	investment	portfolio of stocks
Analysis-Units	one company	compare two stocks
Analysis-Time	one point in time	compare two times
Horizon	long-term (years)	short-term (minutes)
Frequency	sporadic, on demand	continuous supply
Stability	slow, small changes	quick, large changes
Application	individual stock selection	stock trading
* In contrast, the method of anticipation emphasizes earnings growth for the sake of growth rather than the sake of value. Thus, it is not recommended for purposes of estimating value.

Investors will frequently not know why security prices fluctuate. Must look beyond security prices to underlying business value.

Security prices sometimes fluctuate, not based on any apparent changes in reality, but on changes in investor perception.

• The shares of many biotechnology companies doubled and tripled in the first months of 1991, for example despite a lack of change in company or industry fundamentals that could possibly have explained that magnitude of increase. 
• The only explanation for the price rise was that investors were suddenly willing to pay much more than before to buy the same thing.

In the short run supply and demand alone determine market prices. 

• If there are many large sellers and few buyers, prices fall, sometimes beyond reason. 
• Supply-and-demand imbalances can result from year-end tax selling, an institutional stampede out of a stock that just reported disappointing earnings, or an unpleasant rumor. 

Most day-to-day market price fluctuations result from supply- and-demand variations rather than from fundamental developments.


Investors will frequently not know why security prices fluctuate. 

• They may change because of, in the absence of, or in complete indifference to changes in underlying value. 
• In the short run investor perception may be as important as reality itself in determining security prices. 
• It is never clear which future events are anticipated by investors and thus already reflected in today's security prices. 

Because security prices can change for any number of reasons and because it is impossible to know what expectations are reflected in any given price level,  investors must look beyond security prices to underlying business value, always comparing the two as part of the investment process.


Main Point: 
Investors will frequently not know why security prices fluctuate and must look beyond security prices to underlying business value, always comparing the two as part of the investment process

Risk is dependent on both the nature of investments and on their market price

The risk of an investment is described by both the probability and the potential amount of loss.

The risk of an investment - the probability of an adverse outcome - is partly inherent in its very nature.

• A dollar spent on biotechnology is a riskier investment than a dollar used to purchase utility equipment.  
• The former has both a greater probability of loss and a greater percentage of the investment at stake.

In the financial markets, however, the connection between a marketable security and the underlying business is not as clearcut.

• For investors in a marketable security the gain and loss associated with the various outcomes is not totally inherent in the underlying business; 
• it also depends on the price paid, which is established by the marketplace.