Wednesday 22 February 2012

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

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