Sunday, 11 March 2012

The Relationship of Intrinsic Value to Market Price - tracing the various steps culminating in market price.

In Security Analysis by Graham and Dodd, 1934 edition on page 23: "The Relationship of Intrinsic Value to Market Price.--The general question of the relation of intrinsic value to the market quotation may be made clearer by the appended chart [see table below], which traces the various steps culminating in market price. 

It will be evident from the chart that the influence of what we call analytical factors over the market price is both partial and indirect--
  • partial, because it frequently competes with purely speculative factors which influence the price in the opposite direction; and 
  • indirect, because it acts through the intermediary of people's sentiments and decisions. 
In other words, the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.

Relationship of Intrinsic Value Factors to Market Price
I.General market factors

Attitude of public toward the issue (leads to)

} Bids and offers (lead to)

} Market price
II.Individual factors
1.Market factors



2.Future value factors
a.Management and reputation

b.Competitive conditions and prospects

c.Possible and probably changes in volume, price, and costs

3.Intrinsic value



d.Capital structure

e.Terms of the issue


The radical difference between value and price is explained by John Burr Williams in The Theory of Investment Value as indicated in the following quotations: (1938: 33): 
  • "If opinion were not founded in part on current dividends and changes therein, there would be nothing to prevent price and value from drifting miles apart." (1938: 191): 
  • "Since market price depends on popular opinion, and since the public is more emotional than logical, it is foolish to expect a relentless convergence of market price toward investment value. Corroboration of estimates [of intrinsic economic value] by subsequent market action, therefore, ought not to be expected. After all, investment value and market price are two quite different things."

Price is not value.
Pricing is 
not valuation.
Pricing models are 
not valuation models.

Pricing models include:
capital asset 
pricing model (CAPM),
pricing theory (APT), and

No comments: