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Today I will share with you how to identify the perfect moment to buy a stock, and it's probably different from what you expect. Why? Because it has little to do with timing, and more to do with the stock price in relation to the intrinsic value of a company. Let me explain.
"Price is what you pay, value is what you get."
There is a crucial difference between price and value, and the above quote by Warren Buffett captures this perfectly. If you want to sell your desk chair on eBay, you can ask any price for it you like. However, the value the buyer receives in return, a desk chair, remains exactly the same, regardless of the price you decide to ask.
It's the same with stocks. A stock price says little about how much a stock, which is essentially a tiny slice of a business, is actually worth. Investors can ask any price they like, but this doesn't change the underlying business. This means it is possible for stock prices to deviate significantly from their intrinsic value, which is great, because exploiting mispriced stocks is what value investing is all about!
So what is the perfect time to buy a stock?
Well, you first have to determine whether you are dealing with a financially healthy company. Secondly, using conservative inputs, you need to estimate the intrinsic value of a company to determine what a stock should realistically be worth. Is the stock trading at a price way below the intrinsic value you calculated? Sweet! Then this is the perfect time to buy. If not, put it on your watch list until it is finally cheap enough to get in.
Timing the market, or trying to predict when a stock will move up or down in the short run, is impossible. You might get lucky a few times, but this strategy is doomed to fail in the long run, since prices can be extremely volatile, highly irrational and therefore 100% unpredictable. The only sound way to determine when to buy is to look at the stock price in relation to the intrinsic value of the underlying company.
Don't worry if the price declines further after your initial investment, because now you can buy more of a wonderful company at an even lower price! You don't have to buy at the absolute bottom. You just have to buy it for a cheap enough price to make a more than handsome return.
Now that you know when to buy a stock, you might be interested in learning when to sell. In episode #18 of my value investing podcast I cover the only three reasons to ever sell a stock. Here is a link for you below:
Cheers, and all the best to you!