Understand the Intrinsic Value

Intrinsic Value is the "real value" behind a security issues, as contrasted with its market price. 

Generally a rather indefinite concept; but sometimes the balance sheet and earnings record supply dependable evidence that the intrinsic value is substantially higher or lower than the market price.


Benjamin Graham

Market Value versus Intrinsic Value

Market Value

The market value or market price of the asset is the price at which the asset can currently be bought or sold.  

It is determined by the interaction of demand and supply for the security in the market.


Intrinsic Value

Intrinsic value or fundamental value is the value of the asset that reflects all its investment characteristics accurately.

Intrinsic values are estimated in light of all the available information regarding the asset; they are not known for certain



Efficient Market

In an efficient market, investors widely believe that the market price reflects a security's intrinsic value.


Inefficient Market

On the other hand, in an inefficient market, investors may try to develop their own estimates of intrinsic value in order to profit from any mispricing (difference between the market price and intrinsic value).

Equity Securities and Company Value (Intrinsic Value of a company)

Book values and ROE do help analysts evaluate companies, but they cannot be used as the primary means to determine a company's intrinsic value.

Intrinsic value refers to the present value of the company's expected future cash flows.

Intrinsic value can only be estimated as it is impossible to accurately predict the amount and timing of a company's future cash flows.

Astute investors aim to profit from differences between market prices and intrinsic values.

Value Investing - Stock Price

Stock Price  


You can’t buy any stock at any price, right? The price you pay is ultimately determines your rate of return. You want to buy cheap to maximize your earnings.

The actual stock prices consist of two parts: 1) intrinsic value and 2) variance from the human emotion and dynamic market environments. So there are two basic methods to determine the price of a stock: 1) Fundamental Analysis and 2) Technical Analysis.

• Fundamental Analysis determines intrinsic stock prices by projecting future earnings and then applying an acceptable return on    investment to calculate the stock price. This approach is used by most traditional investment analysts.
• Technical Analysis applies statistical charts and techniques to historical stock prices and volumes to identify the future stock price trend. It does not consider the fundamentals of the stock. The business, or economic environment as the influence of these factors is deemed to be already reflected in the stock price.

http://www.trade4rich.com/Price.html

Intrinsic economic valuation versus price bidding in the market.

There are over 5,000 stocks listed on the major U.S. stock exchanges.  Each common stock is continuously changing and never stays the same. Thus the number of stock "deals" is unlimited. 

• You do not have enough time to estimate the intrinsic economic value of every common stock for every moment of every trading session. 
• The competitive, open-outcry, price-auction markets continuously provide bid and ask price quotations. 

Pricing conventions are used to provide a semblance of rationality in lieu of valuation. These conventions include 

• price multiples such as the price/earnings, price/book value, price/dividends, price/cash flow, price/sales and other accounting ratios. 
• Stock pricing conventions vary in applicability and popularity.

Intrinsic economic valuation versus price bidding in the market. 


The stock market participants at the price-setting margin and occasionally the market as a whole are exceedingly irrational. The most important that concerns us is that, in stock market investing, no bidding system can ever replace human judgment and interpretation of the facts based on intelligence, knowledge, and experience.

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	A.Speculative	1.Market factors	a.Technical
			b.Manipulative
			c.Psychological
	A.Speculative B.Investment	2.Future value factors	a.Management and reputation
			b.Competitive conditions and prospects
			c.Possible and probably changes in volume, price, and costs
	B.Investment	3.Intrinsic value	a.Earnings
			b.Dividends
			c.Assets
			d.Capital structure
			e.Terms of the issue
			f.Others

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."

Thus:

Price is not value. Pricing is not valuation. Pricing models are not valuation models. Pricing models include: capital asset pricing model (CAPM), arbitrage pricing theory (APT), and option pricing.

 http://www.numeraire.com/margin.htm

Value Investing: Intrinsic Values versus Emotional Values (Market Prices)

Value investing works if stock prices fluctuate around business value.  ONLY then can stocks be bought at discounts to business value (or sold at premiums to business value).

Value investors believe that markets price stocks in ways that produce such gaps.

Graham's metaphor described this behaviour as Mr. Market, viewing market action as the collective psychological behaviour of human beings prone to periods of excessive optimism and pessimism.  The conception yields several insights for what value investing is.

Numerous complex factors influence stock market prices.  The idea that anyone can predict the outcome of this process (market timers), or that it works in a way that yields prices just equal to value (efficient market hypothesis followers), is far-fetched.  Value investing considers trying to measure market sentiment a waste of time.  Value investing focuses primarily on business value (intrinsic value), not market price (emotional value placed by the market.).

Emphasizing businesses over prices enables value investors to know that owning stock means owning an interest in a going concern.

• That mental quality promotes the discipline necessary to define a circle of competence, do financial analysis, and assess value-price (intrinsic value-emotional value) relationships.  
• Pervasive market price data makes it harder for equity investors to appreciate that they are part owners of a business, making disciplined analysis elusive.

The only reason to consider market sentiment is because in times of general economic despair and market malaise, the odds of successful stock picking rise.  Three factors contribute:

1. there are more companies likely to be priced below value,
2. there are fewer investment competitors likely to wade into the thicket, and,
3. the media and regulatory pressure tend to promote quality management and conservative accounting.

Dow 11,000: Opportunity or Threat?

By Anand Chokkavelu, CFA 

October 11, 2010 

An admission: I'm a long-term buy and hold investor who knows better, but I still check my portfolio roughly 15.4 times a day. More often when the stock market's surging.

With the Dow at 11,000, Yahoo! Finance loves me. But as we all know (or should know), 11,000 is just a number. It should not spur any rash trading one way or the other.

To make the most of this arbitrary market event, I asked three of my fellow analysts for some advice for individual investors at these stock price levels.

Morgan Housel, Fool contributor: These milestones are generally meaningless, but I still think the market at these levels provides more opportunity than threat. The S&P 500 is on track to earn about $83 this year, and an estimated $94 next year. With the index at 1,165, I don't know where the overvaluation anxiety comes from. We're talking broad market multiples of 12-14, which should qualify as somewhere between cheap and reasonable -- with room for error. At the individual company level, high-quality companies like Microsoft (Nasdaq: MSFT)and Procter & Gamble (NYSE: PG) trade at valuations that shouldn't make sense to rational people.

My feeling is that the market's surge since the lows of March 2009 simply has many investors asking, "how is this increase justified?" They see a 70% market increase at a time when the economy looks like a cesspool, and it just feels wrong. But focusing only on the increase is misleading. The important question to ask is, "was the depth of the market crash justified to begin with?" I don't think it was. Look, corporate profits are at an all-time high. Nominal GDP is at an all-time high. Personal spending is at an all-time high. The long-term drivers of the stock market aren't doing as bad as some imagine.

Alex Dumortier, CFA, Fool contributor: Yes, last week the Dow crossed 11,000 for the first time since early May; however, it would be very difficult to argue that higher stock prices are now an opportunity for anyone who is a net buyer of stocks -- which I expect is almost everyone reading this.

Still, I will say that the blue-chip Dow index represents almost certainly a better opportunity than the broader market S&P 500, as the following table suggests:

Fund	P/E Multiple	Dividend Yield	3-5 Year EPS Growth
SPDR S&P 500 (NYSE: SPY)	13.8	1.89%	10.7%
SPDR DJIA ETF (NYSE: DIA)	13.2	2.69%	9.1%

Source: State Street Global Advisors website.

At a cheaper multiple, I'll take the extra 80 basis points in dividend yield of the Dow ETF over the 160 basis point advantage in estimated earnings growth for the S&P 500 ETF any day of the week -- something about birds, hands, and bushes.

Investors who have the time and the ability can earn yet better returns from stockpicking and, given the underpricing of high-quality companies, the Dow components make a good shortlist from which to begin one's search (legendary investor John Paulson likes and owns at least three).

Matt Koppenheffer, Fool contributor: I don't pay a whole lot of attention to the Dow. The index contains all of 30 stocks, and it's really tough to get a good feel for what's going on in the massive U.S. market based on that small number.

Past that, it's meaningless to focus in on a number like 10,000, 11,000, or even 111,000. It looks nice in newspaper headlines, but the price level of an index is only noteworthy when looked at in the context of the profits produced by the companies in the index.

When I focus in on something more meaningful -- like the S&P 500's current price-to-earnings ratio of 16.6 -- I'd say that it's hard to peg the overall market as being particularly cheap or expensive. But I consider myself a stock-picker and I'd say that there are certainly opportunities for investors to find great individual stock opportunities in this market.

The great thing is that a lot of the market's current opportunities are high-quality, dividend-paying, blue chips. Intel's (Nasdaq: INTC) stock, for example, is currently sitting at a forward P/E of just 10.6 and is paying a 3.2% dividend. Chevron (NYSE: CVX) has a forward P/E below 10 and a 3.4% dividend. It doesn't take a whole lot of brain busting to figure out that these are top-notch companies, so when I see these kinds of valuations, I'm all over them.

http://www.fool.com/investing/general/2010/10/11/dow-11000-opportunity-or-threat.aspx?source=irasitlnk0000001&lidx=5

Recognise Your Emotions: Irrational Behaviour and Stock Market Investing

"You have great skill with your bow, but little control of your mind", said the master to his young archer.

This is also applicable in investing.  You can know everything about valuing companies, but it'll come to nothing if you can't apply it rationally when the heat is on.

Human behaviour is directed by a combination of evolutionary hardwiring and development programming, and you can see both in everything we do.

The trouble is that in stock market investing, a very recent phenomenon in human evolution, we haven't developed behaviours appropriate to it.

The usual range of other behaviour responses that we picked up in our early life are often completely inappropriate.


Recognise your emotions


These problems are all tied up with human nature, so it is impossible to eradicate them.   But that's the fundamental irony of investing:  irrational human behaviour creates the opportunities, but to take advantage of them you have to be rational and inhuman!


Whenever you try to put a curb on a natural process, there's a danger you'll overshoot.  If you worry too much about your crowd following tendencies, for example, you could end up going against the consensus opinion just for the sake of it - which might itself be a mistake.

Probably the best way to deal with your emotions is to learn to recognise them, so you get a feeling for when they might be getting the better of you.  If you feel yourself getting a bit overexcited, then put it all to one side and go and do something else.  In the stock market it's best to favour inaction over action.



Read:  Rational Thinking about Irrational Pricing

http://myinvestingnotes.blogspot.com/2009/01/rational-thinking-about-irrational.html

The Determinants of Market Price (Intelligent Investor)

When the market price of a stock tanks?

Is there a change in the company's fundamental to account for the drop in price?

If not, the price is at a bargain.

Sometimes, the fundamentals have not changed ... only the market price due to market sentiment!!!


(The above graph is used for illustrative purpose only.  You should invest only after a thorough analysis of the fundamental of the stock.)

Interactions between Fundamental value, Market Sentiment, Business Cycle and Market Price

Are You Paying Too Much For Stocks?

Are You Paying Too Much For Stocks?
By Joe Bechtel

Market Value Not Equal to Actual Value

 

If you are a lemming investor, please don't use small loans to finance your lack of creativity. You'll be shocked at how much it can cost you.

A small loan can help you if you are short of cash until your next payday, but if you invest in the stock market and follow the crowd in their buying and selling habits, you may end up with many more liabilities than assets. Why is that?

• Have you ever noticed how much the stock market fluctuates over the course of a day, and how much the share prices go up and down?  
• Does that mean that the companies’ values goes up and down as much as the share price, or does that mean that there may be some other force at work here?

As you will see, the market value of the share does not equal actual value of the same share in terms of a company’s value.

 

Market Price Based on Emotions, Not Logic
One of the pioneers in value investing, Benjamin Graham, believed that many people rely too much on their emotions when investing rather than their logic. This explains why the market fluctuates so much, and why so many people claim that the stock market is risky. What makes it risky is the constant buying and selling that goes on day after day, hour after hour. This constant buying and selling is what either drives the share price up or down, and it’s what creates the risk.

 

Ben Graham suggested in his book “The Intelligent Investor” that if you want to build your wealth from the stock market, you need to use a “dollar cost averaging” technique, meaning to consistently buy more shares at a lower price over time. As inflation and company values grow over time, your investments will be worth more in the long run. It’s also known as the “buy low and sell high” technique. Unfortunately, most people tend to bring their emotions into their investing, and will panic and sell when the price is going down, because they are afraid to lose any more money on their investments, leaving them open to take out a small loan to survive.

 

Beyond the Smoke and Mirrors
The stock market is riddled with confusing terms, acronyms and policies, making it very difficult for the average investor to understand. All this is just smoke and mirrors designed to keep most people in the dark and dependent on high-priced brokers to navigate the investing maze for them. However, if you were to peek behind the curtain, you would see that all the confusion is just smoke and mirrors.

 

Inflated Price? Inflated Value!
In an effort to control the market prices, brokers and fund managers will either buy or sell enough shares to drive the price back up or down, depending on where the prices are going. Maybe it’s because a company got some bad news, or even good news, and investors are trying to position themselves to either make or avoid losing a lot of money. However, this tends to skew the value of the share price, making the market unbalanced.

• Therefore, if a share price is going up too high, brokers or fund managers will sell several million shares to drive the price back down.
• Likewise, if a share price is going down too fast, they will buy as many shares to make it even.

So, if you see share prices inflated, don’t make the mistake of thinking it is worth that much. In fact, they may not be worth much at all!

 

P/E Ratio Tells it All
There is a very simple way to determine if a certain share price is on target or not—look at the Price per Earnings ratio. This is a valuation method that takes the company’s current share price on the market divided by the per-share earnings over a certain time frame, usually one year. So, if a company’s share price is $24 and the earnings per share over the past 12 months have been $2, the P/E ratio is 12. Generally, the higher the P/E ratio, the higher the expectations of investors for company growth. This means that you will be able to see higher earnings within the next year with this company. However, the lower the ratio, the slower the growth regardless of what the market is doing.

 

Buy Low, Sell High
When you can learn how to find the correct value of a company or share, you will know when the share price is at its lowest, and when you can buy. After the share price tops out, you can sell your shares and pocket the difference without needing a small loan. If you do this, you will be able to make money on the stock market when everyone else is losing money.

 

http://personalmoneystore.com/moneyblog/2009/12/08/small-loan-value-investing/

Understanding Market Prices

Value investing works if stock prices fluctuate around business value. Only then can stocks be bought at discounts to business value (or sold at premiums to business value).Value investors believe that markets price stocks in ways that produce such gaps.

Numerous complex factors influence stock market prices. Graham identified two categories of factors: speculative and investment.

1. Stock Market Prices
2. Market metrics P/E and Intrinsic value
3. Rational Thinking about Irrational Pricing
4. The Anxiety of Selling
5. Control Value of Majority Interest

Stock Market Prices

MARKET PRICES

Value investing works if stock prices fluctuate around business value. Only then can stocks be bought at discounts to business value (or sold at premiums to business value).

Value investors believe that markets price stocks in ways that produce such gaps.

Graham’s metaphor described this behaviour as Mr. Market, viewing market action as the collective psychological behaviour of human beings prone to periods of excessive optimism and pessimism. The conception yields several insights for what value investing is.

FACTORS INFLUENCING MARKET PRICES

Numerous complex factors influence stock market prices. Graham identified two categories of factors:

• speculative and
• investment.

Speculative factors are the jungle of the marketplace and include

• technical aspects of market trading as well as
• manipulative and psychological ones.

Investment factors relate to valuation, principally assessments of financial data, including

• earnings and
• assets.

Factors sharing traits of both the marketplace and valuations, which Graham called future value factors, include

• managerial qualities,
• competitive circumstances, and
• a company’s outlook for sales and profits.

All of these factors are filtered through the lens of the investing public’s attitude, which produces trading decisions and bids and offers in the market. The output is market price.

The idea that anyone can predict the outcome of this process, or that it works in a way that yields prices just equal to value, is far-fetched. Value investing considers trying to measure market sentiment a waste of time. Value investing focuses primarily on business value, not market price.

Emphasizing businesses over prices enables value investor to know that owning stock means owning an interest in a going concern. That mental quality promotes the discipline necessary:

• to define a circle of competence,
• do financial analysis, and
• assess value-price relationships.

Pervasive market price data makes it harder for equity investors to appreciate that they are part owners of a business, making disciplined analysis elusive.

The only reason to consider market sentiment is because in times of general economic despair and market malaise, the odds of successful stock picking rise. Three factors contribute:
(1) There are more companies likely to be price below value,
(2) There are fewer investment competitors likely to wade into the thicket, and
(3) The media and regulatory pressure tend to promote quality management and conservative accounting.

Also read:

1. Stock Market Prices
2. Market metrics P/E and Intrinsic value
3. Rational Thinking about Irrational Pricing
4. The Anxiety of Selling
5. Control Value of Majority Interest