It seems like no matter where you look, you’ll find an article (or two… or three… or more) about how the stock market either is going to continue to see bullish gains or about how it is edging closer to an impending correction. There are many different opinions supported by a number of different facts and theses when it comes to this. In fact, you may even have your own opinion based on how you feel the economy is performing and how certain companies will overperform or underperform in both the near and long term.
All predictions aside, let’s talk about value. A potential and prudent buyer of a company (or part of a company) is going to do their own analysis and determine what they think the company is worth: VALUE. In determining that value, one will perform various amounts of research (finding comparable company transactions, discounting projected future cash flows, etc.). We don’t want to elaborate too much on valuation theory though.
The point is that value can be calculated and determined, and there is science behind it.
Then, let’s talk about the amount you eventually have to pay for the company (or part of the company) if you determine you actually want to own it: PRICE. Many times, the price you have to pay may be much greater than or much less than the value you calculated when performing valuation.
Let’s think about overall supply and demand in the US stock market today. It seems that based on the overall higher prices, demand is outpacing supply. So, who is buying? Who is investing aggressively in the stock market, resulting in higher prices? On one hand, it makes sense with projected economic growth, low unemployment, rising wages, etc. that investors would be buying at higher prices, expecting more income in the future. On the other hand, with the baby boomer generation (who relies on fixed income) entering retirement, one would think that they would be selling equities and reallocating into more of a cash-producing fixed income “type” of portfolio. This transition results in a lot of supply that might push prices down.
The point here is price is much more supply and demand driven, and there is less science behind it than value.
What is the main point?
It is our belief that as prudent buyers, if you want to own equity in companies, determine value before you even look at the price of the company. That is, determine the price you would be willing to pay for the value you’ll be acquiring. Then, go out and see what the stock is actually trading for. It might be priced at a discount, but in today’s world, it is probably priced at a premium.
If you want to see the wonder of stock pricing, watch the trading for a few days. Prices of stocks go up and down sometimes for no apparent reason. A stock may dip in price one week (sellers outpacing buyers) and could rebound the next week (buyers outpacing sellers). But why? Sometimes we think no one knows…
Which brings to mind the awesome scene in the classic movie Wolf of Wall Street where a seasoned stock broker (Matthew McConaughey) tells a new colleague (Leonardo DiCaprio) “…nobody, if you’re Warren Buffet or if you’re Jimmy Buffet, nobody knows if a stock is going to go up, down, sideways, or around in circles, least of all stock brokers.”
The point we are trying to make is that there is so much going on in the market (speculative buying and selling based on what an investor thinks a company is going to make – or not make – in the future, short positions, hedging positions, company stock repurchases, insider trading, etc.) that it is hard to know when and why a stock is going to continue a bull run or if all of the sudden, the bears are going to hit it for a prolonged amount of time. However, if you want to have equity positions in your portfolio, be careful, be prudent, do your analysis of value, and leave your emotions out of your decision-making process.
Our opinion is that there is a lot being paid for equity in publicly traded companies today based on tomorrow’s value. The problem is that if you pay for tomorrow’s value today, you may be giving up the potential for exponential returns (e.g. 2 and 3 times your money in 5 to 10 years), which is something you should be hoping for in taking equity risk.