Value Investing Formula: Price & Value of Stocks
In this article we’ll talk about price and value which is a very important topic in value investing.
Price is what you pay value is what you get.
Now let’s talk about price and value both price and value are the two sides of the same coin.
Understanding the difference between price and value is important because it helps you sort out good investments from bad investments.
So I want you to take a quick note here.
Price and value are not always the same.
You know most inexperienced investors look at a stock’s price to determine if it’s cheaper expensive.
They think that a $5 stock is cheaper than a $50 stock.
Well it seems cheaper because of the price tag but they don’t know that their $5 stock may be only worth two or three dollars.
For example while the $50 stock can be worth over $80 or maybe $100.
So that’s the difference between price and value.
You know looking at the price side is not investing it’s gambling because you have no idea about how much your stock is actually worth, only considering the market price is like the same as you are going shopping.
You buy a product because the shop tells you that there’s a promotion.
They discount the product and you feel you’re buying something cheap.
But the thing is even with the discount that shop can still make a profit because they’re selling you a product at a price that’s higher than its cost of production.
So that product is overvalued.
The same for the stock market as a value investor.
We need to look at the value side so before making your investment in a company you need to make sure that you’ll only buy it when it’s undervalued.
There are three types of value that you need to know about.
If you want to be successful as a value investor evaluating these values carefully We’ll show you a clear picture of how profitable a potential investment is.
The first is relative value.
The second is absolute value.
And the third is perceived value.
Now let’s dive into each of them in turn.
Relative value can be determined by comparing a company’s financial performance with that of its competitors within the same industry and also at the industry average.
The differences between a company with its rivals tells you exactly how well it’s operating and generating profits.
When a company is profitable and able to operate efficiently that will make a significant contribution to its shareholders value.
This simply means the more profitable the company is the more profitable you are as a shareholder.
So to determine relative value the easiest method you can use is performing a financial ratio analysis will simply compare companies profitability efficiency liquidity and solvency ratios with that of its competitors and the industry average the company with the best ratio values will be the best company in the industry and its a worthwhile investment in terms of its relative value.
Financial ratio analysis is a big topic in value investing.
So I’ll teach you how to use financial ratios the right way.
In another course.
But right now you just need to know that it exists and youll need to learn about it later to master your value investing skills.
OK the second value that we’re going to talk about is the absolute value.
In short it’s the company’s intrinsic or real value you’ll need to perform a stock valuation to estimate your company’s intrinsic value then compare its value with the current market price.
If the intrinsic value is higher than the current market price or the company stock is selling at a price which is cheaper than it’s actually worth.
This means it’s undervalued or cheap to buy.
So we’ll consider buying it to make a profit when the price increases in the future.
And on the other hand if the intrinsic value is lower than the current market price the stock is overvalued or expensive.
We simply avoid buying this company’s stock so to determine absolute value we’ll use some valuation methods such as the discounted cash flow model or dividend discount model okay.
The final one is the perceived value perceived value is the price that people are willing to pay for a product or service.
And in the stock market game it’s the price that people are willing to pay for a share of a company.
The perceived value is completely unrelated to the absolute value.
The best example of perceived value is this picture.
It’s actually worth maybe just a few hundred dollars to pay an artist to paint it.
But guess what.
It’s worth millions of dollars.
Because there are people who are willing to pay that high price to own this picture.
The selling price will totally depend on the perception of the buyers.
And I want you to know this.
The stock market also works on the perceived value in the stock price of a company reflects the perception of investors like yourself.
You can easily see perceive value in growth stocks where companies are growing much faster than their competitors and the whole industry.
So that’s why investors are ready to take higher risks and pay a higher price for owning those stocks and to determine the perceived value of a company.
You’ll need to do a qualitative research.
You’ll need to find out what people think about that company how skillful and experienced its management is and growing their business what the values are that the company brings to the world.
And the only way to know this is spending a lot of time reading news stock analyses and customer reviews. Then you will get a true indicator of the stocks intrinsic value and how much it is actually worth, relative to the price of the stock.