The Difference Between a Stock's Value and Price
Value Is Better Measure for Investors and Price More Important to Traders
One issue that often confounds investors in the stock market is resolving the difference between a stock's value and its price.
If you have spent any time in the stock market, you know that value and price are two different measures arrived at by different means.
The real estate collapse of 2008 demonstrated the same principle. For example, houses that may have had a value derived from appraisals or other means then sell for substantially less.
Back to stocks. Investors in the stock market can determine a stock's value by looking at such factors as:
- Earnings (past, present and, more importantly, future projections)
- Market share
- Sales volume over time
- Potential and current competitors
- Running through a variety of metrics
- Reviewing reports by analysts who follow the company
- And so on
Most of this analysis is straightforward and based on published facts and figures, although there is still room for different interpretations of the number. For example, if a company ventures into a new area of business, through merger or acquisition, it may work or it may not.
Stock market analysts make a lot of money sorting out the facts and figures along with the possibilities for success or failure.
In the end, stock market analysts will arrive at a value, that is, what they believe the stock should trade for on the market.
Often, the stock's price is at or near that value, discounting daily fluctuations due to a rising or falling market.
However, there are many occasions where a stock's price (what it is trading for on the open market) is way off the value.
The price a stock trades for (or indeed the price of anything) is simply the number that a willing seller and a willing buyer reach that is agreeable to each party. In other words, a stock (anything sold in a free market) is worth what someone is willing to pay.
While the fundamentals influence stock prices over the long term, supply and demand rule stock prices in the short term.
More buyers than sellers means the price will rise and more sellers than buyers means the price will fall.
Whether there are more buyers or sellers on any day depends on many factors, such as:
- Overall market trends
- News, good or bad
- Confidence or lack of it in the economy
- Company news (earnings, scandal and so on)
In short, traders are more concerned with price and investors are more concerned with value.
Traders live on price changes, whether up or down. They make money by figuring out which way prices are going to move and taking a position to profit if they are correct.
Investors are more concerned with value since over the long term a correct assessment of value will guide their decision to buy or sell.
Taking a long-term view doesn't mean to buy and forget. Things change and often rapidly. Reassessing value or a regular basis is important.
If you do this, it is unlikely you will hold a failing stock or sell one with strong prospects.