Stock market investors often find themselves trying to resolve the difference between a stock's value and its price. If you have spent any time investing 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 this principle. For example, many houses that may have had a value derived from appraisals or other means ultimately sold for substantially less money, because it was what the market was willing to pay.
Determining a Stock's Value
With regard to stocks, investors in the stock market typically 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
- A variety of metrics such as P/E ratio
- Review of reports by analysts who follow the company
Most of this analysis is straightforward and based on published facts and figures, although there is still plenty of room for different interpretations of the numbers. For example, if a company ventures into a new area of business, through merger or acquisition, it may or may not be successful financially, regardless of how good it might look on paper.
Career stock market analysts make very good salaries sorting out the facts and figures along with the possibilities for success or failure. Ultimately, the analysts will arrive at a value, that is, what they believe the stock should trade for on the market.
Influences on Stock Prices
Often, a stock's actual price is at or near the analysts' estimated value, aside from daily fluctuations due to a rising or falling market.
However, many occasions come up where a stock's price, or the amount at which it trades on the open market, is quite different than its value. A stock's trading price represents the number that an arm's-length willing seller and willing buyer find agreeable to each party. In other words, a stock's actual value is whatever someone is willing to pay.
While fundamental factors influence stock prices over the long term, supply and demand rule stock prices in the short term. More buyers than sellers can mean the stock's price will rise, while more sellers than buyers indicates the price will fall.
Whether there are more buyers or sellers for a given stock 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, such as earnings, financial issues or scandals
In short, traders are more concerned with a stock's price and its fluctuations, while investors are more concerned with the stock's value.
The Final Word
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 so that they can profit if they make a correct trade.
Investors are more concerned with value since over the long term their assessment of value will guide their decision to buy or sell their holdings.
Taking a long-term view doesn't mean to buy and forget because the market changes, and often quite rapidly. It's important for investors to reassess their stock's value on a regular basis. Taking this step makes it unlikely that you will hold a failing stock or make the mistake of selling one that has strong prospects.