Price is what you pay, value is what you getBy Dean Mico | May 16, 12 08:43 AM
How to make smart decisions on the stock market
Whenever you buy a product or service, be it groceries, clothing, furniture, a car, a house or even stocks, the price is what you pay but what you are really buying is what you get. I.e. you are buying the perceived benefit of what you have bought.
With investing, value is based on a business’ ability to grow earnings and increase cash flow. Therefore, when you invest in a business on the stock market, what you are really buying is that particular business’ ability to both earn and generate cash. The higher a business’ ability to earn, the higher the share price will go in the long run. And so it makes sense that every buy decision made in the stock market is done with the belief that the stock price of that particular company will ‘go up’.
In times of uncertainty and pessimism (think Europe currently), stock prices are often lower than the underlying value of the business. It is times of uncertainty that make stocks a bargain.
An investor’s goal
My goal as an investor is to uncover opportunities where the price of a stock is lower than my estimate of intrinsic value, with that intrinsic value rising in the coming years. Then patiently wait for the market to recognise the value.
I am looking for opportunities to pay 50¢ for a $1 of value, with that $1 in value rising in the coming years while waiting for the market to see what I see. And that usually happens when the uncertainty subsides. When the uncertainty subsides (current thinking: Europe fixed), the market will become “bullish” and price the stock more positively.
So, just like when I go shopping for groceries looking for specials or buying quality clothing that is on sal’, I am also looking to buy good quality stocks when they are on special or having a “two-for-one” sale.
The stock market does not display a ‘half price sale’ sign
The difference with the stock market is that it does not advertise a product as on sale or as the special this week. The price creates the opportunity and knowing the distinction between the price you pay for the value you will get, gives more certainty to buy/sell stock market decisions.
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Dean Mico is a full time value investor on the ASX. Edge7 Value Investing is a boutique investment advisory business providing wonderful stock market information giving you certainty to invest in the best stocks when they are good value.
The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.