If the market is efficient, what happens to the intrinsic value (proper price) and the price at which the market is pricing the stock out at?
Won't pricing adjust immediately because the information moves so fast to the analysts?
Investing - economyst, Friday, July 18, 2008 at 9:32am
There are a whole host of reasons why the daily market price of a stock will fluctuate around a stock's "proper" or "intrinsic" price.
First, is the definition or determination of a stock's "proper" price. A stock's price is not based on the company's current performance or current earnings per share, but on the company's expected FUTURE performance. Since nobody (that i am aware of at least) has perfect foresight, expected performance is a weighted average of all relevant investor's expectations and assumptions about the future. And views about the future are different. Further, these collective expectations will change as new information is received. So, bottom line, the intrinsic value of a share of stock is an amorphous number.
Which brings me to the market price or the price of a share of stock right now. Markets are efficient, but they are not perfectly efficient. Buying and selling of stock has transaction costs. In addition, just researching or monitoring a stock or a set of stocks has huge transaction costs. (Reading one prospectus or an analysts report is as dry as sand. Reading a 100+ would be a nightmare) So, many investors, knowingly enter the market with imperfect information.
New information takes time to digest. Markets are constantly receiving information of all types from jillions of sources. Even the best analyst needs time to separate the wheat from the chaff, the relevant information from the spurious,
Every day, the market has some people who are forced or required to sell; e.g., for personal reasons, they need to raise cash and will sell stock to do so. Similarly, the market has some people who are required to buy (e.g., a retirement fund manager who has just received new funds to invest in the market.)
Risk and risk aversion is another reason why the market price may fluctuate away from the "intrinsic" price. Risk-neutral people tend to be Bulls, risk-adverse people tend to be Bears.
With more time, I could think up even more reasons why markets prices fluctuate. But the key is that they fluctuate around your "intrinsic" price.
I hope this helps.
Investing - Ed, Sunday, July 20, 2008 at 10:59am
Good to hear from you again! Thanks, as always for yor hwlp, you explained this alot better than the book did. Much appreciated!