The difference between value and price is one of the essential pillars of investing in the stock market through value investing. Said the poet investor psychology it is usually a very important factor in determining the price, especially during bubbles and cracks.
The value: Definition and characteristics
In finance, the value of an asset is defined as the discounted future cash flows that that asset will report to its owner. In other words, the money we will earn in the future discounted based on your risk and time horizon. To better understand this concept, I recommend my article on discounting cash flows.
Followers of value investing usually call “intrinsic value”To the value of a share or any other financial asset.
The characteristics of the value are as follows:
- The value does not depend on supply and demand, but on two factors, which are the investor's perspectives on future cash flows and the risk of the asset.
- Value, like price, is also quantifiable, but in a subjective way. Each person may assign a different value to the same share according to their prospects for future income and the risk of the asset. For one person, an asset may be risky, while for another it may not be.
- Unlike the price, the value is usually not very volatile, since it is usually based on more solid values.
Importance of the difference between value and price when investing in the stock market
Some investment styles, such as those based on modern portfolio theory, they start from the fact that in the financial markets the value of an asset is equal to its price, that is, that the financial markets are efficient and that it is impossible to beat the market if it is not by pure chance.
However, practice has shown that the best investors in the stock market are those who base their decisions on market inefficiencies, taking advantage of the differences between price and value. In other words, the best investors, the ones who have consistently beaten the market, are the followers of value investing.
Followers of value investing spend most of our time analyzing listed companies to determine their value. We decided to buy shares at the moment in which we consider that the price of a share is well below its value, offering a “safety marginReasonable.
I hope this article has helped you understand the difference between value and price a little better and that it helps you when investing in the stock market.
If you have any questions, criticism or want to contribute something, I await your comments.