THE VIEW FROM TAFT
time. Earnings forecast reflects new information about the company such as management changes. Product lifecycle, mergers, and acquisitions will affect future cash flows. The price of risk and the appropriate risk premiums in the market are sensitive to market and other extraneous forces.
The essence of value is that it comes from a company’s earning power evidenced by what is happening within the corporation. Such information is what causes cash flows to move and risks to be examined closely. This information will influence the value of the asset. Fundamental analysis looks at a company’s intrinsic value and long-term viability.
Pricing, on the other hand, is a market process. Simply put, price represents the point at which demand and supply intersect at any time. Because the market is not necessarily rational, price is often influenced by non-fundamental behavioral factors such as market mood, sentiment, and momentum shifts. Prices can then move up and down based on some patterns not necessarily related to the intrinsic value of the asset. In the short run, the price may be out of sync with real value, but the long run must correct such deviation.
Two investors looking at the same numbers and information regarding a firm or a project can end up with different estimates of intrinsic value.
So, to aspiring market investors, your chances of making money really depend on your appreciation of the disparity between intrinsic value, or the stock’s real worth, and price. Whoever is able to gauge this precisely has the best chance of earning a lot.
But while the principles are clear and indeed rational, the reality is that the market is fickle and unpredictable. Two investors looking at the same numbers and information regarding a firm or a project can end up with different estimates of intrinsic value. One can see this in bids for large infrastructure projects. The bidders’ offers are their estimates of intrinsic value. The bids vary significantly even when they are proposed by conglomerates, which are expected to be staffed with well-trained analysts having blue-chip academic credentials.
To digress a bit, note that intrinsic value has a philosophical meaning. It is at the heart of ethics as it represents what is valuable “for its own sake” or “in its own right.” One cannot help but observe that the ethical notion of value that the thing has in itself can stand alone. But for finance people, the usefulness of financial intrinsic value is that it has to be measured against price. Only then will it have practical significance.
The views expressed herein are his own and do not necessarily reflect the opinion of his office as well as the faculty and administration of DLSU. BENEL D. LAGUA is executive vice-president at the Development Bank of the Philippines. With an AIM-MBM and a Harvard-MPA, he is a part-time faculty of the College of Business,
De La Salle University.
benellagua @alumni.ksg.harvard.edu
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