Disclaimer

Do your own due diligence first before investing. The writer will not be responsible for any capital loss as a result of reading this blog.

Sunday, December 16, 2007

Chapter 3: The Behaviour of the Security Markets

The price to be paid or received for a security is an integral part of any complete analysis. We do not believe that short-run price movements--the day-to-day or month-to-month variations--are a valid or profitable concern. But the broader concept of business cycles should not be left out.

The relationship between Intrinsic Value and Market Price



The chart above traces various factors like speculation and valuation which contributes to the market price. Rather we should say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.

Undervalued Situations When The Market Appears High

When the general market is high there are always a number of individual issues that appear undervalued. One maybe tempted to buy these issues. But that is a time that calls for especial caution. Not only may the 'neglected issue' continue neglected for the remainder of the bull market, but when the downturn comes it is likely to decline in price along with the general market and to fully as great as an extent.

In a word, beware of 'bargains' when most stocks seem very high.

The Factor Of Marketability

The speculator or market trader has a real need for marketability because he may want to buy or sell in a few minutes' time. The typical investor has no similar requirement. It is better to sacrifice quick marketability to attract value rather than vice versa. For every point lost in the spread between bids and offers, the buyers of a true bargain issue may expect to gain perhaps 10 points in increased dividend returns plus ultimate improvement in selling price.

Much of the emphasis on marketability comes from the stock-brokerage business. Brokers are in business to earn commissions. It is easier for them to get orders in active than in inactive stocks. Hence, they are likely to overemphasize the popular and active issues in their work. This attitude tends to create something of a vicious cycle, since it makes active issues more active and inactive ones more inactive.

Summary

The security analyst should be concerned with those fluctuations in security prices which tend to create opportunities to buy at less than indicated value and to sell at more than such value.

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