The Difference Between Share Price and Value

Sorry to use a cliché here, but like beauty, share market value truly is in the eye of the beholder.

That’s not unique to today. It’s not a side effect of the current volatile market. It’s how markets always behave.

That’s how you get buyers and sellers trading ownership of a stock at the same price. The buyer thinks it’s undervalued and heading up, the seller thinks it’s probably overvalued and heading down.

The trick is to know whether most investors think stocks are expensive or cheap right now. Because the answer will largely determine the market’s direction over the next few months…

So, how do you know if stocks are under- or overvalued?

It would be nice if each stock had a label telling you the answer. Unfortunately, that’s not the way it works. In order to figure out if a stock is worth buying you have to do some grunt work.

You either have to work it out yourself or use a computer program to work it out for you.

But even then your work isn’t over. The answer you get still won’t guarantee that your shares will go up. In that case, what’s the point?

 

The Share Price is Only Part of the Story
 

Investing is all about making predictions about the future.

You look at a company and figure out if you think it will do better in the future than it has in the past.

If you think it will do better in the future, then it’s a stock you should consider buying.

But notice we said ‘consider’. It still doesn’t mean you should definitely buy the stock. You may ask why. Well, for the simple reason that you may not be the only investor to think the stock will do better in the future.

If you come across the company too late, after other investors have gotten the same idea, it’s possible the stock has the good news already built into the share price.

Take innovative US electric car company Tesla Motors [NASDAQ: TSLA]. This morning the share price closed at USD$183.07 per share. That’s not so unusual for US companies, many of which trade for big double-digit or even triple-digit figures.

(Warren Buffett’s Berkshire Hathaway [NYSE: BRK/A] trades for USD$169,455.00 per share!)

The share price has gained 451% this year, as you can see on the chart below:

share price

Source: Google Finance

 

The question for investors is whether it’s still good value. You could argue that it isn’t. But we’re certain many investors said the same thing at $50, $100 and $150.

That’s where you look at more than the share price, because the share price only tells part of the story.

Tesla’s market capitalisation (share price x number of shares issued) is USD$22.2 billion. Compare that to General Motors [NYSE: GM] which has a market cap of USD$52.2 billion.

But again, we’re still only looking at price. What you need to do is compare the relative value of these stocks…

The Difference Between Price and Value
 

This is where you’ll see what we’re talking about when we refer to predicting the future prospects for a company.

Despite Tesla’s big market cap of USD$22.2 billion, the company only sold USD$413 million of cars during the last financial year.

Compare that to GM, which sold USD$152 billion-worth of cars last year.

In other words, GM is only two-and-a-half times the price of Tesla and yet it sells 53-times as many cars in terms of revenue.

So which company represents better value? Is it the new high-tech company that’s starting from a low base and which could become a new force in the car industry? Or is it the established carmaker with billions in sales and an existing worldwide market presence?

We’re afraid we don’t have the answer for you. Our inclination is towards the high-tech Tesla. But that’s because we like technology stocks. And if you think Tesla could one day achieve the same sales numbers that GM has now then it’s a no-brainer.

But there’s no guarantee that will happen.

So we’re sure you can now see just how tricky it is to identify which stocks represent better value than others.

A Buyers’ or Sellers’ Market?
 

Of course this is just one example, but this same analysis of stocks is playing out across the market every day.

Investors are sizing up one stock against the other or one stock against the whole industry, or one industry against another industry. Or even one economy against another economy.

The answers these individual investors and the market as a whole come up with will have a huge impact on where the market goes next.

If investors view the market as a ‘Tesla’ with plenty of growth opportunities then you should see the market head higher. But if investors view the market as a ‘GM’ with limited growth opportunities then it could spell trouble for stocks.

You know where we stand on this. Despite the macro-economic problems facing many economies (including the Aussie economy) we’re positive about the future, and that’s why we’re using the current pullback as an opportunity to buy.

Just be warned, our view is by no means the consensus view. There are many more analysts who say investors shouldn’t waste this opportunity to sell before the big crash arrives.

Cheers,
Kris+

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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