There are some investing beliefs that are widely accepted but may not be entirely true. One such belief is the idea that a company has a “common” intrinsic value.
When investors think of investing in stocks, the thought is often that a stock has the same intrinsic value for everyone, and eventually the stock price will gravitate toward that intrinsic value. But this may not be the case.
Intrinsic value is dependent on the circumstances of an investor.
Imagine a stock that consistently and predictably pays out $1 per share in dividends every year for eternity. An investor who seeks to find investments that will give a return of 10% a year will be willing to pay $10 per share. In other words, $10 is the “intrinsic value”. On the other hand, another investor may be highly connected and can find high-return investments that gives him 20% a year. This investor will only pay $5 for the above company. His intrinsic value is thus $5 per share.
As you can see, the intrinsic value for the same share is very different.
Intrinsic value changes with rates
Besides the circumstances of each investor, the intrinsic value of a stock can also change when the risk-free rate changes. If the risk free rate goes up, theoretically, investors will gravitate towards the now higher-yielding bonds. As such, stocks will require a higher rate of return and hence their intrinsic value falls.
As the last couple of years have shown, interest rates can have a very big impact on stock prices.
While all this is happening, the company in question is still the same company.
So despite being the same company, it can have different intrinsic values to different people and may also have different intrinsic values on a day-to-day basis based on the risk-free rate at the time.
So what?
This naturally leads to the question, what price will a stock trade at if its intrinsic value differs from person to person and from day to day?
I believe that it’s impossible to know what price a stock should or would trade at. There are too many factors in play. It depends on the market as a whole and with so many market participants, it is almost impossible to know how the stock will be priced.
Given this, instead of focusing on price, we can focus on the dividends that will be distributed to the investor in the future. This means we do not need to predict price movements and our returns are based on the returns that the company will pay to shareholders. Doing this will ensure we are not beholden to fluctuations in stock prices which are difficult to predict.
What’s more predictable is how a company will perform and whether it can generate cash flows and dividends to the shareholders. As such, I prefer focusing my efforts on looking for types of companies with predictable earnings and paying a price that fits my personal investing returns requirement.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have no vested interest in any company mentioned. Holdings are subject to change at any time.