Well, I was checking my stocks today, and I noticed a note next to one of them (LUV), that it’s trading about 32% under estimated intrinsic value. I tried clicking on the note for an explanation (I was doing this in Quicken 2004), and all I got was a bunch of economist babble (worse than technobabble because I understand even less of it). My guess is that it means that the stock price is currently undervalued–that is, that the stock should be trading higher than it currently is. My question is, if that is so, what should I do? Just stick with my 3.75 measly shares of Southwest or buy more? I don’t want to sell, as the comission will eat up my profit. It’s only a couple bucks higher than when I originally bought last year, so I wouldn’t feel too bad about adding another three or four shares.
The price of a stock depends on several factors: the value of the underlying assets, such as airplanes, the current profitability of the business, and most importantly, the expected future profitability of the business. It sounds like someone set up a mathematical model and plugged in information about LUV and got an ‘intrinsic value’, which is more than the current price. There is nothing particularly rigorous about such an exercise, especially since it depends on guessing the future profits. Someone else’s model might tell you that the stock was overpriced.
My advice, for what it is worth (it’s worth about as much as you are paying for it) would be to check online brokerages and see if they have a ‘buy’ recommendation for the stock. Even better advice would be to just throw the money into a mutual fund.
To really simplify things, it means the stock price is below the value of the assets owned by the company.
I would not sell your stock. The comission will eat up more than the profit you made. the total value of your stock is only about 60 bucks. You may as well hold or buy.
If you only have a few shares of a stock, you are getting killed on commissions. How did you get 3/4 of a share anyhow?
Sharebuilder. 4 dollar commission per trade, or 20 bucks a month for commission-free trading. It’s a totally online broker, really good for small investing and DRIPs when you are just trying to invest for a longer term. The cheap commission orders go through every Tuesday, so it’s not live trading, although live trading is available for a higher commission. I think what they do is they pool all the orders for a particular stock, buy it, and then redistribute. The only commission that might hurt would be the 15 bucks for live selling or buying, but I figure 15 bucks is a pretty competitive commission. I was buying stocks by dollar amount, not whole stocks, and that’s what it came out.
I have to disagree. You could look, for example, at the Society of Actuaries syllabus for the Course 2 exam, you’ll find Brealy & Myers. They identify fundamental value as the present value of the dividend stream of a stock going on into infinity. They demonstrate that if a portion of the dividends is invested in growth, you’ll come up with the same value.
Basically the idea is that based on fundamental factors, you expect the stock to pay back over time, and the fundamental value of a stock is the present of this income stream. This is fundamental analysis. Of course, these fundamental factors are estimates, often very rough estimates, so the resulting estimated correct price can vary wildly depending on assumptions made.
You can juxtapose this against technical analysis, where the analyst looks at the price pattern over time and attempts to tease out a predictable pattern, and then trade using that pattern as a guide.
I cannot recommend strongly enough A Random Walk Down Wall Street.
That sounds like either a really crappy mutual fund or a scam.
asterion, if you’re really interested in long-term investing, I recommend looking for a no- or minimal-fee index fund that is not managed. Purchase shares regularly ($x worth every y weeks) to take advantage of dollar-cost averaging.
This gives you diversification, a guarantee that you haven’t bought at too high a price (you’re buying at a pseudo-average), and if you have discipline, and refuse to sell when the price is less than what you paid to buy, then you will make money in the long run. I don’t have a cite, but I seem to recall that managed funds (where an analyst moves stocks around in a mutual fund to try to squeeze out marginal advantage) tend to get beaten by the Dow something like 3 times more often than they beat the Dow.
As for individual stocks, I love LUV, but there are financial analysts who spend sixty-plus hours a week trying to discern which individual stocks are “good buys” relative to their price. When they find these stocks, they buy them, driving the price closer and closer to what they believe its true price to be. All of this happens before you’ll ever read that stock’s name printed as a “good buy”.
If you really intend to make money in the long run, do some reading (I hear “Random Walk” recommended every other breath, and have not yet managed to read it, either), and think twice–or even thrice–before selling anything you’ve purchased in the last ten years.
I think this phrase “below estimated instrisic value” is very odd.
Here’s a “for instance”. I sometimes think of stocks a little like real estate. House prices in my neighborhood have gone through the roof the last couple years. One thing you hear all the time is someone saying “that house isn’t worth $225K” (or whatever amount). It’s the kind of phrasing that assumes something like “3 bedrooms, 2 baths, and 1500 sq. feet is worth $150K”. It’s as if there’s an “intrinsic” value on the house, completely ignoring that the 'hood is safe, there are kids around, there’s a park nearby, etc. etc. etc.
There is no “intrinsic” value. 1500 sq. ft. might be $45K in Montana, 1.5M in Manhattan. The “value” of the house is exactly what two people can agree upon.
And so like stock. The value of a stock is based on what one guy is willing to sell it for and one guy is willing to buy it for. That’s after they both assess the “hard” parts of it (cash, material, inventory, etc.) and the “soft” parts, (what “zimaane” called expected future profitability, which varies greatly from one person to another). You might also throw in there the wishy-washy: “what you expect others expect it to be”. Its just the market is a bit more efficient than real estate probably because its been analyzed to death.
See, that “estimated instrinsic value” is just what some guy got when he plugged all of the parameters he wanted to consider into his model and hit the enter key. But the real value of that stock was exactly what it was trading for that day. [he did say “estimated” though so it gets him off the hook of actually saying a stock has an “intrinsic value”.]
Anyway, that’s how I think about it. I’m not very sophisticated in these matters, though.
Welll, that’s why they have the words “estimated” and “intrinsic”, and don’t pretend it’s the actual value.
I would disagree with that comparison. real estate markets are often very thin, i.e. few buyers and sellers, and lots can vary wildly. Additionally, we would be trying to price in a lot of intangibles. Also worth noting is that a lot of real estate isn’t for income; that is, people are looking for places to live, vacation, etc.
The stock market is packed with lots of buyers and sellers, many of these are highly trained and handle huge portfolios. Your average assessor or appraiser is certainly a skilled professional, but a Ph.D. in finance has an additional 4-6 years of highly specialized training. It has also been found that experienced traders are more “rational”, and people generally do more stock buying than house buying. Finally, there really is an objective value to a stock, in the sense that we aren’t looking for intangibles. A dividend stream has a definite value that is real, if uncertain; a future price has a definite value, if uncertain.
So, to say that house X isn’t worth a certain price is a lot different from saying that stock Y isn’t worth a certain price.
That said, the evidence that such a value for a stock exists seems to be pretty scanty. Again, I refer to the aforementioned Random Walk. Also, Paulos’s A Mathematician Plays the Stock Market is a good read.
Leaving all that aside, I will re-assert that there is a definite answer to the OP, which is that by intrinsic value, the analyst is conducting fundamental analysis rather than technical analysis. She is looking at market predictions, balance sheets, dividend policy, etc. and using those to estimate a present value for the stock as an income stream (for lack of a better term).
Boy, did I misread that at first.