1b. What is stock valuation?
Price vs. valuation
When a firm is listed in a stock
market, it has a market price. So everybody knows what it is worth.
What an equity is worth is its price, obviously.
Thus, why the need to do a stock valuation if we know the stock price?
Can the value differ from the price?
In absolute, no, but in my mind or in your mind, yes, it can be different. This is because:
if you buy a stock, it is that you think it can reach an higher price.
if you sell it, it is that, either you need the money to buy a new bread toaster or a Ferrari,
or you think it can reach a lower price.
So you need a stock valuation that give such potential prices.
Valuing a stock is to estimate
its potential price(s). Simple, Isn't it ?
And of course many businesses are not listed in a stock market (private corporations).
Here, sorry, we have no market price on the window, you have to find another value reference
Stock valuation methods are useful for such a business valuation.
The only extra things to take into account are:
* the lack of liquidity of the stock, it could lead to apply a discount to the estimated value,
* or in the contrary the rarity, that could lead to apply a premium.
Potential price vs. fair value,
Economic vs. market-based value
Mind you, in this approach, valuation is about.
* Potential price(s), a practical concept,
* Not "fair price / fair value", a theoretical
concept, which is based only on the stock's
economic fundamentals (*)
(*) or on some philosophic-political norms, for
example in the case of the Marxist theory
of value, but that is another story.
Of course, fundamental calculations might help, but are not sufficient to estimate potential
prices,which depend of stock market players' attitudes.
We can talk here of the difference between:
*"Intrinsic" (= economic) value
* "Extrinsic" (= belonging to the stock market) value.
This shows the need for market-based valuation (aka relative valuation) to complement
fundamental valuation methods, in order to take into account those market elements.
Valuation cannot give only one potential price
You have - at least - two potential prices for a given asset :
the lowest potential price
and the highest potential price.
This is oversimplifying things, you might say.
You would be right, as talking about "extreme" potential prices means there is a
potential ones between those two extremes.
So valuing a stock, as I see it, is to determine a bracket of potential prices.
Among them the so-called "fair price", might be - or might not be - the pivot of the range.
Beware of "range estimate aversion"
Deciders often have a "range estimate aversion".
They often determine a
precise number instead of a range of values that would allow to see the
various possibilities and risks among which to build a strategy.
They focus on what they expect has the most chance to happen and forget to imagine other
Also they expect from experts and analysts
to be given such a precise number instead of a choice
To reduce an estimate to one number is a typical framing (see that word) that gives the
deciders an illusion of certainty and waters down their appreciation of risk.
Also, if things turn bad, it allows them to attribute the responsibility on the expert,
forgetting that the role of the decider is to make its choice, not obey to experts.
How to find this potential price range
Valuation criteria include fundamental ones and behavioral ones
1) Normally fundamentals should play a part.
In other words, the first element of the bracket
would be various economic scenarios about
the predictable results of the firm.
Of course there is some subjectivity in economic predictions.
And some subjectivity
also in the choice of the calculation methods to deduct a financial
value from economic predictions.
In theory, economic valuation should use
discounting methods, but it as to be chosen
to what expected data it will be applied (earnings, cash earnings, dividend, rents, resale
values...) and what discounting return rate could be used
Yes, valuations are always subjective to some degree. Better admit it!
However refined is the valuation technique, it only gives what we consider
- by using our tools,
information, and projections - could / should be the "value" of the stock.
2) The second element to assess the bracket would be behavioral.
What would be the attitude and behavior of investors towards the stock?
What are the economic scenarios and valuations methods investors would choose?
What cognitive biases might interfere?
And what emotional value (image) they give to the stock, which would add a love bonus
or deduct a dislike penalty to their valuation.
Yes, subjectivity at power 2!
That financial affect (market sentiment) vary also inside a bracket, from highly
bullish to highly
bearish, from hatred to adoration.
Contrarians would say here that the more bearish or bullish the sentiment, the
are to a trend inversion in the opposite direction.
But that is another story and let us go back to stock valuation.
3)The combined elements
Is there a behavioral stock valuation model, built on the
idea of assessing potential price
brackets with a dual set of criteria, fundamental + behavioral?
The only one that exists to my knowledge, is the one presented in this site.
Its main innovation is the
"stock image coefficient".
One of the main purposes of this site is to show you how this method works, theoretically and
And, to make it even more practical, it gives you access to the related
From valuation to price objective
The next step after doing a valuation, or better, a
valuation range, is obviously to compare it with
the market price.
We see then if the stock looks expensive (near the upper
price potential) or cheap (near the lower
Also it is important to spot if the market is in a downtrend or an uptrend.
To detect this, it might help you to have a look at the basics of image evolutions
All this helps to determine price objectives for the stock.
=> This site has a chapter on portfolio management, even if it is not its main topic