Short term vs Long Term Valuations
Really quickly, I just would just like to say a few words about valuation. The correlation between the value of a company and its share price is very strong in the long term, but weaker in the short and medium term.
There are two main ways to value a company using fundamental analysis
- P&L: Correlation between a company’s profit and loss account and its share/stock price.
- Balance Sheet: Correlation between the balance sheet of a company and its share price:
These 2 methods can be used independently or by combining them together.
It’s important to note that not all people involved in the stock market are long-term investors. If they were, the prices would have a much lower volatility than they actually have and they would always be trading at a price very close to their value.
But the market involves investors and traders with all kinds of strategies and time horizons. Day traders, long term investors, quants, robo advisors etc…all differ in their strategies, yet participate in the market at the same time. This is what makes the correlation between the price of a company and its value in the short and medium term relatively weak. Many people who buy stocks have no interest in knowing the value of companies, but that does not mean that they are bad investors or that they get poor results. It simply means that their way of operating is very different, neither better nor worse.
This de-correlation is a source of insecurity for many long-term investors, which does not explain, for example, why a good company with increasing profits can continue to fall in the market. The problem is that they analyze the situation as if everyone who invests in that company had the same mentality and they do not find it reasonable to sell shares of a solid company. The explanation lies in the great variety of market participants with many different and sometimes contradictory objectives.
But this short- and medium-term correlation between the price and the value of the companies should be seen by long-term investors as something very good because it implies the emergence of great buying and selling opportunities that would not occur if all those buying shares were long-term investors.
A long-term investor should not complain because the shares of a good company fall for technical reasons of the market while its profits continue to rise, but should take advantage to invest in that company with the assurance that in the long run the value of a company and their price will converge. In short, find an ETF, index, or group of companies that you believe strongly in, and wait. Over time, you will be rewarded.