The stock market just went down (or up) X points and here’s why … blah, blah, blah. If this sounds like something you heard today or yesterday, it will also sound like something you’ll hear tomorrow.
The financial media pays a great deal of attention to prices – what sector or index was up or down and by how much. All sorts of reasons are posed and most of them are valid, although there is still a certain amount of emotion in the market that reacts with no predictable pattern to breaking news.
A disappointing report on unemployment or a strong report on housing prices can send the broad stock market up or down. During earnings season (that period following every quarter of the year when companies report earnings and revenue from the previous quarter) are particularly anxious for the stock market.
If a few key industry leaders fall short, the market will likely fall, however, better-than-expected profits often give the stock market a lift.
Price news is of the utmost importance to traders and investors with a short-term window.
For example, even long-term investors must focus on price at least twice – once when they buy a stock and once when they sell.
Most long-term investors, however, are more interested in value, and value and price are not the same things. A company’s value for many investors is its ability to generate a satisfactory return over a long holding period.
A number of things including financial strength, market dominance, growth potential, and so on, contribute to defining the value of a company to long-term investors.
Value is about what the company is worth, while stock prices are about what people will pay (or sell) the stock for at any given moment in time. It is the task of long-term investors to determine the value of the company, often called the intrinsic value.
This value may or may not be reflected in the price of the stock. Over time, a company’s stock will reflect the value of the company, but daily prices are more a matter of the push and pull, the supply and demand of the stock market.
Many stocks will go through periods when there are more buyers than sellers (for whatever reason) and the price will rise, often above the intrinsic value – sometimes way above this price.
At other times, there will be more sellers than buyers and the price of the stock will drop below the intrinsic value. It is during these cycles that long-term investors look to buy the stock.
When the market price falls below the intrinsic value, long-term investors know it is a matter of time before the price rises back to that level. They will buy the stock when it is a bargain compared to the intrinsic value. If they have done their homework they know the intrinsic value of the company and will not buy above that price.
The day-to-day price fluctuation of the stock is usually more about volatility than value. Most investors are not overly concerned with stock price fluctuations that are driven by market conditions (inflation reports, oil prices, and so on).
While these events may move the stock’s price up or down, they usually do not affect the underlying value of the company and its ability to deliver the returns you desire.
Clearly, there are market conditions that may change the value of the company and you must stay on top of those changes to re-evaluate your holdings.
However, listening to the daily din of market chatter can divert your attention from the important goals of investing: focusing on quality companies and not worrying about daily volatility.