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The Valuation Puzzle of Stock Markets

4 December 2006 - Features - Editor

How much are stocks and bonds really worth? Stock market experts are endlessly divided on this tricky issue of valuation. The rate at which future cash flows are discounted, the sensitivity profile of projections, and the opportunity costs which one takes in to account, are all highly subjective elements. Management teams and investment advisors show their pet projects in best light, but how far can they be trusted to take our priorities in to account?

Many qualitative factors affect individual valuation of securities. The price which you put on a share can be at wide variance from what the stock market in general thinks. The assured numbers of a bond may be worth more than ambitious plans of any enterprise. Association with a company, as an employee, supplier or distributor, may develop emotional bonds which go far beyond the numbers. You may see some new developments on the horizon which will affect future valuation in dramatic manner. Security valuation, like beauty, lies in the eyes of the beholder!

This does not mean that security valuation is a jungle, with each to his or her individual devices! There are three cardinal principles which everyone can use to arrive at independent and personal decisions on how much securities are worth:

  • Discounting and opportunity cost principles always apply: long gestation projections have lower present values than likely short-term returns. Similarly, the real value of a security is only the increment it offers over other opportunities available to you. The bank rate and government bonds are good yardsticks in this respect.

  • Durability and reliability of company worth are key considerations. Aggressive plans which threaten financial integrity amount to playing with your capital! All securities you own should be assured reservoirs of cash for emergencies and for new opportunities which arise all of a sudden.

  • Human resources are most important for the continuity of an enterprise: management quality, domain expertise, and clarity of vision are key determinants. Unfortunately, conclusions about such vague matters require intense company tracking, and some Business Management training as well.

Do visit our pages on companies, and share your thoughts on your favorite securities on our forums!

 


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