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I feel a little extra pressure for my first post, going second after Wayne Collins last week. There’s always been an element of healthy competition between us. Considering we’ve known each other since the age of 4 that may be no surprise! So I’m hoping to get more comments and feedback on my thoughts below, just a friendly nudge to the reader…!

What do you think the difference is between price and value?

Just ask yourself that question from a general point of view for now, not looking at the Stock Market.

What comes to mind? Did you struggle to articulate it or do you have a clear distinction between the two? It’s actually not an easy question to answer as often there are a number of variables involved, however I like to summarise as…

Price is what you pay. Value is what you get.

In normal life this isn’t too difficult to understand. Imagine that you are considering buying something in a shop. You will only pay for it if you feel that the benefits you’ll get from owning the item is equal to or greater than the price tag.
These benefits aren’t always directly related to the ability of the item in question to fulfil its purpose. They can be softer, such as emotional, aspirational, egotistical and is always influenced by the perception of your own individual views on how important all of this is to you.

Ever wanted to be 007?

Consider if you were looking to buy a watch. The price you will be willing to pay will depend on the value you expect to receive from owning one.

If simple functionality is the most important, then a £10 Casio may be perfect for you. But if you value fashion, prestige, impressing others etc. then this isn’t valuable to you, even at this cheap price. You’d have little pleasure in owning this.

You want an Omega at £5000. You want this because you want to feel like James Bond. You want to communicate sophistication. You want people to notice your watch and make a snap judgement on you and how successful you are. You would be willing to pay £5000 for all this, so you feel the price is fair for the total value you receive from ownership.

I hope you’ve stuck with me here, because what I’m saying is that value is subjective in normal life. It lives in the perception of individuals. Companies can sell products to the public at different price points because they are able to target groups of people who share similar views, communicate the benefits and influence the perceived value of their product.

OK, what’s this got to do with Stock Markets?

You came here to learn about the Stock Markets right? So how does this relate to my ramble above?

The stock market behaves in essentially the same way.

At its most simple, all the financial markets are is a group of people who are constantly buying and selling based on their own perception of whether the price on offer is a true reflection of the value they believe the true worth of the company to be.

What I often see from private investors is that they can focus too much on the price of a stock and not enough on the underlying value. They look at where the price is now in comparison to where it’s been, and if it’s lower they think it’s good to buy.

However if they haven’t looked at the reasons behind these price drops related to the value in the stock, this can lead to losses as they are really buying a low-priced stock with little inherent value, rather than a higher-priced but more valuable stock.

Basically it’s cheap so they think it’s a bargain. Like when you walk out of a shop that had a sale on holding that abdominal exerciser that was so cheap at only £10 for a ‘trim waistline just by watching TV for 10 minutes a day’, that never made it out of the box… You got no value out of that and just lost money.

How to Assess Value in The Stock Market

There are many, many ways that investors and traders use to come to their own opinion on the true value of a stock, commodity or any other traded instrument. I’m not offering advice on specifics here, but if there’s enough interest I may focus future posts on some of these. Leave your comments below if this would be helpful.

Some examples of the methods available include financial statement analysis, Price per Earnings ratios, price-to-book analysis, industry analysis, product knowledge, market knowledge just to name a few. You must make sure that you understand what each of these mean before you use them.

What the most successful investors and traders have that sets them apart is a consistent or systemised way of reaching their value number, and they act each time it’s higher than the current price. They have clear entry and exit points both for profit and loss.

An Example

If after looking at a company and doing your own research and analysis you believe this company’s value is really £2, but you can currently buy it for £1. I’d suggest that it’s likely you’ll buy it as you expect the price to reflect the true value at some point in the future.

What you’re really saying is that you believe you can see the true value of a company ahead of the rest of the other people operating in that market. Others may start with the opposite view, but if the weight of opinion starts to side with you over time and more of the market participants also believe this company is worth £2, they will start buying at every price on its way to this price target.

Make Investing Work for You

This is both the challenge and the opportunity of being in the Stock Market. You need to develop a consistent way to carefully sift through all the information on each company, commodity or whatever instrument you are trading, and be able to quantify the real value. You will then need to find the gap between price and value and at the same time limit your emotional reactions and be confident enough to go stick to your plan as this may mean you going against the crowd.

So in summary, don’t fall in to the trap I so often see private investors succumb to by only focusing on low price when investing in stocks.

Don’t rush out and put a chunk of your money on a stock just because its “cheap”, you read about it in the financial press or a guy in the pub told you it’s a ‘sure thing’. Buying stocks just because they’re cheap is a good way to lose money in the Stock Market.

Always consider “where is the value?”

Does this ring true with your approach? How do you approach stock selection? Let me know in the comments below or email editor@css-investments.com.

Luca is Co-Founder & Director of CSS Investments. If you’d like to find out more about him, including his love of all things Ducati, connect with him on LinkedIn here LinkedIn Button

 


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Comments

  1. Peter Burgess says:

    Luca, most interesting. To be honest I think that the majority of investors, particularly those of us who have been “in the market for some year” know exactly what you are saying is true. However, our hearts sometimes over-rule our heads and yes we go for “cheap” stocks rather than value stocks. What is refreshing is to see your thoughts written down in front of us and for us to use them as a constant reminder to keep to the fore when making our next investment.

    • Luca Sarri says:

      Thank you Peter for your comment. I’ve always found its helpful to remind yourself of the many simple rules to investing as its all too easy to get caught up in the moment and make an irrational decision.

  2. Robin Rispin says:

    Thanks Luca. Of course you are right, assessing “real value” is the key. The difficulty -as ever- is doing it !
    Presumably most buy a stock because they believe future total returns (income and stock price increase) will be good/in the top 20% etc.. The difficulty I have is doing it (sufficiently) accurately because seeing into the future is difficult/inaccurate/time consuming and the competition is enormous. There are also sharks, who are working to a different agenda and “mislead”; so I’d welcome any (simple) guidance that works.

  3. Paul says:

    Hi Luca,

    Thanks for your post to the blog. I have read all the posts to the blog so far and have found them all very useful and informative. So thank you to all the team their for the input so far. And i look forward to reading further posts.

    Following on from your post, Yes, I would like to request your views on assessing the true value of a stock, commodity or traded instrument. And I am sure that others would also be very interested to understand this also.

    As you say, there are many ways to assess the value of a stock, commodity or traded instrument including the ones you mention. However, I would be interested to understand the more technical ones such as financial statement analysis, Price per Earnings ratios, price-to-book analysis, as these are able to be calculated from a company’s financial statements, which are all accessible online.

    If you have time, then comments on the other types of ways to assess the value of traded instruments would be most appreciated.

    Thanks and best wishes.

  4. Nordy Tawndish says:

    Thanks Luca. What you say may seem pretty obvious when looked at objectively but humans are strange creatures and do equally strange things. I have speculated for decades and it took me 10 years to really understand how markets tick – largely thanks to following Terry Smith. I now hold only 9 stocks ( 4 US , 4 UK one Finnish ) which I add to periodically when the price weakens against earnings. Ive held each one for an average of over 11 years now and I dont see myself selling any of them anytime soon because they are all superb cash generative growing businesses – as you say value is what you get.

  5. Keith Meech says:

    Thank you for this Luca, Us newer participants need all the info we can get.

  6. Hyder Ali Merchant says:

    Hi Luca,
    your comment about assessing the value of any stock will be appreciated. I have noticed that some of the high priced stocks have value that is difficult to judge and seeing that it scared to buy that high priced stock. dividing the total number of shares you get many a time very wide variations between the ruling price and the actual equity value behind those stock. I will much appreciate any guidance on this aspect.

    Thanks and with kind regards.

    • Luca Sarri says:

      Thanks for all the comments so far. Robin, Paul, Nordy and Hyder, you each clearly have similar questions. So I think it is something people struggle with! What I’ll do is work with our senior analyst to create a guide on how to assess value – the ways to go about it, the pitfalls, definitions etc. This way it will be more detailed than we can go into in a blog post.

      It may be a few weeks to create, but one key reason for this blog is to help us understand what you struggle with, and respond in the best way.

      I hope this would be something that would be helpful?

  7. Tariq says:

    Hi Luca
    You needn’t have been nervous. I think you have started your blog on a point that probably bewilders most private investors if not the professional community. I think constructive and incisive analysis will be much appreciated and I look forward to reading the guide. A point that professional investors often talk about is asset allocation. Perhaps, at some point you would consider covering this.

    • Luca Sarri says:

      Thanks Tariq, I appreciate the reassurance! I’m so glad this has touched on a subject that people need help with. I’ve found this to be a part of investing over the years that does challenge even the seasoned investor, so I’m relishing now in the challenge to create something that you can use!
      Interestingly, on the subject of asset allocation, our senior analyst has written a number of reports on the subject. Most recently on diversification beyond the UK100, and previously looking at geo-political issues and how correctly allocation of your assets can help to mitigate your risk to such factors. Take a look, they’re on the website and you can download a pdf to read offline if you wish too. First one is here https://www.css-investments.com/research-analysis/asset-diversity-beyond-the-ftse-100/. Second one is here https://www.css-investments.com/?p=2876

    • John Symons says:

      Tariq, asset allocation is crucial to stable portfolio value, by which I mean steady, not zero, growth. I have inherited funds which I do not dare to “play with” but my financial advisor achieves steady growth even though I have seen individual investments in the portfolio rise or fall by as much as 43% in 6 months. For the money I do play with I want to do something a little more exciting than trying to track all the investments in the world so I tend to pick up themes of the moment like emerging markets, consumer staples, uranium, etc. and buy one share in each.

  8. John Symons says:

    As an oil and gas project economist familiar with valuation of assets for acquisition or disposal I would model future net cashflows and discount them to the present day, add cash holdings and pending tax rebates, subtract debts and pending tax payments and divide by the number of shares in issue. A typical company is even more complex than an oil or gas field, however, forecasting all the cashflow components especially tax is very tricky and it is very hard to estimate the company’s weighted cost of capital to use as a discount rate. Alternatively if I had a view on the share price at some point in the future I could discount that, plus intervening dividends, back to the present day at *my* marginal or opportunity cost of capital depending on whether I was borrowing (unlikely in my case – I do not like borrowing to invest) or investing at the margin.

    • Luca Sarri says:

      Thanks John, really insightful comment. It’s great that the blog is becoming two way and our readers can offer great information as well as the author! Good to hear from you again by the way, hope all is going well!

      Also, I’m new to this blog stuff, but Adam has asked me to mention that we are also looking for guest post contributors, so as you’re an economist he’d be interested in a chat to see if there’s an interest or suitability in you doing one? Drop him an email at editor@css-investments.com if you’d like to talk to him about this.

      • John Symons says:

        Thanks, Luca. I always stress *project* economist because it is really what used to be called cost benefit analysis. I can apply microeconomic concepts like supply and demand curves but I am not a macroeconomist forecasting exchange rates, etc. or even oil and gas prices with any degree of confidence. Neither am I a cost engineer, which is a rare and expensive beast, as a reservoir engineer is too. You have also probably noticed that project economics is somewhat related to income statement and balance sheet analysis but that unlike an accountant the project economist is only interested in cashflow. I could possibly help with specific questions about the economics of different types of oil and gas fields or the impact of different types of tax regimes around the world. Perhaps you could feed that back to Adam together with my email address and let him take it from there, either now or at any time in the future. Some kind of joint guest post might I suppose also be possible, with two or more of us receiving a potentially business enhancing credit.

  9. Paul says:

    Thanks for this opportunity Luca, at an 2015 AGM the issue of buy backs led to a discussion of ‘maybe the company can’t see an opportunity to invest more money’ with a penalty to loyal long term holders compared to a gain those selling; verses fewer shares leading to higher dividend per share. And viceversa for releasing further shares. A well managed company may be judging size of such to keep immediate price change within a few percent. Comment please also on spikes verses setting stop-loss.

    • Luca Sarri says:

      No problem Paul. You raise a fair point so I’ll add this to the questions and hopefully we’ll be able to work it into the guide. I think Tom replied to a comment on his post relating to stop-losses, might be worth seeing if that is along the lines of your question. Have a look here https://www.css-investments.com/uncategorized/married-to-your-stock-a-cautionary-tale/

    • John Symons says:

      Paul, some oil companies have been cutting down on share buy-backs so that they can borrow more, their debt equity ratio being in danger of becoming a problem from the lenders’ point of view. When I worked for Shell (leaving almost 20 years ago now) their very conservative investment criteria, using a low “project screening value” rather than an oil price forecast and also using a high discount rate, meant that a lack of more attractive investments under those strict criteria sat alongside spare cash. At one time they were criticised along the lines of not seeing enough attractive investments when the real reason for their cash mountain was that being an Anglo Dutch company they could not buy back shares when that was forbidden under Dutch law.

  10. Cliff Tolputt says:

    From an investment point of view politics and economics, be they local or global, are always key factors to bear constantly in mind. Markets are in constant flux and it is insightful to assess why. The wise investor is a perpetual learner so make a habit of writing down why you’ve decided to purchase shares in a company. Do it at the time of purchase, and possibly add a postscript when they are sold. This is the root of learning to control emotion and thus lead to a desired, objective approach to investment. Mistakes are a certainty for the future is unknown. Spread the money invested into a number of companies in the expectation that some will go wrong, and keep a stop loss on every one of them. At the very least this will serve as an alert to review if the investment is still attractive when the market is suggesting otherwise.

    • Luca Sarri says:

      Great comment Cliff. Sounds like the voice of experience in your words? I’m sure many reading will take some insight from them, so thank you for sharing

    • John Symons says:

      Cliff, this is a great comment in terms of any kind of decision making. In my field, for example, prudent companies apply sensitivity analysis to their project economic results but tend to apply standard ones like capital cost +/- 20%, etc. If they documented the central assumptions made for every investment decision and reviewed the outcomes, they might find, for example, that on average they estimated capital cost 10% too low and that equally likely extreme sensitivities were not +/- 20% but -10% and +30%. Back on our type of investment, if you use a tips service like Stockommendation it is useful to review the performance of the individual tipsters and let that guide you as to how much attention you should pay to each of them.

  11. John Symons says:

    One problem we have to deal with is the herd psychology of markets and the consequent “weight of money” effect. A topical example is that there may be a capital flight away from bonds that temporarily overvalues both shares and gold. The link that used to apply between share and bond yields has been broken by the low central bank interest rate environment. Another problem is knowing how much an event like the UK general election is already discounted, i.e. priced into, shares. With hindsight we can see that a Labour majority or minority government was pretty much priced into the FTSE indices, with the market responding rapidly to the Conservative majority. I put the funds I “play with” into cash a couple of months before the election, so the incorrect opinion polls cost me something like 5%.

  12. Luca Sarri says:

    Great comments John. Thank you for sharing your experience and knowledge. It’s one of the reasons we started this blog, to have people in our community helping each other. I’m so pleased this is already happening in such a short time, so thank you again for being so generous with your time. Please keep it up!

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