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Stock prices: Reality or fiction?

Last updated on: February 11, 2010 14:44 IST
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Stock prices are easily the most vivid representation of listed companies. They are so easily available, and there for anyone and everyone to see and judge at any time of the day. And in any way that one likes.

It is not surprising then, that stock prices are by far the most sensitive element of a company. They are extremely sensitive to all kinds of events, even distantly related ones, both external and internal.

But is that the way it should be?

After all, the rest of the various facets of a company are much more durable than its stock price. They hardly change so much from day to day, let alone every minute. Its customers, the value of its plants, its knowledge base, its goodwill in the market, its long term earning power, its cash dividends paid every year.

None of this goes through the kind of extreme fluctuations that a company's stock price goes through.

Coming to the real question, what does all this mean for the investor? Does he have anything to gain from this tendency of the stock markets?

The answer is a clear yes. That is because it is exactly this tendency of the market that leads to exaggerations in the value of a company. And the good thing about this is that these exaggerations take place on the upside and the downside. Thus making way for the shrewd investor to take advantage of the same.

He can buy when some short term uncertainty or problem lets him buy the company's substantive features like its assets, earnings, dividends and definite long term prospects at a beaten down price.

Similarly, when the pendulum swings to the opposite extreme and the company's stock price begins to quote much higher than what its factual features like its earnings, assets and dividends can justify, it would probably be wiser to exit the stock.

Indeed, while stock prices are a function of the opinions of a capricious and fickle minded public, the fundamentals of a business are not. You would do well to realise that.

And correspondingly, you would also do well to not give this aspect of a company more importance than it deserves. Despite its deceptively accurate appearance.

Equitymaster is India's leading independent equity research initiative.
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