Most Important Investing Lesson That I Learned This Diwali!

Diwali celebrations have ended and so have the usual discount offers on shopping. Being a gadget freak, I couldn’t help notice that Apple’s latest offering the iPhone 11 Pro, was available for a discount of almost Rs. 11000 under the Diwali offer last week. Now since the offers are over, the phone is available at the original price of Rs. 109,000.

So does the drop in price due to discount indicate a decrease in the quality of the phone? Obviously no. It is merely the same phone with great features, but only the price had changed. But the value remained the same.

Now, this is exactly what happens with stock prices too. But remember the quality of the stock does not change every second, despite the change in stock prices. That’s why, before purchasing any stock, one should remember Warren Buffet’s famous quote in his letter to shareholders of Berkshire Hathway at the peak of 2008 financial crisis, “Price is what you pay, and value is what you get!”

Rather than judging a share by its price, it is essential to evaluate a share by its fundamental strength. Several economic and global factors make the headlines every day, and this affects the stock prices as well daily. On the contrary, company’s performance reports are released on a quarterly, half-yearly or annual basis. In the interim period, share prices can be very volatile, and companies may become under-valued or over-valued.

I have seen that many investors incorrectly assume that a stock trading at a lower price is cheap, while another with a high price is expensive. This notion often results in some bad investment decisions.

Stock price and value are two different things

For an investor, it is imperative to understand that we can never determine a stock’s actual value by its price because there is a massive difference between the two. The stock’s price only depicts the company’s current value or its market value which is the price agreed upon by a buyer and seller. Or in short, the demand and supply in the stock market. When the number of buyers is more, the stock price will increase, whereas when there are no buyers, the stock price will fall.

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A stock’s actual value depends on its intrinsic value

The intrinsic value of stock depicts its real value which includes both tangible and intangible factors and can be determined only after detailed fundamental analysis using the company’s business model and financial statements. Investors often make this crucial mistake of looking only at the stock price, because that is the number which appears everywhere be it stock tickers, news channels or business newspapers. To be honest, it has very little significance.
To help you better understand this, let me share an example. The current stock price of HDFC Bank is Rs. 1,232.20 while Yes bank currently trades at the stock price of Rs. 68.35. Now some investors might think that HDFC Bank share price is very high as compared to Yes Bank and the Yes Bank stock has a better chance of doubling its share price as compared to HDFC Bank’s share price which has run up significantly.

This is a misconception because there is a reason why HDFC Bank’s share commands a higher price. The 6.74 trillion market capitalization of HDFC Bank is much higher than Yes Bank’s 173.17 billion market capitalization. Besides this, HDFC Bank has a better asset quality, higher earnings and lower NPA’s as compared to Yes Bank. This justifies HDFC Bank’s lofty share price.

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The Bottom Line

Any long term investor should focus only on the stock value rather than the stock price. Looking at stock prices alone while investing can be a bad idea. As they say “Never judge a book by its cover.” Remember if there is a value associated with a stock, its share price will go much higher under the right circumstances, whereas a low priced stock with no value will sink even further.

Read more:  How Long-term investing helps create life-changing wealth – TOI.