The valuation of a stock will always matter in the end. There could be a period when the price is getting ahead of itself, but eventually, the price returns to the means. There are many factors that affect the valuation of a company’s stock. In this post, I’ll be going over some of the key factors.
Disclaimer: None of what I’m talking about should be considered as financial advice. It is for entertainment and educational purpose only.
Different Cycles in the Market
There are times when the market is fearful and then there are times when the market is greedy. Depending on if the market is fearful or greedy, it acts as an amplifier for the price of a stock. For example, when the market is fearful the price of stocks tends to be suppressed since people are not looking to take a risk. This can lead to very well-run companies having a cheap stock price. On the other hand, when the market is greedy, price tends to be high since people are looking to take risks. This can lead to poorly managed companies having a very high stock price.
Psychology of a Market Cycle
While the market as a whole has different cycles, an individual stock can have its own cycle within a market cycle. The psychology of investors towards a certain company can skyrocket the price up or down. This leads to the price being temporarily disjointed from the fundamentals of the company. When such a situation occurs it can be a golden opportunity to invest in the company.
Stock Price Is a Mix of Fundamentals and Human Emotions
When you look at the change in the stock price you can almost tie it to the emotions of investors during that time. This is because the stock price is mainly comprised of fundamentals and human emotion. The fundamentals tend to be relatively stable, while the emotional side is volatile.
A bit of generally good news can cause people to be happy and ends up driving the price upwards. Similarly, a bit of bad news can drive the price downwards. In either of those cases, the performance of the company likely didn’t change just the emotions of the investors.
Understanding that the short-term price movements are largely due to human emotions will help you navigate your investments better. This is because, at the end of the day, valuation does matter, and if the price drops due to fear, uncertainty, and doubt there is a high chance that the price will go up to be at equilibrium again.
Nobody Wants to Invest in Vaporware
Inherently, nobody wants to invest their capital into something that doesn’t exist yet. However, when the market is hot and the price of anything is going up, people get more greedy and way less risk-averse. This leads to the valuation of a company that might have no products to have a massive valuation that may be even higher than companies with products. These euphoric moments in the market don’t last forever. Whenever the bubble bursts the valuation of these types of companies will come crashing down massively to reach equilibrium with its fundamentals.
Everyone Wants a Good Deal
If valuation doesn’t matter then people wouldn’t care about the price. However, that’s not the case. There are investors who wouldn’t enter into an investment because the valuation is too high. When the price drops enough investors would flock in because the valuation is a good deal. This scenario demonstrates that valuation does matter because if the valuation doesn’t matter then there would not be new investors to buy at a lower valuation.
To conclude, the valuation of a company will always matter in the end. It just depends on how long it takes before investors start to care about valuation. That duration will vary largely depending on which psychological phase the market is in. The main takeaway as an investor is that you’ll need to understand that valuation does matter and the real question is when will it start to matter and if you are prepared for it.
I hope this post was helpful to you. If you found this post helpful, share it with others so they can benefit too.
If you’re new to investing and need a guideline to help you start your investment journey you can check out my post on setting yourself up for financial success. I also have a post about beginner mistakes to avoid in the stock market.
To get in touch, follow me on Twitter, leave a comment, or send me an email at steven@brightdevelopers.com.