MARKET COMMENT
The Case For Intrinsic Value

By Maynard Paton (TMFMayn)
August 23, 2002

It's often said that 'a share is only worth what somebody else is prepared to pay for it'. Such thinking is liable to lose you money.

To beat the stock market, you always have to get more than you pay for. In other words, you must always consider a company's value. Whether it's by using a price to earnings ratio, a dividend yield or a discounted cash flow, you must determine whether or not the market is assessing the company's future prospects correctly. As such, what you believe the company to be worth (i.e. the company's fair, or intrinsic, value) may significantly differ from what the stock market currently believes (i.e. the present market value).

When making a share purchase, you are effectively stating the market has got it wrong. You essentially believe the share to be undervalued. Why else do you buy a share, unless you think the market has missed something which it will -- in time -- latch on to and send the price rising? It stands to reason, then, that a share cannot just be worth what somebody else is prepared to pay for it. It has to be worth fundamentally more for you to buy it -- and fundamentally less for you to sell it!

Relying on the stock market as an arbiter of value is a mug's game. Investors generate far too much emotion, noise and all-round irrationality to underpin the Efficient Market Theory. Instead, a value anchor will help steady you from a choppy stock market. Simply find the right company, set suitable 'undervalued' (i.e. buy) and 'overvalued' (i.e. sell) prices, and just take the appropriate action whenever those prices happen to come along.