Sharp declines in the stock market have prompted a few calls from clients. Not nearly as many as you might expect, actually. We all know that news networks thrive on worry, and that those who would temper a sense of hysteria are mostly ignored.
That said, what are we thinking?
- Taking practical precautions in our daily lives is certainly worthwhile. For instance, it’s not hard to imagine that supermarkets will restrict their hours at some point in the days ahead, so having some extra supplies on hand seems a good idea.
- There is no obligation to watch minute-by-minute news concerning the coronavirus outbreak. This provides no useful perspective and only encourages the worst aspect of what we called in our last issue of Viewpoint the “financial drama industry.”
In fact, and in all seriousness, you may get a better perspective by watching the Travel Channel. You may see scenes from a beautiful island resort and recall that this locale had been smashed by a hurricane not that long ago. A useful reminder that things do have a way of recovering.
- Investors are under no obligation to sell at bad prices. As the article below points out, the current price of a stock is only relevant to a seller who must sell now. All others can bide their time until prices are better.
This is the reason that we ask you about upcoming expenses when we meet for a portfolio review. We want to maintain a cash balance you can use to pay these so that you are not compelled to sell at a bad time.
- People will adapt, and markets will recover. Human beings have been through far worse events than coronavirus. We note that factories in China are already re-opening and new cases of the virus in South Korea have fallen sharply.
As the outbreak wanes, investors will note that the US still welcomes investment, and low interest rates still make stock investing especially attractive.
- We are encouraged that some great businesses we have wanted to own are now approaching attractive buy prices. We can use some of the cash we built up over the past few years to fund selective purchases of companies we expect to do very well in the future.
Is a Stock Only Worth What Someone
Will Pay For It?
James Thurber wrote that “It’s better to know some of the questions than all of the answers.” The topic at hand helps prove the point.
Even though I’ve titled this post as a question, it’s probably more common to hear someone say flatly that a stock is only worth what someone will pay for it.
Are they wrong? Well . . . no. But also yes.
Do You Have to Sell or Not?
If you are compelled to sell right now, a stock is only worth the current quote.
That’s not a good position to be in. That’s why we advise our clients to keep a cash reserve for expenses that are reasonably foreseeable.
At other times, it’s up to you to decide whether to take advantage of prices that are being bid.
How Are Prices Determined?
When some people say that a stock is only worth what someone will pay for it, they really mean that prices are determined by luck. What sells for $100 today could trade for $10 tomorrow. Successful investors, they think, are no better than winners of the lottery. Luck is the key thing.
But even though prices can be crazy, it’s worth applying some rational thought to the subject. You don’t have to accept what’s being offered. Eric often illustrates this point by asking whether a client would feel compelled to sell their expensive house for $30,000 simply because someone knocked on the door and made that offer. Of course not.
Time to Hit the Books
The finance textbooks say that a business is worth the value of the income it can produce over time, adjusted for the timing and certainty of receiving those returns. Stocks are ownership interests in businesses. When news comes out, it’s examined for the impact it may have on the estimates that go into valuations.
This isn’t to say that each investor in the market is aware of the precise impact that news will have or that they rush to update a detailed valuation spreadsheet.
But the market as a whole does make adjustments as the outlook changes. A slowdown in the economy may reduce the income a company is expected to produce. If the company is poorly funded, it may not make it.
The Current Uncertainty
In times of particular stress, as now with the coronavirus outbreak, there can be a general increase in uncertainty.
It’s plain how some companies are being affected. Those in the travel industry are hurt directly as people cancel trips. But there are less obvious impacts in a complex economic system.
For instance, worried investors may decide not to provide as much funding to startup companies. That would reduce demand for office space, hurt real estate developers, and lead to higher losses for lenders. Financial institutions, in turn, might become more reluctant to lend.
But in a flexible economic system that welcomes investment, there will be adjustments that help set the stage for an upswing. Investors will come to expect better earnings and less uncertainty. Estimate changes will become positive for valuations.
Stocks will be worth what someone is willing to pay, yes, but a potential seller may find that prices then coincide with his estimate of long-term business value. Not having been compelled to sell when prices were low, he can realize a better price.
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Registration with the Securities & Exchange Commission is not an endorsement by securities regulators and does not indicate that an advisor has attained a particular level of skill or ability. Be aware that past performance is no indication of future performance, and that wherever there is the potential for profit there is also the possibility of loss.