Chapter 9

Do Stocks Have Intrinsic Value?

Do stocks have intrinsic value? It all depends on your beliefs and underlying assumptions.1

If you believe in the traditional academic assumption2 that prices reflect all the information available in the marketplace, you are assuming implicitly that prices equal the average intrinsic valuation of all market participants. Price changes precisely equal changes in intrinsic valuations. Believing in perfectly efficient markets, where price equals intrinsic value, prompts you to invest in capitalization-weighted indexes. Don't try to beat the market. Minimize trading costs, management fees, and price impact costs.

However, we hope and assume that you are reading this book because you are an active investor or want to explore the possibility of active investing. Implicitly, therefore, you do not believe that price reflects intrinsic valuation. Markets overreact. You see it all the time! The dispersions of price around averages are just too wide to suggest instantaneous efficiency every minute, day, week, month, or year.

We agree with you. The empirical data support your desire to be an active investor.

We offer a caveat. Beating the market is not easy. It requires hard work. There are a lot of very smart people out there. And price-impact costs can easily wipe out excess returns when trading volume becomes large enough—as with some mutual funds.

Beating the market requires an information advantage over the people on the other end of the trades. ...

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