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The value and price of a financial asset are two different concepts and thanks to this difference they are bought and sold on the financial markets.
The value is a subjective value and corresponds to the perception that each investor has of each asset’s capacity to generate future returns.
There are different types of estimations for value analysis and these all correspond to the different methods that investors use to analyse the future behaviour of a certain asset. In simple terms, to try and summarise these estimations we can establish these three different types:
There are investors who do no individual analysis of assets because they believe that the market is efficient enough, and do not do so because they think that market price of an asset is an adequate estimation of its intrinsic value.
These types of investors wait for the market as a whole, or a specific category of assets, to increase favourably. The value of a specific asset is not as important as the future growth of an entire market or a certain asset class.
These investors have a long term focus. This category includes index funds and indexed ETFs.
Technical and chart analysis investors (the lines and graphs generated to identify trends), based only on the historical behaviour of the asset prices, attempt to identify behavioural patterns to estimate the future behaviour of them.
For these investors the value of an asset is simply the difference between the current market price and the price that they think may be reached on the market in the future.
In this case, there is value when returns can be made from the buying and selling of an asset at different times in the market, mostly focused on short term trades. Trading is included within this category.
Other investors analyse in depth the financial and economic situation of a company and its environment as well as the future perspectives of all these parameters to forecast the company’s capacity to generate future returns.
This type of investor analyzes the current intrinsic value of a stock compared to its current market price. The sense of this type of analysis is that the market, in the near future, will be able to recognize this undetected value.
These investors have a long term focus. Value Investing would be within this category.
An asset price is the market consensus of what value an asset has at any given time. In the market, transactions are made whenever there are discrepancies between the market price of an asset and the value that each investor assigns to an asset.
An investor buys when they believe that the value of an asset is greater than its current market price and then sells when the opposite is true. When in the market there are more investors who are willing to buy an asset at a certain price than those willing to sell at said price, the price of an asset increases until the point at which the difference between the assigned value and buying price disappears. The opposite happens when there are more investors willing to sell at a certain price in respect to those wanting to buy at said price.
The market consensus fixes the price. The combination of different opinions about the value of an asset and what drives market transactions, is what sets the market prices of assets at different times.
As we can see, the price is an objective variable and is the result of a buying and selling transaction and the value is subjective because it depends on the specific analysis made by each investor.
The three main types of investors listed above have an influence on market prices, but not all in the same way:
If we start with the first type, those who believe in market efficiency, these do not do any individual analysis into any specific asset and, therefore, are not involved in the differentiation of prices of each asset on the market.
The instruments which embody this vision of the market (index funds and index ETPs) and the corresponding management of these, cause block movements in the markets or the asset class that they are trying to replicate.
When investors invest in these types of instruments this money goes into the market or asset class that the fund is attempting to follow, causing a block increase in said market, without differentiating between the different assets within the market. The opposite happens when investors, usually due to their economic outlook, sell off these types of instruments.
The second type, those who analyse the historic behaviour of an asset price and look for trends and behavioural patterns, act in the market based solely on the price expectations of an asset. This means their role in the market to adjust the price of an asset to its intrinsic value is non-existent.
Their influence in the market exists, but it is in line with the behavioural and sentiment trends of investors when facing market situations beyond this rational analysis role of the true value of an asset.
The third type are those investors who really help to adjust the different asset prices on a market accordingly. They believe that with their in depth analysis of an asset they are able to detect the unrealised value at said price and therefore invest in the asset.
The collective opinions of these analysts are what contribute to a suitable valuation of a certain asset on the market by means of the asset’s price at any given time.
Interestingly, the more analysts that follow an asset and the more opinions there are, the less sense it makes to do any analysis as the market price of any asset will adjust even more towards its true value. The opportunity to detect the possible differences between the intrinsic value of an asset and its market price tends to disappear.
In order for the financial markets to fulfil their economic purpose of raising capital funds for those companies with good future outlooks, there needs to be a lot of analysts who believe that the markets are not efficient enough when assigning the price of the corresponding value, resulting in them believing that said analysis needs to be done.
The more analysts who believe that the market is not adjusting as it should, the better the adjustment between the value and price in the financial markets.
An in depth analysis made of an asset will improve the assignment of the funds into the financial markets, as with an improved adjustment between the intrinsic value of an asset and its list price, there tends to be more rewards by means of increased prices for those companies with a solid potential future growth.
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