How can an overvalued stock be rated a 'buy'?

[Aussiesteve]

Take this for example from VectorVest (which appears to be a good free method of gaining valuations on stocks)

CAR.AX is overvalued compared to its Price of $11.35 per share, has about average safety, and is currently rated a Buy. (26/12/15)

Update: came across this post (also on ASF) "Unlike Stock Doctor's ratings which are almost entirely on fundamentals, VV also uses technical analysis so that you sometimes see buy recommenations on stocks VV rates as overvalued and sells on undervalued stocks."

Still not sure why the inclusion of technical analysis can result in this paradox?

 

[systematic]

You'd have to ask VectorVest about their methodolgy; but it sounds like all they mean is that a price trend might be 'good enough' to make the stock a 'buy' based on the momentum (what they call, 'T/A') aspect; despite the valuation.

 

[systematic]

Still not sure why the inclusion of technical analysis can result in this paradox?

...because price trend and valuation travel in their own directions and if you are considering both in your analysis, there is going to be tension at times.

 

[luutzu]

Take this for example from VectorVest (which appears to be a good free method of gaining valuations on stocks)

CAR.AX is overvalued compared to its Price of $11.35 per share, has about average safety, and is currently rated a Buy. (26/12/15)

Update: came across this post (also on ASF) "Unlike Stock Doctor's ratings which are almost entirely on fundamentals, VV also uses technical analysis so that you sometimes see buy recommenations on stocks VV rates as overvalued and sells on undervalued stocks."

Still not sure why the inclusion of technical analysis can result in this paradox?

It's standard operating procedure: either ignore your own rules and follow the market when it's popular; or cover both ends so you can cover your hide.

I've read a few "insights" from the likes of Motley Fools and their recommendations are all like this. That so and so company looks cheap, well managed, may have a good future ahead of it but... but don't buy it now because xyz (when the trend is down and you don't know if it's hit bottom yet).

 

[Rainman]

... Still not sure why the inclusion of technical analysis can result in this paradox?

Because technical analysis tells you nothing about the value of a stock. All it does is tell you how popular (or unpopular) a stock is.

 

[minwa]

The rating is just an opinion of the writers.

When the market opens, you will see quotes at specific price how many orders want to buy and sell - this is also indicating how many market participants are rating (via their orders) the current price as a buy or sell. It changes by ever second - much like a recommendation by a company can change.

I've also heard that newsletter writers receive offers all the time from listed companies to rate their company as a buy. Bribes, and it's not illegal. If you read the fine print of newsletters, almost all of them disclose that they MAY or MAY NOT have received compensation for any recommendations made.

 

[timlisten]

Overvalued or buy rating are purely an opinion, nobody can really predict the stock price with 100% accuracy for the short term. People make money trading because of discipline and strategies, not because they are right every time. One analysts can say the stock is overvalue while another can say it is a strong buy. You should do your own research.

 

[CanOz]

Because technical analysis tells you nothing about the value of a stock. All it does is tell you how popular (or unpopular) a stock is.

Is the value of the equity not the 'price'? Are you telling me Rainman, that your fundamental analysis can put a value on an equity by trusting what is published?

 

[galumay]

Is the value of the equity not the 'price'? Are you telling me Rainman, that your fundamental analysis can put a value on an equity by trusting what is published?

Vaue and price are definitely not the same thing!

 

[CanOz]

Vaue and price are definitely not the same thing!

The market is valuing the equity at the current price, you might not be, but trust me the market's auction process is.

If you go to an art auction, with a value in mind for a certain piece, you will likely not buy if you feel the price has gone above your idea of value. However, the auction continues higher because others have a different idea of value, right or wrong.

 

[galumay]

The market is valuing the equity at the current price, you might not be, but trust me the market's auction process is.

If you go to an art auction, with a value in mind for a certain piece, you will likely not buy if you feel the price has gone above your idea of value. However, the auction continues higher because others have a different idea of value, right or wrong.

With all due respect that is a pretty poor analogy, art has no intrinsic value, it only has price - it has no capacity to produce income.

From a FA point of view price is specifically not used in any calculation of value.

There are many obvious examples of cases where a company's price was very different to its value, any time a company's share price reflects something much greater or less than the sum of the future cashflows, discounted back to present value this disparity exists.

Mind you, I suspect you are just teasing and I am wasting my breath, because I am quite sure you know very well the difference between value and price!

I suppose sometimes confusion arises because those who use TA and traders, treat shares like art - in which case I guess value is irrelevent and price is everything!

I will leave the thread here, i suspect that it will just turn into a 'religious' debate otherwise! I have taken to only posting in the stock threads, that way I avoid the extremist RWNJ's that pervade the 'off-topic' threads and also the ping pong debates about investing stratagy in these sort of threads!

 

[CanOz]

With all due respect that is a pretty poor analogy, art has no intrinsic value, it only has price - it has no capacity to produce income.

From a FA point of view price is specifically not used in any calculation of value.

There are many obvious examples of cases where a company's price was very different to its value, any time a company's share price reflects something much greater or less than the sum of the future cashflows, discounted back to present value this disparity exists.

Mind you, I suspect you are just teasing and I am wasting my breath, because I am quite sure you know very well the difference between value and price!

I suppose sometimes confusion arises because those who use TA and traders, treat shares like art - in which case I guess value is irrelevent and price is everything!

I will leave the thread here, i suspect that it will just turn into a 'religious' debate otherwise! I have taken to only posting in the stock threads, that way I avoid the extremist RWNJ's that pervade the 'off-topic' threads and also the ping pong debates about investing stratagy in these sort of threads!

Certainly not teasing anyone G. It is a FACT that the market is an auction process, its not my opinion. This is not a debate between fundies and techies. They both have their place in my view, in fact I've embraced macro fundamentals more and more in my trading with great results in providing the backdrop to the auction process.

Anyway, lets move on as you say. Happy New Year!

 

[Rainman]

... If you go to an art auction, with a value in mind for a certain piece, you will likely not buy if you feel the price has gone above your idea of value. However, the auction continues higher because others have a different idea of value, right or wrong.

That is a stupid analogy. Art does not produce value: that is, art does not produce a stream of future cash flows and/or does not itself contain assets that capable of producing a stream of future cash flows.

 

[Rainman]

Is the value of the equity not the 'price'?

The value of an equity may be the price if the equity's price and its value more or less coincide. In my view, the market usually correctly values an equity's value. But not always.

You use the analogy that the stock market is like an auction. That is, I think, a fair analogy when considered over the short term. But market prices and equity values sometimes diverge and when they do you get mispricings. Sometimes the mispricings can be very great. However, ultimately price converges with value. That is what Benjamin Graham meant when he said that, in the short run, the market is a voting machine but in the long run it is a weighing machine. In the short term, the market is a popularity contest but in the long run it is a marathon and it is those who are the fittest that will lead the race.

If you do not accept this, then you are really saying that the market price always correctly reflects value and that human emotions like fear and greed can never cause value and price to diverge. If that is what you are saying, then your logical conclusion is that a holder of a stock can never be a forced seller of that stock, i.e. someone who sells regardless of price or value. Yet we know that that is not true.

Are you telling me Rainman, that your fundamental analysis can put a value on an equity by trusting what is published?

I am not sure that I quite understand what you mean by this. But you seem to be assuming again that the market and market prices perfectly, fully and at all times correctly price individual securities. I agree that most of the time they do. But sometimes they do not and that is when there is an opportunity to profit from the mispricing.

 

[luutzu]

That is a stupid analogy. Art does not produce value: that is, art does not produce a stream of future cash flows and/or does not itself contain assets that capable of producing a stream of future cash flows.

True that value generally refer to an asset that generate cash and hence profits to the owner... BUt given the rise of the uber rich having way too much cash nowadays - breaking records at auction houses year on year for a while now - we can't just dismiss art being a good investment in the foreseeable future.

Some company might not currently produce any income, or is making a loss. That does not mean it is worthless right? Its assets, its patents have some value.. and could conceivably produce cash in the future when it's auction off or rented out or turn a profit.

Speculative, but the future... include cash flows, are also speculative. So it depends.

 

[luutzu]

The value of an equity may be the price if the equity's price and its value more or less coincide. In my view, the market usually correctly values an equity's value. But not always.

You use the analogy that the stock market is like an auction. That is, I think, a fair analogy when considered over the short term. But market prices and equity values sometimes diverge and when they do you get mispricings. Sometimes the mispricings can be very great. However, ultimately price converges with value. That is what Benjamin Graham meant when he said that, in the short run, the market is a voting machine but in the long run it is a weighing machine. In the short term, the market is a popularity contest but in the long run it is a marathon and it is those who are the fittest that will lead the race.

If you do not accept this, then you are really saying that the market price always correctly reflects value and that human emotions like fear and greed can never cause value and price to diverge. If that is what you are saying, then your logical conclusion is that a holder of a stock can never be a forced seller of that stock, i.e. someone who sells regardless of price or value. Yet we know that that is not true.



I am not sure that I quite understand what you mean by this. But you seem to be assuming again that the market and market prices perfectly, fully and at all times correctly price individual securities. I agree that most of the time they do. But sometimes they do not and that is when there is an opportunity to profit from the mispricing.

Utimately, in the long run, price does not do anything but is what it is - it's the price investor set at each trade.

To say that in the long run, price will converge with value... while true, is misleading.

Misleading because, one... it implies that any established companies are right now priced correctly (close to its "true value"). Well, if it's been around for decades or a century.. .that's long enough for its price to merge towards intrinsic value right? So that assumption is wrong.

If by that line Graham (or his followers and value investor) mean that if we buy something now then in the future it will get to the true value. This is also misleading and wrong... The price might eventually be properly reflected in the medium to long term - but how far is that or for how long will the correct price be we cannot say.

So value will always have to be done in the present. And in that nth future period, it will need to be reappraised - taking into account new developments or further deterioration etc.

We can't just buy seedlings and think that in time it'll grow into a mighty oak - it could die or be eaten by birds long before it ever see the light.

---

Having said all that... yes, in the long term the market will reflect the asset's intrinsic value. Just that we as investor have to have some idea of what that value is to recognise it.

 

[Rainman]

... To say that in the long run, price will converge with value... while true, is misleading.

Misleading because, one... it implies that any established companies are right now priced correctly (close to its "true value")...

No, it doesn't. It implies nothing of the sort. To say that "in the long run price will converge with value" means that a stock or any other security that is currently mispriced will at some point converge with value. It may do so only to become mispriced again because the market is dynamic, not static. It follows therefore that prices of securities are always diverging and converging from true value and when they do converge it does not mean their prices can never again diverge from true value in the future.

... If by that line Graham (or his followers and value investor) mean that if we buy something now then in the future it will get to the true value. This is also misleading and wrong... The price might eventually be properly reflected in the medium to long term - but how far is that or for how long will the correct price be we cannot say...

I don't understand what you're trying to say here. Either you accept that price ultimately converges with value at some point or you do not. If it takes 5 years for a security that you hold to double in price, that is still a 20% return annualised.

So value will always have to be done in the present. And in that nth future period, it will need to be reappraised - taking into account new developments or further deterioration etc...

Of course. That is why valuation normally involves discounting the future cash flows of an asset back to a present value. But it does not follow from that that prices cannot diverge further from value now or that events may not supervene in the interim which prevent price and value from ever converging. Stuff happens - including to the economics of an investment.

 

[Rainman]

... [W]e can't just dismiss art being a good investment in the foreseeable future...

Art is not an investment. If you buy an artwork solely in the hope of being able to off-load it onto someone else at a higher price at a point in the future, you are speculating, i.e. you are hoping that someone will pay you a higher price than you paid. In the meantime, the artwork itself will not pay you anything. Contrast that with an asset that steadily and regularly throws off cash to the owner of the asset: I don't need anyone to buy that asset from me at a higher price than I paid for it in order to be enriched by those cash flows and in order for those cash flows to have a reasonably clear present value.

Some company might not currently produce any income, or is making a loss. That does not mean it is worthless right? Its assets, its patents have some value.. and could conceivably produce cash in the future when it's auction off or rented out or turn a profit...

As a generalised statement, this is true. But if what you are saying is that an asset - say, a business that is presently losing money and will continue to lose money in the foreseeable future - is or can rationally be as valuable as a business that is presently profitable and will likely remain so, then that is less clear and may in fact be entirely speculative.

 

[howardbandy]

In my opinion, there are three classes -- investments, trades, and expenses.

When I buy something, if I call my lawyer and have it noted in my will, along with who gets it after I die, that is an investment.

If I buy something anticipating selling it at some time in the future, hopefully at a profit, that is a trade.

If I buy something expecting it will have little or no value, that is an expense.

I have very few notes in my will.
Houses are trades at best, maybe expenses. All stocks and funds are trades.
Cars, food, wine, clothes, etc are expenses.

Art, wine, etc are not investments, and are terrible trades. The bid-ask spread is very high, liquidity is very low, scoundrels abound. Buy wine to drink, art to enjoy. Live as though they will never be worth more than you paid for them. Be pleasantly surprised if someone wants them enough to buy them from you at a profit. (In the US, an individual cannot sell wine to another individual. There must be at least one licensed dealer involved. Counterfeits are wide spread. One of the first questions asked is "prove they were stored correctly.")

Best,
Howard

 

[CanOz]

In my opinion, there are three classes -- investments, trades, and expenses.

When I buy something, if I call my lawyer and have it noted in my will, along with who gets it after I die, that is an investment.

If I buy something anticipating selling it at some time in the future, hopefully at a profit, that is a trade.

If I buy something expecting it will have little or no value, that is an expense.

I have very few notes in my will.
Houses are trades at best, maybe expenses. All stocks and funds are trades.
Cars, food, wine, clothes, etc are expenses.

Art, wine, etc are not investments, and are terrible trades. The bid-ask spread is very high, liquidity is very low, scoundrels abound. Buy wine to drink, art to enjoy. Live as though they will never be worth more than you paid for them. Be pleasantly surprised if someone wants them enough to buy them from you at a profit. (In the US, an individual cannot sell wine to another individual. There must be at least one licensed dealer involved. Counterfeits are wide spread. One of the first questions asked is "prove they were stored correctly.")

Best,
Howard

Well said Howard, happy new year to you!