Investment Price Isn't Everything, But It Matters

The investment price of an asset must always be considered in relation to other factors. A good investment is not always a purchase with a well-known, growing company. At times, a good investment can be the purchase of an undervalued security or an under traded stock. Looking for "value" instead of price can lead to larger capital appreciation with your investments. 

Value Stocks

Value stocks trade at prices lower than the sum of their parts would indicate. Essentially, an analyst will review the underlying factors that can be used to set a theoretical price for a stock. There are a number of ways to set a theoretical price, including arbitrage pricing, the Capital Asset Pricing Model and the French model. The details of each of these models vary slightly, but the goal of analysis is the same. They aim to discover what price the stock should reasonably be trading at. If the stock is currently trading above this price, it is overvalued. If it is currently trading below this price, it is considered a value stock. This is the type of stock investment analysts will recommend for purchase. 

Explanation of Value Stocks

Value stocks are often under priced because they do not have a high trading volume. This means brokers and traders are not receiving constant bids for the stock. As a result, the market may not catch up to the reasonably set price very quickly. It will lag behind even when the company is performing well. An investor who sees this opportunity can place a bid order and secure the stock at a low price. If, and when, the market catches up, the investor will earn a healthy profit off of selling the asset in the future.

Explanation of Over-Valued Stocks

Many investors want to own shares in a good company with a strong financial history. Big names like Berkshire Hathaway, Wal-Mart, and General Motors have a large brand that extends beyond the United States. Investors frequently place bids for these stocks, believing they are very low risk and will provide consistent, healthy returns. While this may be an accurate prediction, the appreciation of capital on these stocks is likely to be low. Because so many investors request shares in these companies, the price of those shares may be inflated beyond their actual value. The price is not likely to climb quickly or change very much. It has already reached its stable point, and it will take a large change in the corporation to break the threshold and produce very high returns.

Choosing Investments Based on Price

Price does not exist in a bubble. It fluctuates due to market conditions, and it is heavily reliant on the number of investors who currently desire shares in the company, i.e. demand for the stock. By finding a stock that has a low demand relative to its value, and investor can benefit by purchasing a low price stock. This stock may come with slightly higher risk than a highly-traded stock or over-valued stock. As a result, value stocks should be mixed into a portfolio with other, lower risk investments. 

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