Any investor must weigh two factors: Is this company a good value, and is this a good time to buy it—that is, is the price favorable?
The stock market establishes price. The investor determines value after weighing all the known information about a company’s business, management, and financial traits. Price and value are not necessarily equal. As Warren Buffett often remarks, “Price is what you pay. Value is what you get.”
If the stock market were truly efficient, prices would instantaneously adjust to all available information. Of course, we know this does not occur. Stock prices move above and below company values for numerous reasons, not all of them logical.
It’s bad to go to bed at night thinking about the price of a stock. We think about the value and company results; The stock market is there to serve you, not instruct you.
WARREN BUFFETT, 2003
Theoretically, investors make their decisions based on the differences between price and value. If the price is lower than its per share value, a rational investor will decide to buy. If the price is higher than value, any reasonable investor will pass.
As the company moves through its economic life cycle, a savvy investor will periodically reassess the company’s value in relation to market price and will buy, sell, or hold shares accordingly.
In sum, then, rational investing has two components:
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Determine the value of the business.
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Buy only when the price is right—when the business is selling at a significant discount to its value.