Do They Know Something That You Don’t Know?

Why do certain stocks react negatively to news that interest rates might rise over the long run? Probably because present values of future cash flows will be less and therefore the value of certain stocks should decline. That is a good basic answer, right? Makes sense, but how low should a stock’s price decline if it should decline at all?

The answer to that question is anyone’s guess since rates might not rise by as much as one thought and future cash flows are highly unpredictable. The reality is that no one can accurately determine a stock’s exact current or future value.

Then why do people try to buy/sell stocks daily based on their ability to determine where a stock should be trading? It is generally because they think they know something that no one else knows which is not likely the case.

Remember, a stock’s price will follow earnings and earnings expectations and that is a fact. When that does not happen then there is an opportunity to earn excess returns relative to the market by holding a basket of stocks that violate that principle. This is an advantage to investors who are willing to hold on to their stocks for long enough to capitalize on this fact. Think of it as your gift from those who claim to be or think they are omniscient.

Most methods that attempt to discover undervalued stocks are usually costly and require millions of dollars in resources and experienced personnel. Also, in the end, these methods usually produce inferior results. However, a more commonsense approach, like the one described in the previous paragraph, is superior and requires only intellectual capital and common sense.

Interested in learning more about our approach? Schedule a consultation.