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From: res@ihlpl.UUCP (Rich Strebendt @ AT&T Information Systems - Indian Hill West; formerly)
Newsgroups: net.invest
Subject: Re: Stock market a present value machine
Message-ID: <721@ihlpl.UUCP>
Date: Wed, 19-Mar-86 18:43:26 EST
Article-I.D.: ihlpl.721
Posted: Wed Mar 19 18:43:26 1986
Date-Received: Fri, 21-Mar-86 04:56:18 EST
References: <1738@decwrl.DEC.COM>
Organization: AT&T Bell Laboratories
Lines: 49

> 
> >Someone mentioned that the stock market is just a present value machine
> >This can't be totally true, because then every stock with a given P/E
> >ratio would sell at exactly the same price, right?  A quick glance
> >at the stock listings shows this not to be the case.  Comments?
> 
> Wrong. The price of a share of stock is the net present value of the
> company divided by the number of shares outstanding. Even if two
> companies had the same net present value (highly unlikely), their
> share prices would differ if they had a different number of shares
> outstanding.

WRONG WRONG WRONG !!!

The price of a share of stock reflects the OPINION of the most recent
buyer of the stock as to a lower bound on the FUTURE value of the
stock.  This price has little (if any) relationship to the value of the
company (hence the Grahame strategy of buying undervalued companies) or
of any other RATIONAL attribute of the company.  The value of a stock
is set by EMOTION, not rationality.

As an example, General Public Utilities of Pennsylvania stock dropped
from something like 24 to 4 at the time of the Three Mile Island 
incident.  Did the value of the company's assets (less its liabilities)
really drop to 1/6th of what they were the day before?  Not really.  Did
the incident have an EMOTIONAL impact?  You betcha!  I do not know what
the stock is selling for today, but I expect that it has recovered a
good bit, but is not yet up to the pre-incident price.  The emotional
reaction is wearing off, but is not yet gone.  [This arguement is, of
course, grossly oversimplified, but the basic thrust I think is valid.]

This also explains (at least in part) why the market reacts to the
changes in the economic indicators, the price of oil, and the direction
of flatus outflow of Congressional Committee Chairpersons.  There is
no link between the number of housing starts in the month of March to
the net asset value of General Motors.  There is an emotional
expectation that the future price of GM stock will increase if the
number of houses being built has increased.  Hence, when the Leading
Economic Indicators rise, the price of GM stock rises, unless there is
another contravening emotional issue that forces that particular price
down.  Consider also the "market's resistance" to cross certain values
(say, 1800 recently) -- purely emotional reactions of the stock buyers.

So, when you hear someone speak of the market as a rational entity, you
should be thinking "AHA -- Another sucker donating money to MY
brokerage account!!!"

					Rich Strebendt
					...!ihnp4!iwsl6!res