Investors should avoid using share prices as a measure of the value of a company and instead concentrate on intrinsic value, according to a microcap investment expert.
“Most people view market value as the key proxy of the health of a company. They think that the stock market perfectly encapsulates all available information and hence the stock market is this perfect weighting machine and therefore the share market price, the market value of a company, perfectly reflects it’s true value,” MicroEquities Asset Management chief investment officer Carlos Gil told delegates at the Australian Shareholders’ Association Conference in Sydney in May.
“We know that is not accurate. We know that is a fallacy.”
Gil suggested the intrinsic value of a company provided a much better gauge of true value when assessing an investment in a company. “This ultimately comes down to earnings. If you put $1000 into a business partnership, the value of that stake will ultimately be reflected on how much cash generation that investment is going to generate for you,” he said.
“That’s how we value businesses. We look at the intrinsic value, not the market value, because the market value and the intrinsic value can diverge certainly over the short to medium term and therefore the market value is not the this perfect weighting machine.
“It is not a proxy for intrinsic value.”
Gil used the stock market crash of 1987, where world share prices in a 24-hour period fell by an average of 20 per cent, to highlight his point. “It couldn’t have been that simultaneously across the world all companies fell by 20 per cent. There wasn’t a fundamental change in intrinsic value overnight that would seemingly justify a fall of that magnitude,” he said.
“Yet somehow the market said they were worth 20 per cent less on average.”
He said it meant stock price as a measure of value was wrong before the crash or extremely wrong after it.''