Some investors perceive that stock valuation is everything, but it is essential to demystify the stock valuation myths. Stock valuation provides an estimate of the stock’s intrinsic value. Based on this estimate, analysts, traders, or investors might identify the stock as cheap (undervalued), fairly valued or expensive (overvalued). Others presume that technical analysis is the key to entering the stock market. Hence the question arises, “Is the valuation method still relevant for traders or investors?”
5 Stock Valuation Myths and The Facts Beyond Them
1) Myth #1: Valuation should be accurate.
Fact: Valuation is not an exact knowledge that a high accuracy degree can be achieved. It is more practical to set up a reasonable range of values as a benchmark for analysis. The report of auditors within the financial statements of the company points out this matter. To be 100% accurate in the financial market is very challenging and even almost impossible. That is why analyses based on reasonable assumptions are acceptable and preferable.
2) Myth #2: The more complex the valuation model is, the more accurate the result is.
Fact: Inversely, the more complex the valuation is, the higher the probability of resorting to mistakes because of more assumptions. However, keep in mind to “Make things as simple as possible but not simpler.”
3) Myth #3: Stocks with a low ratio of PB or PE are always cheap.
Fact: These two ratios sometimes indicate bias valuation. This is because companies always go through a business life cycle, such as growth, maturity and decline. Low PB or PE ratio can give the impression that a stock is cheap, but the company’s business may be not promising or in the decline stage. Investors must be conscious of which stage of the company they will buy.
4) Myth #4: Stock valuation does not matter because market players or market makers determine the stock price.
Fact: The myth might be valid for the short-term horizon. However, in the long run, stock prices often move in line with their fair value. Therefore, valuation does matter for long term purposes.
5) Myth #5: Valuation is an objective method because it is quantitative in nature.
Fact: Before proceeding into valuation, there are always some assumptions that we create to base our calculation. For example, capturing quarterly financial reports instead of semi-annual as the denominators can result in different analyses. Sometimes, the results might be biased if the analysts are not mindful and precise.
What to Do Next?
Knowing these facts might help us decide which type of stocks’ purchasers we are. Traders are inclined to pay more attention to technical analysis, but valuation complements them to ensure that they are trading good stocks. Investors prioritize valuation because they seek long-rung financial objectives. Technical analysis can help them enter the market and determine whether the targeted stocks are fluctuating within the moving average of the market price. Indeed, they can use several technical analysis methods as they wish.
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