Why stocks prices do not always reflect companies real value?

And how to deal with it.

Financial statment and share price

If you ask yourself a question is a share price reflects company’s performance? The answer is not easy to come because to get it you have to compare simultaneously many company’s figures and parameters from financial reports together with stocks price movements. But we still want to get an answer so let’s simplify our task and try to compare companies on one key parameter – EPS which stands for Earnings per share.

Let’s consider three graphs of share prices  – Gap (GPS), Amazon (AMZN) and Tesla (TSLA):

As you can see on the GAP (GPS) graph during 2010 – 2012 years mean EPS was about 0.4$ per share and mean share price was about 20$. During the next 2013 – 2015 years mean EPS was about 0.7$ per share and the mean share price was about 42$. Seems to be reasonable at this point. But look what happened next in 2018-2019. Mean EPS was about 0.6$ per share so based on previous results the price per share should be around 34$ but instead, the price went down to 17.8$ per share. This is definitely unreasonable. Why did this happen? It is difficult to say.  Maybe the reason was an insider sell of (William S. Fisher sold about 5 000 000 shares in the second quarter of 2019) or maybe another reason. So from this example, we can conclude that for Gap there is NO direct correlation between EPS and price movement. But an indirect one definitely persists.

Let’s go to the next Amazon graph and see what’s there:

From 2014 till mid-2015 median EPS was 0.04$ and the median price was about 348$ per share. From 2016 till mid-2017 median  EPS  was 1.1$  and median price was 870$. But in 2018 – 2019 median EPS was  5.8$ and share price 1772$. Strange isn’t it? Either in 2015 price should be lower or in 2019 price should be higher in order to maintain correlation with EPS.

Now compare results to Gap EPS. Again either Gap price should be higher or Amazon price should be lower fo fairplay.

Lets now move on to the third case:

As you can see from Tesla graph from year to year EPS is constantly falling from -0.77$ in 2012 to -2.44$ in 2019. But look at the share price, it is rising. How can that be possible? That is definitely unreasonable since investors are buying shares to get profit, not to finance strange ideas of geeks.

You can compare other companies parameters and financial figures but still get the same results. The stock prices are not directly reflecting companys performance, usually, they do it in some derivative way. And more I may say that a company’s financial statement is the secondary factor that influences the price. But what is the Primary factor that determines share price then?


As we have determined the price of stock could be above its fair market value or below quite for some time. But why does this happens?   Well for many reasons. It could a big investor that pouring in or it could be a big fund that selling off or an insider purchases or just hype of many small investors. It is really doesn’t matter whatever the reason of price movement. But what really matters is the real motive of all those investors and funds. And you know their motive, it is to get profit. So when they buy or sell stocks it means that they expect something in the future to happen. Market expectations of big investors funds and crowd that is the primary factor that drives the stock price.

Here we come to a big problem. Information about the future is hidden from the market.  I mean that people cant know for sure that an event will happen or not. So what people do then? They try to evaluate the probability of events and then expect or do not expect them. Let’s get to our examples. Tesla share price rise is based on the expectation that in the future it will dominate the car industry. This belief is the real reason for Tesla share price rise despite negative EPS.  As soon as the market will change its expectation about Tesla for example to bankruptcy in the future the price will immediately drop down.


Value Stocks

Ok, we know that financial reports are not the primary factor that determines the share price. From the other side market expectations which we consider to be a primary factor is generally unknown. But even if we could known market expectations for example for Tesla yet we don’t know when those expectations may change. What should we do then?

Well, as Portfolio investors we could try Value stocks investment strategy.

Why? Warren Buffett does, at least he is successful. )))

OK, let’s figure it out step by step.

Buying value stocks is an investment strategy that implies the selection of shares that are likely to be traded at a price below their real value. Investors are actively searching for shares that, in their opinion, the stock market underestimates. They believe that the market overreacts to good and bad news, which leads to high volatility in stock prices that are not consistent with the long-term fundamentals of the company. The excessive reaction makes it possible to make a profit by buying shares at reduced prices because in the long run market removes inefficiency in prices.

Seems to be simple enough. Find a company with strong fundamentals which looks cheaper than its similar peers which mean that it is very likely underestimated by the market. Simple but not easy. You have to spend a lot of time studying financial reports and balance sheets of hundreds of companies every quarter which looks impossible for a single person. So for an ordinary investor, there are two ways. The first way is to find an investment fund or an investment company which has many financial analysts in their stuff and pays them usually high price for information in which value stocks to invest. The second way is to find a technology startup which uses Artificial Intelligence technology instead of the number of financial analysts to analyze companies performance to pick value stocks.

When done, you should know which stocks to buy.