The pitfalls of valuing shares

Julie Brownlee, Fsp Invest, 10 Mar. 2014

Tags: shares, valuing shares, investing, investor, analysts, invest, investment, bonds, valuing bonds, forecast, problem of valuing shares, professionals, fund managers, assets, forecasting

When it comes to investments, one vital thing most investors want to know is the worth of an investment. To make money, you want to buy when the price is cheap and sell at a higher price giving you a healthy profit. But if only it was that easy. It depends on the asset you’re trying to value. Some assets are easy to value, but others are not. Let’s take a closer look at the problems of valuing shares…

Valuing a bond is quite easy

Bonds are quite easy to value, Phil Oakley in Money Week explains. You know what the ‘coupon’ (interest rate) a bond will pay every year is.

And you know when it will mature or when you’ll get your money back.

So for a bond, you can calculate the money it’ll produce over its lifespan and you can decide whether to invest or not.

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It’s a very different story for shares

Shares don’t have fixed pay outs or a lifespan. This makes it fundamentally hard to value a share properly.

But that doesn’t stop a whole industry of people working to try and determine the value of shares. It’s the job of analysts. They play this professional guessing game.

Fund managers, investors and share tipsters rely on the forecasts analysts give out for profits, dividends and cash flows. What these analysts think has a large influence on decisions made by investors.

And while many rely on the forecasts of analysts, they’re generally not very good. And the further into the future they forecast, the poorer the prediction.

So why are analysts so bad at forecasting?

The majority of analysts simply extrapolate the most recent trend that bit further into the future. But by doing this, they ignore possible recessions, drops in profits, new products in the market, competitors, etc. Nobody can predict this kind of change.

And inaccurate forecasts can be problematic. If a company fails to meet forecasts, it can be detrimental to its share price. For example, if a company falls way short of its forecast, investors may sell shares causing the price of the share to fall.

So there you have it, the problems with valuing shares.

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