Global Market has corrected sharply since start of the year… How do I as a Fundamental Analyst (FA) reacts to such a situation?
As a FA, when we buy a company’s share, we are actually buying a share of the profits that the company can generate in the future. The potential profits, collective, determine the value of the company. Or technically speaking, intrinsic value of the company is determined by the present value of all potential profits of the company.
When market corrects, price of the share decreases. So the question is this, does the intrinsic value of the company decreases as well? To answer this question, you must first understand that price and intrinsic value are 2 separate things; intrinsic value, as described earlier, is a function of the potential profits of a company. Whereas price, is a function of demand and supply of the shares at a particular point in time.
So has the company intrinsic value or potential profits decrease? It will depend on the company’s business model. As per what most believed, the recent correction is mainly due to the weakening of the Chinese economy. Demand from China is expected to reduce and hence profits from companies serving the Chinese markets may suffer. I would avoid such shares as the intrinsic value of the companies are indeed reducing in tandem with the price.
But for companies that do not have much exposure to the Chinese economy, the price drop to me is senseless as intrinsic value has not changed! Let me give you an example: for those who need to take MRT daily, would you stop taking the train when China economy is not doing well? Of course the answer is no. In that sense, has the potential profits and hence the intrinsic value of SMRT changed? Again the answer is No. The price correction for such companies thus doesn’t make sense. It just make the intrinsic value of the company cheaper to purchase!
So back to the first question, how do I react to the current situation? To me, I am actually quite excited… prices of many large caps stocks and blue chips has reduce and yet their intrinsic value remained intact. It may actually be a good time to pick up some of such stocks!
Disclaimer! Please take note that this article is purely for education purpose and does not constitute to any recommendation. The example cited is for illustration only. Many other factors have not been considered to assess if the share is worth investing. As a FA, we also believe that the share market over short term is irrational. Cheap shares can become cheaper for reasons that are not justifiable!