There are such things as market fundamentals. What you're buying when
you buy stock is a claim on the future cash flows of the firm. If the
stock price gets too far from the NPV of those cash flows, then you
need to wonder what's going on.
The difficulty is that it's hard to predict what the NPV of cash flows will be. Reasonable people can disagree about whether a firm's business model is sound (and therefore will lead to growing cash flows). So it's not always (ever?) clear what a firm's stock price should be.
Another difficulty is that in bubble times people often start arguing that "fundamentals don't matter any more." Example: About eight years ago, a friend told me that NPV of cash flows had nothing to do with demand for stocks. People bought stocks, he argued, because they liked the company and wanted to be associated with it. If true, then investing in Apple is sort of like rooting for the Utah Jazz.
If you're interested in an economist's view on these questions, go read "Irrational Exuberance" by Robert Shiller.
The difficulty is that it's hard to predict what the NPV of cash flows will be. Reasonable people can disagree about whether a firm's business model is sound (and therefore will lead to growing cash flows). So it's not always (ever?) clear what a firm's stock price should be.
Another difficulty is that in bubble times people often start arguing that "fundamentals don't matter any more." Example: About eight years ago, a friend told me that NPV of cash flows had nothing to do with demand for stocks. People bought stocks, he argued, because they liked the company and wanted to be associated with it. If true, then investing in Apple is sort of like rooting for the Utah Jazz.
If you're interested in an economist's view on these questions, go read "Irrational Exuberance" by Robert Shiller.
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1 comment:
Or the White Sox.
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