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August 8, 1997 |
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From the inception of my portfolio on May 1, 1997 through July of this year, its market value has appreciated by 48.56%. In contrast, the total return of the Standard & Poor's 500 for the first six months of this year is +20.61% (total return is the combination of price change and dividends reinvested daily). For the same period as my portfolio, the S & P 500 index increased by 19.51% from 798.53 on May 1st to 954.31 on July 31st. Despite being a long term investor, I would be lying if I told you that I am not excited by my short-term performance results. However, I am quick to remind myself that to pat myself on the back based on such short-term results would be a violation of My Investment Principles. The only thing this gives me is some unjustified bragging rights. It is important to stay focused on the bigger picture. Market Value The market value of my portfolio is derived from the market prices of the securities in my portfolio, which are predominantly stocks. The market price of a stock is the price at which someone in the market is willing to buy or sell the stock. It represents the public's appraisal of what the stock is worth at a given moment. Such public appraisal is based on many factors, such as fundamentals of the business and, also, human emotions. Market price is not necessarily the same as the real worth of a stock. Just because someone in the market is willing to buy or sell a stock at a certain price doesn't always mean that the price is an accurate reflection of the underlying worth of the stock. The real worth of a stock is measured by the intrinsic value of its business. Intrinsic Value The intrinsic value of a stock is driven by fundamental factors of the business such as its earnings, management, and the future outlook of the business. Quite simply, if a business makes more money this year than last year and its future outlook continues to be favorable, then the intrinsic value of the business has increased. Such fundamental factors are mostly detached from the daily gyrations of the stock's market price. In the short-term, the market value of a stock is not necessarily the same as its intrinsic value. In fact, the two figures may diverge significantly. This is because short-term market price reflects the public's judgment of a stock's value at a given moment. And such public consensus often includes a high degree of human emotions and folly that can cause large differences between market value and intrinsic value. Astute investors will be able to exploit and profit from such discrepancies. Over the long run, however, the intrinsic value of a stock will be reflected in its market price even though the two may not be in sync with each other all the time. Measuring My Portfolio's Performance Consequently, what matters to me as an investor is not short-term movements in the market prices of the stocks in my portfolio, but the progress in intrinsic value of the stocks I own. In this regard, it is too early to tell how well my portfolio is performing. Therefore, I need to realistically ask myself what caused the sharp upward appreciation in the market prices of my stocks. Is the appreciation justified - is market value simply playing "catch up" with the intrinsic value of the stock? Or is the increase in market value simply driven by the public's emotions and therefore not justifiable? I should neither be overly excited by the sharp appreciation in my portfolio's market value in the last three months nor overly depressed if my portfolio had declined by the same magnitude (as long as fundamental factors of the stocks I owned have not changed). In fact I ought to be depressed by the quick run up in the market prices of my stocks since it deprives me of further buying opportunities. I'll actually be rubbing my hands with excitement if my portfolio declines significantly in the future as it will enable me to buy more of the same stocks at a bargain basement price. The jury is definitely still out on the performance of my portfolio. |
