Scientific Discovery in the Social Sciences by Unknown

Scientific Discovery in the Social Sciences by Unknown

Language: eng
Format: epub
ISBN: 9783030237691
Publisher: Springer International Publishing

6.4.2 Calculating Theoretical Value

When calculating a value for securities an investor tries to work out what the price of a security should be. They may use a variety of methodologies for doing this. When an investor believes that a security price should be different from the price at which it is currently trading, then they are likely to buy, or sell the security on the expectation that the market price will adjust to reflect the information in the investor’s pricing model. Let us continue with the example above. Company A releases information about cost cutting plans. Suppose that the company’s press release is discussed in the financial press, where most journalists argue that the management will not be able to achieve their cost cutting targets. Suppose that I spend a lot of time with the company’s management and believe, not only that they will succeed, but that, when they do, Company A will be in a considerably stronger position than other investors believe. Based on my expectations I believe Company A’s shares should trade at £16. They currently trade at £12. I buy Company A shares and wait. Let us suppose that the cost cutting program proceeds in the way that the management team suggested it would. The shares rise steadily to £14. My most obvious explanation of this is that I am right in my assessment on company A, and what the shares are worth.

However, I cannot be sure of this, based on the stock price moves alone. All I have confirmed in this situation is that my assessment of Company A’s management and their ability to cut costs is correct. I have not confirmed that the stock price has risen because other investors are adjusting to this information. This is because I have no idea whether the investors responsible for influencing the stock price care about this information. And even if they do care about this information, that they interpret it in the same way. The price of Company A’s shares may have risen because investors have reacted to other information entirely. Perhaps even to information of which I am unaware. For example, many macro investors may have bought Company A because of views about the economy in which Company A operates and do not care at all about cost cutting.

To demonstrate that the price of Company A’s share price rose as other investors incorporated the implications of the cost cutting plans, I need to show, firstly, that a sufficient number of investors view Company A in the same way that I do; as a fundamental equity investment. Secondly, I then need to show that they did, in fact, change their expectations about the company because of the cost cutting plans. This is not impossible, but complicated by the highly diversified nature of financial markets.

Questioning the status of the theoretical value of financial assets is not new. One recent example is McCauley, who writes that the idea of the “real value” of a financial asset is “not a


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