Part One: Stocks and their Value Flashcards
What’s the firm foundation theory?
The firm foundation theory uses analytical data and methods to properly understand the intrinsic value(a firm foundation/anchor) of a stock/investment. The principle is used to find if stocks are overvalued or undervalued based on their intrinsic value. You look for stocks(that are undervalued based on their intrinsic value) and buy them. And you would usually sell stocks that are overvalued.
What does “discounting” mean?
Discounting is the process of determining the present value of a payment or a stream of payments that is to be received in the future. Given the time value of money, a dollar is worth more today than worth tomorrow. Discounting is the primary factor used in pricing a stream of tomorrow’s cash flows.
What’s the castle in the air theory?
The castle in the air theory states that investors should devote their energies not to estimating intrinsic values, but rather to analyzing how the crowd of investors is likely to behave in the future and how during periods of optimism they tend to build their hopes into castles in the air. The successful investor tries to beat the gun by estimating what investment situations are most susceptible to public castle-building and then buying before the crowd.
THE CROWDS ARE MAD
What’s the greater fools theory?
The greater fool’s theory is buying an investment, knowing it’s overvalued, but believing that a greater fool will buy it at a higher price. This method is halted VERY quickly as people want their money, and the price plummets.
What’s the tulip-bulb craze?
(Example of the Greater Fools theory)
The tulip-bulb craze is an event that happened in the late 1500s and early 1600s Dutch. Tulip bulbs were introduced to Dutch, and a professor who had them wished to make a profit. But a thief stole the bulbs, which were subsequently sold at a lower price but a greater profit. Over the next decade, the tulip became very popular but expensive(viruses also destroyed many of them). Slowly, tulip-mania set in. At first, bulb merchants simply tried to predict the most popular variegated style for the coming year, much as clothing manufacturers do in gauging the public’s taste in fabric, color, and hemlines. Then they would buy an extra-large stockpile to anticipate a price rise. Tulip-bulb prices began to rise wildly. The more expensive the bulbs became, the more people viewed them as smart investments. Apparently, as happens in all speculative crazes, prices eventually got so high that some people decided they would be prudent and sell their bulbs. Soon others followed suit. Like a snowball rolling downhill, bulb deflation grew at an increasingly rapid pace, and in no time at all, panic reigned.
Do all these bubbles mean that markets are inefficient?
It actually means the opposite. All the bubbles eventually popped and the market revealed the true value of the stocks/investments.
