Trying to calculate the value of any business is incredibly difficult. It's even more challenging in the stock market. Every day millions of different buyers and sellers fight over equities, pushing and pulling prices in different directions.
Every single one of these investors has a different reason for buying and selling. Some may be traders hoping the price goes up by the end of the day. Others may be investors who are buying for the next 30 years. There is a different reason why the person or computer behind the order has decided to pull the trigger in every situation.
Even investors who buy a stock hoping to hold it for many years may have different methods of calculating how much they think the equity could be worth. This will lead to different intrinsic values and, as a result, different opinions on the stock at different prices.
Take a step back
By taking a step back and viewing the market as this complex mass of different buyers and sellers, it becomes easier to understand that the stock market is impossible to predict and that one should not be swayed by the opinion of a particular author or another investor.
Warren Buffett (Trades, Portfolio) explained this principle better than I ever could at the 1994 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual shareholders meeting. At this meeting, one investor asked the Oracle of Omaha if he had seen a recent article in the financial publication Barron's, in which the author had tried to calculate Berkshire's intrinsic value.
Buffett started by saying that he had read the article, and it was not the way "I would calculate the intrinsic value of Berkshire." He went on to say that everyone in the market makes different choices on valuing securities. "Every day somebody sells a few shares of Berkshire and someone buys, and you know, they are probably coming to differing opinions about valuation," Buffett went on to add.
It is the same with other stocks, he explained. And with so many people buying and selling, whoever one talks to, one will get a different answer:
"I mean, on any given day, two million shares of Coca-Cola (KO, Financial) may trade. That's a lot of people selling, a lot of people buying. If you talk to one person, you'd hear one thing, and you'd talk to another — you really should not make decisions in securities based on what other people think."
The CEO of Berkshire advised that any investors who are making decisions based on what other people think are probably in the wrong business. Making decisions based on others' opinions will "not get you rich," he declared.
Instead, investors should focus on businesses that they feel they can evaluate themselves without having to rely on the input of others. More often than not, insights from analysts are based on forecasts and projections, which are entirely unreliable ways of projecting business growth.
"You cannot get rich with a weather vane," Buffett explained.
For individual investors, it is essential to remember that the stock market is not a popularity contest. No one cares if you outperform or underperform or which stocks you like and which you don't.
At the end of the day, all that really matters is whether or not you have been able to achieve your financial goals. Basing investment decisions off others' ideas can be a quick way to lose money, and that's not conducive to wealth creation.
As Buffett advised in 1994, a better strategy is to focus on the companies you know and ignore outside interference. This strategy has worked incredibly well for the Oracle over the past six decades.
