How important is the stock price when investing?

“Bhava Bhagwan Che” is a Gujarati phrase meaning “the price is God”. Though it may sound like a slogan, the Gujarati phrase is more of a philosophy which means that the stock market is always right and the stock price is the most important factor when investing.

But is it valid for all market participants? After all, there are many participants in the market. The list includes speculators, traders, long term investors, value investors, etc. Everyone wants to achieve different things, and their approach differs greatly from each other.

In that context, this blog will discuss the importance of a stock price for various market participants. And we will understand how this “Bhava Bhagwan Che” or “Price is God” philosophy holds for all of them.

Importance of stock price for traders

Traders buy and sell stocks on a short-term basis. They do this by predicting the future direction of a stock’s price based on its historical prices and volumes. And since they rely heavily on stock price charts, stock prices are definitely essential for traders. In other words, for traders, expressions are definitely god.

Importance of Stock Prices for Momentum Investors

Momentum investing is a strategy in which investors buy stocks on an uptrend and sell stocks that are at a peak. Momentum investors believe that the uptrend in the price of a stock will continue for some more time and they will be able to sell at a higher price. Similarly, the downward momentum works on the premise that stocks that have underperformed recently tend to go down even more in the short term.

Overall, momentum investors often consider both a stock’s price and a stock’s fundamentals. They invest their money in stocks with solid fundamentals and pay attention to the direction and speed at which share prices are moving. Hence, Bhava Bhagwan Che Momentum is very relevant for investors as well.

Importance of Stock Prices for Finance Professors

One of the most prominent theories in finance is the efficient market hypothesis (EMH). It states that the price of a security reflects all relevant information about it and trades at fair value on stock exchanges.

Thus, the EMT principle implies that all analysis (fundamental, technical, etc.) is useless. And one should simply buy the market or the index. In short, the price of a stock equals its value to those who believe in EMT. So, even for our finance professors, the spirit is God.

The Importance of Stock Prices to Value Investors

Most market participants consider a stock’s price as a proxy for its fair or true value. This makes sense because stock prices tend to be accurate, measured, visible and easy to verify. In addition, using stock prices as a proxy of its fair value is convenient for market participants who do not wish to ascertain the intrinsic value of a stock.

In this context, a value investor’s approach is quite different. A value investor continually assesses whether a stock’s price accurately reflects its value. Therefore, from a value investor’s perspective, the price of a stock is not always god.

That said, even value investors fall back on a stock’s price. Let’s take Benjamin Graham’s (father of value investing) stock investing philosophy. Graham advocated buying companies below intrinsic-value. But he realized that some of his investments would yield no returns or even give negative returns. Therefore, Graham followed the 3-year rule. This simply meant that he would exit the stocks that did not reach the expected price level in three years.

So, despite being deeply involved in value investing philosophy, Graham had a value-based benchmark.

Importance of stock price for credit rating agencies

Can there be a relationship between a company’s share price and credit rating?

It may sound strange, but it is true. In fact, the link starts to make sense when you look at some real examples of downgrades.

For example, the credit rating agency CRISIL downgraded the rating on long-term bank facilities of BHEL (Bharat Heavy Electricals Limited) on 19 August 2021. But interestingly, from early June 2021, the stock prices started falling sharply even before the downgrade. An examination of the company’s books revealed evidence of weak business and imminent financial risk.

As you can conclude from the example, the unexpected drop in the stock price was a signal for the credit rating agency to re-examine the company’s finances. Hence, the share price is also in the picture for the credit rating agencies.

Importance of Stock Prices for Equity Analysts

The basis of equity research is to estimate the estimated share price of the company based on the available information. So, on the face of it, the stock’s current price shouldn’t matter. However, equity analysts often contaminate their research based on stock prices.

Let’s look at an example where a company has one or more listed subsidiaries. For example, companies like HDFC, Tata Investment Corporation or State Bank of India. These companies have several listed and unlisted subsidiaries. Now, what analysts often do with listed subsidiaries is that they choose the market capitalization of the listed subsidiary and multiply that by the company’s stake in that subsidiary.

For example, State Bank of India has a 55% stake in SBI Life Insurance, 69% stake in SBI Cards and Payment Services Ltd and 30% stake in Yes Bank.

Analysts would multiply these stakes with the market capitalization of the respective subsidiary. As a result, they arrive at the cumulative value of the subsidiaries in the holding company.

This approach looks fine. But the problem with such an approach is that it does not have an independent valuation of the three subsidiaries. This can result in research being exposed to the uncertainties of the subsidiaries, which themselves are at a higher or lower cost than their value.

Therefore, equity analysts need to be careful about giving importance to stock prices. Otherwise, it can lead to serious evaluation mistakes.

ground level

In this blog, we understood the importance of stock price from two perspectives. The first approach is that of value investors. They believe that the price and value of a stock are different. As a result, they try to find discrepancies between the two and make money from the valuation gap. The second approach is more popular because most stakeholders believe that you should rely on price, and all determinations should be based on the price of the stock.

While you may or may not agree with the “Bhava Bhavan Che” or “Price is God” philosophy, you cannot ignore the fact that there are many areas of stock valuation that are influenced by stock prices. . As an investor, it is in your best interest to understand price behavior in order to make an informed decision.