In the previous post , I discussed the idea that a stock has an intrinsic value that is different from the current price of the stock. The stock market can become irrational and sometimes value a stock well above or well below its intrinsic value creating profitable opportunities for knowledgeable investors. So what? Most of us can’t figure out the intrinsic value of a stock any better than we can pick lottery numbers. If you’re like most people who fall into this camp, your best bet is probably to avoid individual stocks and invest in low-cost broad index funds. (See this post for more about index funds.) There are index funds that allow you to own a small slice of an entire economy. You can own your share of stocks in the US, Canada, and other countries. The better index funds have very low Management Expense Ratios ( MERs ). The stock market as a whole has an intrinsic value just like an individual stock. U.S. markets dropped about 10% in the first 3 weeks of January. Is it r...

What is a stock really worth? One answer is “whatever the stock is trading for in the stock market.” Unfortunately, this is not a useful answer. The stock market just tells you the price at which people are willing to buy and sell a stock. The true value of a stock (also called the intrinsic value) is determined by the value of the business represented by the stock. If a business is worth $10 million, and there are a million shares, then each share is worth $10. But, how do we determine the value of a business? Suppose that we know what is going to happen to ABC Company. ABC will pay a $1 dividend per share each year for the next 50 years and then close down. Now each person can decide how much to pay for a share that will pay $50 over 50 years. Some might be willing to pay $10 and others $15. This amount that you are willing to pay is your assessment of the intrinsic value of the business. Suppose that you decide that the intrinsic value is $15. If you find that the majority of people...