The Hazard of Tardy Adjustment of Price Value

SA, page 69

In that portion of the analyst's activities which relates to the discovery of undervalued, and possibly of overvalued securities, he is more directly concerned with market price. For here the vindication of his judgment must be found largely in the ultimate market action of the issues. This field of analytical work may be said to rest upon a twofold assumption :

• first, that the market price is frequently out of line with the true value;
• second, that there is an inherent tendency for these disparities to correct themselves.

As to the truth of the former statement, there can be very little doubt.
(First assumption)


The second assumption is equally true in theory,

• but its working out in practice is often most unsatisfactory.

• Undervaluation caused by neglect or prejudice may persist for an inconveniently long time, and the same applies to inflated prices caused by over-enthusiasm or artificial stimulants.
  

The particular danger to the analyst is that, because of such delay, new determining factors may supervene before the market price adjusts itself to value as he found it. In other words, by the time the price finally does reflect the value, this value may have changed considerably and the facts and reasoning on which his decision was based may no longer be applicable.

The analyst must seek to guard himself against this danger as best he can :

• by dealing with those situations preferably which are not subject to sudden change;
• in part, by favoring securities in which the popular interest is keen enough to promise a fairly swift response to value elements which he is the first to recognize;
• by tempering his activities to the general financial situation--laying more emphasis on the discovery of undervalued securities when business and market conditions are a fairly even keel,
• and proceeding with greater caution in times of abnormal stress and uncertainty.