How Stock Price Fluctuation Indicates Company Value

This article is an excerpt from the Shortform book guide to "The Intelligent Investor" by Benjamin Graham. Shortform has the world's best summaries and analyses of books you should be reading.

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What is stock price fluctuation? Should you consider fluctuation when choosing your investments?

Stock price fluctuation is when a company’s stock price changes, and may deviate from its value. You should be aware of fluctuations, because they may force you to speculate.

Read more about stock price fluctuations and how they might affect your investment opportunities.

Stock Price Fluctuation

In a narrow sense, a stock price should be considered an indication of the value of a business. If you examined a private business and tried to estimate its value, you might consider its book value (or its assets minus liabilities), as well as its current earnings.

However, in public markets, a high-quality company tends to have its stock price inflated well above book value. This is due to the market’s expectation that the company will continue growing (and so today’s stock price might represent the company’s book value 10 or 20 years from now).

The more a stock price deviates from the company’s current book value, the more speculative the stock is, and the more volatile the price will be. When the stock price well exceeds the appraisal value of the business, the movements of the stock price are not really based around whether the fundamental value of the business has changed, but more around the enthusiasm of speculators.

This is why fundamentally sound companies can see their stock price change dramatically, or experience stock price fluctuation, even when the underlying business hasn’t changed much at all. For instance, in 1963 IBM stock fell by half, from 607 to 300, even though its long-term growth prospects hadn’t materially changed. 
Graham thus cautions the conservative investor to concentrate on stocks trading at no more than one-third above the company’s book value. Investments in these stocks can be justified on solid financial grounds and will be less subject to the whimsies of stock speculators.

Example: A&P

To illustrate the wild stock price fluctuations, Graham gives the example of A&P, a grocery store chain. From 1915 to 1965, A&P was the largest retailer in the US. Durings its lifetime, its shares went from tremendous bargain to alarmingly overpriced.

A&P Stock Reaches a Low

In 1929, A&P started trading publicly, with stocks as high as 494. By 1932 the price had fallen to 104, and in the recession of 1938 it plummeted to a low of 36.

This low price was remarkable. The market valued the company at $126 million, less than its current assets: $85 million in cash and working capital of $134 million. At this time, A&P was the largest retailer in the country, if not the world, yet the market believed it was worth less than if the company were liquidated that day.

Why would the market believe this? Partially because of the overall depressed bear market, and partially because of temporary fears (chain stores might have new taxes levied against them, and earnings had declined). 

Any investor holding stock in A&P would have felt the emotional pull of the stock’s collapse, but on inspection, he might find that A&P was still a sound company with strong future prospects. Instead of selling in a panic with the rest of the market, he would judiciously hold onto his stock or even buy even more stock at a bargain. He would find himself vindicated. In 1939, A&P shares rose to 117.5, triple the low the previous year. This is an example of stock price fluctuation.

A&P Stock Reaches a High

In 1961, the price soared to the equivalent of 705 (the stock had a 10-for-1 split, so its literal price was 70.5). This represented a price-to-earnings ratio of 30, compared to 23 for the Dow Jones index. 

This rich price implied bright growth prospects. In reality, A&P was headed for an irrecoverable decline in earnings and revenue. The company was larger than it was 30 years ago, but it was not managed as well, was not as profitable, and could not ward off competition. Within a year, the stock price halved to 34, then over ten years halved again to 18 in 1972.

The example illustrates the stock price fluctuations in relation to the fundamental prospects of the business. When A&P was in its prime and poised for growth, the market wouldn’t touch the stock. Inversely, when A&P was headed for obsolescence, the market was breathlessly enthusiastic about its future.

A patient, alert investor will watch for gross aberrations like these and take advantage.

How Stock Price Fluctuation Indicates Company Value

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Carrie Cabral

Carrie has been reading and writing for as long as she can remember, and has always been open to reading anything put in front of her. She wrote her first short story at the age of six, about a lost dog who meets animal friends on his journey home. Surprisingly, it was never picked up by any major publishers, but did spark her passion for books. Carrie worked in book publishing for several years before getting an MFA in Creative Writing. She especially loves literary fiction, historical fiction, and social, cultural, and historical nonfiction that gets into the weeds of daily life.

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