What is a stock worth?

This is a guest post from Tusk Trader, an experienced Bay Street trader who will be writing here until Tusk’s own blog is set up. Tusk had a front row seat to the twists, turns, and almost collapse of our capital market systems a few years ago and provides a unique perspective you won’t find anywhere else. For most people, financial literacy is the elephant in the room. Let Tusk Trader help change that. If you are on twitter, make sure to follow Tusk at @TuskTrader

What is a particular stock really worth? This is a question I get asked often by friends and friends of friends when I am out socializing at the local watering holes. There are as many answers to this question in the financial community as there are people with the ability to answer. All day long you can find pundits, experts and financial icons on TV and on the internet discussing overvalued and undervalued stocks. How is an investor supposed to decide what a particular stock is worth today? When investors turn to experts, this is what they hear:

“The new guy running the firm is terrible, the stock is overvalued.”
“The street is not paying attention to the strong sales growth, they are undervalued!”
“Don’t believe the hype, this stock is not worth it and should be dropping like a rock.”

According to my finance professor years ago at Uni, “a stock’s worth is the present value of expected future earnings”. I will always remember this classroom moment. The craziness of the Tech Bubble that past just became that much crazier to me. I slightly questioned my goal of working in the capital markets. Did I really want to put my career in the hands of managers who bought equities and brokered deals for firms with no plan for a dividend and no plan for when they would even have some profits? These firms did not have enough revenue to pay someone to come up with a plan for a dividend. I decided yes; that my general career goals would still push me towards Bay Street. Well, more accurately, I decided not to worry about that and to focus on more near term goals. Like how to sneak beer into a school hockey game, and still keep it chilled. Someone really needs to invent a cooler bag in the shape of a satchel.

In these volatile trading times we are living in, the value of a stock is very easy for a trader to figure out and I wish more investors saw the beauty in being a little simple sometimes. Let the rest of the investing community fight about the complicated details. What is a stock worth? …..What is the bid? My answer is a question (just like Jeopardy) and it’s correct. Looking at the bid is your best way to know what a stock is worth. It is the most any person (or firm) at any given time is willing to pay for the stock. The capital markets are actually very good at showing you what something is worth; just look at the bid. It is hard to calculate what a stock will be worth in 5 years, or 10 years but very easy in present terms. Want to know what your house is worth? Put it up for sale and see what someone will pay you for it. In times of volatility, don’t get caught up in the complex and miss the simple, like what the bid is. What an investment is worth is directly tied to how much someone else is willing to pay for it. You cannot trade buy yourself.

*Bid: the bid is the price an investor (or firm) is immediately willing to buy a stock at. If you were to look at a stock quote for ABC and it was $3.50 – $3.55
The spread is 5 cents. The bid is $3.50, the amount you can immediately sell ABC at. The amount that you would sell it at is also the highest amount at that moment that someone else wants to buy ABC at. $3.55 is the ask, an amount you can immediately buy it at. Since $3.55 is the lowest you can immediately buy it at, it is also the lowest any other investor is willing to sell it at.

Thanks Tusk. Make sure to follow Tusk Trader on twitter: @tusktrader

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