Many people do not understand that at the core of investment is actually a cycle of cycles.
Just as the succession of historical dynasties is a cycle of eras, economic cycles also have their patterns, repeating in a continuous cycle.
The stock market has both large and small cycles, but it can never escape the essence, the cycle of valuation.
The so-called valuation refers to the fluctuation range of the market value of a stock.
Stock prices always have so-called undervalued moments and overvalued moments, which is due to the influence of capital in the cycle.
Most of the capital will buy in the favorable cycle and choose to sell in the adverse cycle.
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This leads to the fact that even if a listed company has no change in performance, there will be fluctuations in the stock price.
The valuation of the stock will also cycle from undervalued to overvalued, and then from overvalued back to undervalued, repeatedly in a cyclical pattern.
To understand the stock market, it is only necessary to see the valuation of the entire large cycle clearly.The market value formula for stocks: Stock price × Number of shares = Market value.
Another formula for calculating market value: Price-to-earnings ratio × Net profit = Market value.
The main variable in the first formula is actually the stock price, and in the second formula, it is actually the net profit.
It is the change in net profit that causes fluctuations in the price-to-earnings ratio, affecting the market value of the stock.
And when the price-to-earnings ratio is stable, the theoretical value of the stock price should also be linked to the net profit.
In other words, the fair valuation of a listed company is actually based on net profit.
The higher the company's valuation, the higher the corresponding net profit should be.
When the net profit decreases, the valuation should naturally fall, and when the net profit increases, the valuation should naturally rise.
Of course, these are just theoretical values, and the actual situation is definitely not the case.
Here we see another result variable, the price-to-earnings ratio.The so-called outcome variable refers to the fact that the price-to-earnings (P/E) ratio does not change actively, but rather changes due to fluctuations in market value and net profit.
When the net profit is stable, a decrease in the P/E ratio is due to a decrease in market value, and an increase in the P/E ratio is due to an increase in market value.
Correspondingly, the valuation system of a stock is essentially the P/E ratio system.
When the P/E ratio is low, the valuation of a listed company is relatively low; when the P/E ratio is high, the valuation of the listed company is naturally higher.
We can fully determine whether the stock of a listed company is expensive or cheap by combining the company's profitability with its market value.
This method is essentially correct.
However, problems will arise when applied in practice.
The main problems come from three aspects, which are also the main reasons why many people feel that the valuation system is ineffective.
1. Fluctuations in net profit.
The net profit of a listed company is actually not stable.Especially for small companies, it is possible that receiving just one more order could lead to a significant leap in performance.
Once net profits fluctuate, it becomes difficult to accurately price the stock valuation.
Last year, the net profit was 100 million, but this year it has reached 300 million, and the stock price may have already increased threefold, or even five to ten times.
Since the net profit has increased, the stock price should theoretically rise in tandem, and the company's valuation should be raised.
Moreover, the expectations brought about by the growth in net profits may cause the stock price to rise far more than the increase in net profits.
2. Changes in growth expectations.
If net profits rise, the corresponding stock price will also increase.
However, in reality, there are many exceptions.
For example, if the original growth expectation was 50%, but now it is only 30%, the stock price is likely to fall rather than rise.
The main reason for this situation is the change in growth expectations.If the growth of net profit becomes increasingly lower, or even turns to negative growth, then theoretically, the future valuation should be lower than the current one.
Following this logic, large capital would naturally abandon those listed companies with declining performance expectations.
The reason why many listed companies are abandoned by capital is actually this.
Once growth is questioned, the stock price will quickly return to a reasonable range for self-repair.
3. Changes in capital liquidity.
The last factor affecting valuation is actually capital, which is also the key reason why many people lose money by investing in stocks based on the valuation system.
A stock, if its net profit is increasing and the growth expectation is also good, will it not fall?
The answer is no, it will still fall.
The reason is also very simple, because capital wants to leave, and if there are more stocks sold, the stock price will naturally fall.
Therefore, what affects the change in capital liquidity is not only performance and expectations but also the attitude of capital.Regardless of the reasons for the capital outflow, as long as there is a significant withdrawal of funds, stock prices will fall, and valuations will decrease.
When capital flows back into the market in large amounts, stock prices naturally rise.
The supply and demand of buying and selling easily affect the rise and fall of stock prices.
Behind this, there is actually another major logic, which is the capital's judgment of the stock's value.
The price-to-earnings ratio we think is not high is not necessarily what the capital thinks is not high.
When capital wants to cash out, it doesn't care about the price-to-earnings ratio; as long as it can sell and exit, it's perfectly fine to sell at a lower price.
This is similar to when a large amount of capital buys stocks, and the supply of shares is insufficient to meet the demand, capital will naturally offer a higher price to buy.
The change in capital is the most complex, but the inflow and outflow of capital will definitely affect the valuation of stocks in the short term.
The above three factors are the direct causes that affect the valuation of stocks, but the main culprit behind the scenes is still capital.
The reason why some stocks can continue to rise is that the company is more profitable, and the valuation given is higher.Consider a profound question at the end: referring to valuation, how should one conduct trades?
In fact, it is a truly simple method.
Buy at low valuations and sell at high valuations, disregarding the liquidity of funds.
This method goes straight to the essence through the appearance.
When a listed company is profitable but has a low valuation, it is a good opportunity for investment.
When a listed company is profitable but has a high valuation, it is a poison for investment.
The reason is simple: high valuations overdraw the stock's growth potential, rushing past the finish line in advance.
No matter how good a listed company is, once the stock enters the bubble area and the valuation is off the charts, it will inevitably fall.
Whether it makes money is one dimension of measurement, and whether the valuation is high or not is another dimension.Markets grant higher valuations to companies that are profitable and have expectations of performance growth, but this higher valuation is within a certain range; obviously, valuations that are excessively high do not fall within this range.
Stock prices cannot be inflated by speculation to the point where they become detached from reality; if performance does not keep up with the stock price, the risk is significant.
In contrast, stocks that have been undervalued for a long time may not necessarily rise immediately. However, the cyclical patterns of history will cause these listed companies to restore their deserved value at some point, returning to their reasonable valuation range. This is the cycle of valuation.
The last point, if you can understand it, then you truly understand.
Capital is always digging for bargains in the market, and then it inflates the cheap goods to make them expensive, sells them to the next buyer, and then seeks the next bargain, which is what is called the cycle.