Stock valuation

The secondary market runs on three trends - bullish, bearish and sideways trends. A bullish trend is upward movement of stock prices.

The market is bullish when the investors are confident that the stock or industry or market will give them a good return.

When a larger group of people think on the same line, the demand for the stock increases relative to supply. This is also called herd mentality. Investors might even be interested to pay a premium in the expectation of a high return.

But there are numerous reasons for security demand being higher than supply. Investment for a retail investor is possible only if he has surplus funds, which is a symbol of a strong economy with lower inflation and higher purchasing power.

The other major factor for increase in demand is non-availability of other alternatives. The best example of this reason is the recent growth of NEPSE in the time of COVID-19. People could not invest in their personal businesses, real estate, and industry was running low.

The only option for the general public was to invest in it.

The interest rate of banks and financial institutions on deposit being lower also promoted the bullish trend in the market.

Rather than keeping money in the bank, people invest in shares hoping for a premium.

A bull market results in increase in the market value of security, but increase in the market value of the security may not necessarily increase the worth of the security. Security basically has two values - market value and intrinsic value.

Market value is the value at which it is currently traded in the market where as intrinsic value is the real value which is not influenced by an external factor. Intrinsic value gives the worth of the security and is unaffected by the market trend, be it bullish or bearish or sideways.

The intrinsic value tells you whether the security is undervalued or overvalued.

The Dividend Discount Model is one widely used technique to calculate the intrinsic value.

In this model, future dividend earnings from the security are discounted from the present value. It predicts the value of the security based on the principle that its current market value is worth of future dividend.

The securities are overvalued in a bullish market. People bid for a price that is more than the income generating capacity of a security. The informed investor does not buy in a bullish market but wishes to sell the overpriced security in his portfolio. Since the market is perfect in only an ideal situation, people are guided by their emotion. This imperfection of the market attracts the investor.