Question

Do you believe managers should focus directly on the stock's actual market price or its intrinsic value, or are both important? Why?

Answer 1

*Assumption - Since the question is not clear about who the manager is, I have answered in context of portfolio Manager.

The primary objective of a portfolio manager would be to make the best use of the funds received from investors and focus on wealth maximization . For this he may construct a portfolio with various asset class such as stocks,bonds,commodities,etc in accordance to the risk appetite of the investor.He would rely on various technical as well as his own experience and judgement to manage the portfolio.

Stocks would be an interegal part of any manager's portfolio. Choosing a right stock ,buying at the right price and holding onto it for the right duration would help achieve the objective of wealth maximization for investors. As they say ,price is what you pay, and value is what you get, any portfolio manager would aim for value creation.

Now to the question, should managers focus directly on the stock's actual market price or its intrinsic value, then the answer is quite simple and straight forward - he should give equal importance to both and focus on both for better decision making. Market is efficient and rational investors are present in the market. This assumptions is very important since it implies that market would give the fair value of the stock. However at the same time, in computing intrinsic value, the most widely used technique is "Discounted Cash Flow" approach which discounts the future value of cash flow to present value. Some times it may so happen that a stock's current market price is trading at a price less than the intrinsic value and the market has not taken into consideration the future growth aspect of the company. In such a case, the stock should be bought to make gains. Hence without comparing both- the market value and the intrinsic value of a stock, it would be impossible to make a correct decision in choosing a stock.