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I've been trying to wrap my head around the idea of stocks with future earnings/value "priced in". How does this work exactly, with a fund. Does some manager look at the possible earnings a fund might gain (over some period) and add that to the current valuation of the fund?

If that is so, what time period does a manager use?
What research does a manger use to get the number?
How can one tell if the "priced in" numbers are valid?

  • Different stock funds may well use different strategies would be a starting point to my mind that you may be missing here. – JB King Jan 13 '17 at 2:39
  • The simplest way to understand the answer is this -- imagine if everyone agreed that gold would be worth $2,000 per ounce next month. Under anything remotely resembling normal conditions, would it be conceivable that people would sell it for significantly less than that today? – David Schwartz Jan 14 '17 at 19:04
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Anyone who wants to can use any method they want. Ultimately, the price of the stock will settle on the valuation that people tend to agree on. If you think the priced in numbers are too low, buy the stock as that would mean that its price will go up as the future earnings materialize. If you think it's too high, short the stock, as its price will go down as future earnings fail to materialize.

The current price represents the price at which just as much pressure pushes the price up as down. That means people agree it's reasonably approximating the expected future value.

Imagine if I needed money now and sold at auction whatever salary I make in 2019. How much will I make in 2019? I might be disabled. I might be a high earner. Who knows? But if I auction off those earnings, whatever price it sells for represents everyone's best estimate of that value. But each participant in the auction can estimate that value however they want.

If you want to know what something is worth, you see what you can sell it for.

  • Are you for real, value investing is subjective and biased, and if you buy a stock you think is undervalued there is no guarantee the price will go up in the future. In fact in many circumstance the price actually falls further. – user9822 Jan 13 '17 at 12:45
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    @MarkDoony This answer is correct; it doesn't imply that it is easy, or necessarily even possible, to properly value future earnings. In fact, it says explicitly that price reaches the price that people tend to agree on. It also says that the value of the stock is what you can sell it for. – Grade 'Eh' Bacon Jan 13 '17 at 13:35
  • People can't agree on a price that is why the price is constantly changing. You said "If you think the priced in numbers are too low, buy the stock as that would mean that its price will go up as the future earnings materialize." This is so incorrect as it is only based on your subjective and biased assumtions, and the market does not care one bit what your bias is and what your assuptions are. – user9822 Jan 13 '17 at 13:44
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    @MarkDoony Please observe the level of discourse provided by the OP - this answer provides the information that was asked for; getting into opinion-based answers of what investment strategies are best is outside the realm of what the OP is asking. – Grade 'Eh' Bacon Jan 13 '17 at 14:26
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    @MarkDoony I think you are (intentionally?) misreading what I'm saying. If I said, "If you think it's going to rain, bring an umbrella as that means you will need it", would you complain that you only need an umbrella if it actually rains not just if you think it will rain? It's clear from context that the stated consequence only applies if you are correct, not merely because you think you are. – David Schwartz Jan 13 '17 at 17:31
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I think the first misconception to clear up is that you are implying the price of a stock is set by a specific person. It is not. The price of a stock is equal to the value that someone most recently traded at. If Apple last traded at $100/share, then Apple shares are worth $100. If good news about Apple hits the market and people holding the shares ask for more money, and the most recent trade becomes $105, then that is now what Apple shares are worth. Remember that generally speaking, the company itself does not sell you its shares - instead, some other investor sells you shares they already own. When a company sells you shares, it is called a 'public offering'.

To get to your actual question, saying something is 'priced in' implies that the 'market' (that is, investors who are buying and selling shares in the company) has already considered the impacts of that something. For example, if you open up your newspaper and read an article about IBM inventing a new type of computer chip, you might want to invest in IBM. But, the rest of the market has also heard the news. So everyone else has already traded IBM assuming that this new chip would be made. That means when you buy, even if sales later go up because of the new chip, those sales were already considered by the person who chose the price to sell you the shares at.

One principle of the stock market (not agreed to by all) is called market efficiency. Generally, if there were perfect market efficiency, then every piece of public information about a company would be perfectly integrated into its stock price. In such a scenario, the only way to get real value when buying a company would be to have secret information of some sort. It would mean that everyone's collective best-guess about what will happen to the company has been "priced-in" to the most recent share trade.

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    @MarkDoony I think the simplest way to say this is, "some markets are more efficient than others". The more frequently an item is traded, the more efficient the price. Foreign exchange markets, for example, are incredibly efficient. As I said in the answer above, not all people agree that the stock market has a high degree of efficiency. Personally, I think that for highly traded stocks, it is efficient. – Grade 'Eh' Bacon Jan 13 '17 at 13:56
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    @MarkDoony You are welcome to your opinion, but please do not state "We know [market efficiency] is not the case", because it implies consensus on your opinion. I personally do not believe in perfect market efficiency, but I do believe that it is fruitless for an amateur investor to attempt to trade 'better' than the institutional investors who create most of the trades that move prices. For simplicity, for a junior investor (ie: one like the OP who believed that the price of a share may be set by a single person), I believe starting from an assumption of market efficiency is appropriate. – Grade 'Eh' Bacon Jan 13 '17 at 14:12
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    It is not my opinion, it is fact about what actually happens in the markets on a daily basis. Maybe you should concentrate on what actually happens in the markets instead of unproven theories. By the way the OP is talking about funds and fund managers not individual stocks. – user9822 Jan 13 '17 at 14:18
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    @MarkDoony Please clarify: are you saying, that 'for a fact', there is zero market efficiency? Because I have not stated that there is perfect market efficiency, just that it generally exists [I also stated that not everyone agrees with this principle]. If you say that I am wrong, for a fact, you are saying... that no market efficiency exists? I am not trying to make a controversial opinion, just to provide the OP with a starting point. Also - funds are priced by market forces, not individual price-setters, the same as stocks [except in the case of public offerings]. The same principles apply. – Grade 'Eh' Bacon Jan 13 '17 at 14:24
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    @MarkDoony all of quantitative finance finance is based around this being an assumption rather than a theory. My assertion that it was similar to the approximation of pi (calling it a rounding down rather than an approximation is disingenuous - it is not pi if it is not the exact value) was a simplification as I didn't want to get into the mathematics of the assumption. – MD-Tech Jan 13 '17 at 16:00
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"Priced in" just means that the speaker thinks the current price has already taken that factor into account. For example, the difference in price right before and right after a dividend is released often differ exactly by that dividend -- the fact that the dividend would function as a "relate" on the purchase price was priced into the earlier quote, and its absence for another year was priced into the later quote.

The ten can be applied to any expected or likely event, if you really think the price reflects that opportunity of risk. It just means that this factor, in the speaker's opinion, doesn't create an opportunity one can take advantage of.

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