Facebook’s stock declined by more than 20% in trading on Thursday this week. A stock’s price can seem random at times, but (hopefully) it aligns with the underlying financials over time. Unfortunately, a lot of investors don’t actually understand what they’re buying when they purchase stock. By this I mean a lot of people buy stocks using a sentiment similar to this: “Well, I really like FILL IN THE BLANK COMPANY’S products, so I should buy their stock.” Often, there is little to no consideration for the underlying financials of the company. A more astute way to invest might be to compare valuations among companies by scaling the price by book value (an accounting measure). In this way, you can compare all companies’ relative price. So, for a given dollar of book value, how much are you paying for this investment???
Well, it turns out that there is quite a range of values that investors are will to pay for a dollar of book (accounting) value. In the brief video below, CIO of Dimensional Fund Advisors Gerard O’Reilly explains that value stocks are in line with their historical price to book ratio, while growth stocks (similar to Facebook) are currently being valued at historically high price to book ratios (scroll down to the 3rd video in the link: Valuation Changes Over Time for Growth and Value Stocks (Excerpt length: 1:35))
Let us know if you have questions about your portfolio or the value vs growth dynamic of the market.
This is not a recommendation to buy a particular type of stock (value vs growth). Past performance is not indicative of future results. Talk to you advisor for advice about your particular situation.