A beginner’s guide to understand stock’s value – Explained with examples

Imagine you are willing to buy a car. We have different varieties of cars from different car manufacturers. To buy a car, you need to go to a authorised dealer, who works as an intermediary between you and the manufacturer.

The dealer will offer you different prices based on the variety of car they have. Similarly dealers of another manufacturer will show you cars with a different price.

Now three things will come to your mind while buying cars;

  • Budget
  • Specifications
  • Car price
  • Manufacturer to take care of after service

You may look for certain additional features based on your requirements. But this is the overall thing you must be interested to know.

Car price will be the amount that you pay to the dealer for buying the car you selected. Now what if you have two manufacturers offering similar specifications, brand value and after sale service, at two different prices, one costs you 5,00,000 rupees and the other costs you 7,50,000 rupees.

Which car will you choose?

You may look at both cars, specifications, brand, after sale service and quality. After a comparison, if you find both cars similar, then you might choose the cheaper car. You will not choose the car costing you 7,50,000 as it’s overpriced.

The same thing is applicable to stocks

Now immagine, what will you do when two companies that are similar in every aspect and from the same industry but offering different prices for stocks in the market. Investors will prefer to go for the price that is cheaper as it offers greater value in less price.

When a stock is available at a bargain price, value investors jumpin to buy it for future gain.

Now let us go back to the car example. Imagine with the same price what happens when the quality of the two cars is significantly different.

Which one you will buy, when both the cars within your budget but one car is of poor quality and the other is of superior quality. Definitely you will choose the car which is of superior quality.

This same example works with stocks. When you stick to a stock of a better managed and fundamentally sound company instead of going for cheap quality stocks, then it’s a good choice of making money in future.

is a fellow member of the Institute of Chartered Accountants of India. He lives in Bhubaneswar, India. He writes about personal finance, income tax, goods and services tax (GST), company law and other topics on finance. Follow him on facebook or instagram or twitter.