Relative Value

A method of determining an asset’s value that takes into account the value of similar assets. In contrast, absolute value looks only at an asset’s intrinsic value and does not compare it to other assets. Calculations that are used to measure the relative value of stocks include the enterprise ratio and price-to-earnings ratio.

When value investors are considering which stocks to invest in, they do not just look at the financial statements of the companies whose stocks they are interested in buying to make sure that the company is profitable and well-managed and that the stock is underpriced. They also look at the financial statements of competing companies to assess the stock’s value relative to its peers.

Example:

Consider the following scenario;

1. You make $80,000 in a world where everyone else makes $50,000.

2. You make $90,000 in a world where everyone else makes $150,000.

Most people would select the 1st option even though they are receiving less money than in option 2. The 1st option has more relative value.

The lesson you should take from these examples is that price doesn’t always equal value. And that the price should not is the only factor looked at when making a decision.

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