One core misconception by many is that good news should lead to an increase in asset prices and bad news leads to the reverse. While this is the case at times, there are other times when good news still leads to a decrease in asset prices and bad news leads to an increase. The simple reason for this is that the pricing of an asset not only involves the past and present performance of an asset but also future expectations. Everyone can see the balance sheet of a company and deduce how much cash can theoretically be liquidated for its shareholders, the more difficult question is how will the company perform in the future and how much cash will it produce for its owners moving forward.

Investors will price the future expectations into the price they are willing to pay in the present, and as time unravels and new information comes to light, investors will adjust their valuations and expectations of an asset. When news and performance are better than expected, and projections are more optimistic than previously assumed, prices tend to rise, while if news and performance are worse than expected, and projections are more pessimistic than previously assumed, prices tend to fall. The current price of an asset reflects the market’s expectations of its future, and when the future is realised, the prices are adjusted as the new reality and expectations replace what was previously only future expectation in the valuation assumptions. The ultimate returns of an asset are a matter of the underlying performance, but the pricing of an asset is a matter of the expectations placed upon the asset.

The core focus in value investing should always be on the cash an asset can generate over its lifetime attributable to shareholders, discounted to the present, but it’s useful to understand pricing is a function of expectations and as such, how price moves often is how a company performs relative to expectations. Understanding the pricing by the market to a larger degree helps to clarify your own thinking, and reach better conclusions on what assets may or may not be valued incorrectly by the markets. In saying that, one must also keep in mind there are other determinants of price, especially as technical and momentum analysis becomes more popular within some investment institutions, and the same goes for the increase in popularity of passive investing which leads to indiscriminate buying/selling regardless of fundamentals.

In modern-day investing, with the increasingly rare liquidation bargains, nearly all of the price paid is for the future return of an asset, as such, it is more important than ever before to understand the expectations of others and see if you can find cases of incorrect assumptions in their expectations. Ultimately, everyone can value what companies already have, it is what the future brings that affects the valuations of the market and individuals. You must beat expectations for successful investing, as market expectations are reflected in market price. When an asset performs better than what the market expects, that is where you will find sources of investment profit.