As the Stomach Turns

Like an episode of the well-watched daytime soap operas, the stock market has been full of drama lately. On May 6th between 2:00 and 3:00 p.m. EST, the Dow Jones stock market average plunged nearly 1,000 points. If you didn’t watch the evening news that day, you might not have even known about it. You won’t see it reflected on your month-end financial statements, because by now the loss has already been largely recovered.

Earlier in the day with regard to its potential impact on the other European countries and beyond, the market slid on legitimate concerns surrounding Greece’s debt crisis. At about 2:40 p.m., the bottom dropped out of some stocks. Frenetic trading caused prices to spiral downward at an alarming rate. Most observers blamed computer program trading, but the real cause has yet to be determined.

Proctor & Gamble (P&G), which had been trading above $60 per share, recorded a trade of $37. This was a drop of 37% in just a matter of a few minutes time. Please note that P&G is the company that makes Pampers© diapers, Gillette© razor blades, Crest© toothpaste, and dozens of other popular consumer products.

Other stocks experienced strange trading as well. Fortunately, only a few individual investors were hurt by these events. The regulatory authorities will likely void some trades outside a certain range, as if they never happened.

During the frenzy, I was ironically in a meeting with a new client, who owns a sizeable number of shares of P&G stock. While we talked about other matters, oblivious to the day-time drama unfolding, my client lost in just a few minutes time on paper about $15,000 from the one position alone. Of course, no actual loss occurred, because he didn’t sell his stock.

People will use this incident as justification to install better mechanisms to ensure orderly markets. I for one am all for that. The real lesson here is not that quantitative models can be flawed or that program trading can run amok. The take away from this incident is that price does not equal value.

This time there were technical reasons, but the next time it could be completely something else. Reactive selling could cause the price of any security to respond violently at any time for any reason, such as a rumor or some misinformation. It is important to understand what you own and why, so that you don’t become one of the panic stricken.

At any moment, the quoted price of a stock or the level of the Dow does not equal its inherent value. The true value of an asset must reflect a reasoned evaluation of its long-term prospects. The market is generally very good at disseminating information and allowing fair pricing, but it is not perfectly efficient. Anomalies occasionally occur that can distort the true worth of a company.

When you own stocks, either directly or through mutual funds, you don’t just own a piece of paper. You actually own a piece of a company with genuine assets and profits that generate dividend checks to stockholders. Good companies, like P&G, raise dividends over time to provide investment growth. The present intrinsic value of a stock is the sum of all future expected dividends. Currently, there has been no new information to alter the long-term prospects for Proctor & Gamble. Consequently, my client and the other investors who held their shares were not affected by the May 6th episode of “As the Stomach Turns.”

By the way, P&G also makes Pepto-Bismol. Now that’s a true irony.