An interactive explainer
A short illustration of how forced selling can push a stock
below what the business is worth.
What follows is a heavily simplified, hypothetical illustration built on simulated data. It is not a depiction of any actual security, market event, investment strategy, or performance. Real markets are messier, outcomes vary widely, and losses occur. Nothing here is investment advice or an offer of securities.
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A stock's price moves every second, but the value of the underlying business changes slowly. The two usually stay close together. Occasionally they drift apart, and those gaps are what a value investor looks for.
Here is a durable business with steady cash flows. In normal conditions the market prices it reasonably well, and the stock trades close to intrinsic value.
Selling often has nothing to do with the business itself. Index deletions, spin-offs, fund redemptions, rating downgrades, and tax-loss selling all push investors to sell for reasons of their own. In this example, ACME is being removed from an index that billions of dollars track automatically. The business itself hasn't changed at all.
Index funds have no discretion here. When a stock is deleted they sell every share they hold, billions of dollars' worth, on a schedule the whole market can see. Notice the stock falling behind the index it is leaving.
None of this selling says anything about the quality of the business; it happens for mechanical reasons. Whatever the catalyst, the result is the same: a durable business trading well below its intrinsic value.
A value investor can buy from sellers who have no choice, at prices those sellers would never accept in normal conditions, and then simply wait. Over the following months, the price tends to work its way back toward what the business is worth.
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