1 · Three ways to think about a stock price
I divide a stock price into three parts: fundamentals, a liquidity premium, and a sentiment premium.
Value investing focuses on fundamentals; Warren Buffett is a familiar representative. Macro investing and hedging focus on liquidity, with figures such as Ray Dalio and George Soros. Jesse Livermore represents the speculative side associated with sentiment.
2 · A quotation is not the same as value
Why do we say investment should use money you can afford to leave invested? Because a stock price is a quotation. It moves up and down. The premium—the quoted price minus a conservative estimate of fundamental value—can become extraordinarily high in optimistic times and extraordinarily low when people are pessimistic. The latter is the moment a value investor hopes to find.
My manuscript recalls Buffett’s lesson about using Mr. Market, discussed in The Snowball. The source note below links to Buffett’s own account of Graham’s metaphor.
Imagine a city-centre house in a neighbourhood where comparable homes usually sell for five million. Its owner urgently needs cash and lists it for two million. You see an unusual opportunity and buy it—after checking, of course, whether there is a serious hidden problem with the property.
Something similar can happen in stocks. Unlike a house, a company usually has thousands of shareholders. They are unlikely to all make the same mistake at once, and many alert investors are already watching for a bargain. That is one reason people believe in market efficiency.
Still, I do not think a reasonable argument for efficiency means that every price is right, every moment of every year. Sometimes a business is caught in indiscriminate selling.
3 · KC: a fictional example
Suppose KC has a fundamental value of 60 yuan, with a liquidity premium of 20 and a sentiment premium of another 20.
In an easy liquidity environment, it might be quoted at 80. If investors become very optimistic and everyone is enjoying gains, the quote might reach 100 or even 150. In this hypothetical story, you might notice how large the premium has become, sell part of the holding, and look for a different KC2 still quoted at 60 or below.
| Fundamentals | Liquidity premium | Sentiment premium |
|---|---|---|
| 60 | 20 | 20 |
Fictional prices in yuan. 60 + 20 + 20 = 100. A thinking framework, not a measured valuation; these parts are not necessarily independently observable.
4 · Xiaoming: leaving just before dawn
This is also why I emphasise avoiding leverage. Even if you buy KC at 50, the next quote could be 40, 30, or 10. Price and underlying value are like a dog and its owner: the dog sometimes runs ahead and sometimes lags behind.
Xiaoming carefully values KC at 60 and buys at that price. Excited, he goes all in, expecting to benefit eventually from a liquidity or sentiment premium.
But the quote falls to 50. Convinced it is undervalued, he borrows and raises his exposure to 2× leverage. A month later it falls to 40. He doubles down again, increasing his leverage to 4×.
KC keeps falling. Xiaoming is liquidated and forced out. The manuscript deliberately leaves the exact liquidation price unspecified: it depends on financing and margin terms. Then, in this fictional story, the market recognises KC’s value and its quotation rebounds rapidly to 80, heading toward 100. Xiaoming no longer owns the shares. He has fallen just before dawn.
5 · Wang: no borrowing, but no time to wait
Avoiding leverage is not the whole lesson. We also say investment should use genuinely spare money.
Like Xiaoming, Wang researches KC and estimates its intrinsic value at around 60. When the quote falls to 50, he believes he has found an unusually attractive opportunity and invests most of his family’s savings.
Wang does not borrow or use leverage. He thinks patient ownership will be enough to wait for the market to recognise the business’s value.
The market does not immediately prove him right. The price falls from 50 to 45, then to 40. Months pass. Investors remain pessimistic, and the price reaches 30.
Wang is distressed but still trusts his fundamental work. He tells himself that, if the company’s value has not fundamentally changed, the lower quote is temporary; selling now would crystallise the loss.
But life outside investing does not follow an investor’s timetable.
Around the time KC is quoted at 30, Wang’s daughter becomes ill and needs immediate treatment. The medical bill cannot wait, while most of the family’s cash is already invested in KC.
Wang no longer has the option of waiting for the market to become more rational. However strongly he believes the company is undervalued, he must sell shares to pay for treatment. He exits at 30.
A few months later, KC’s business improves and market sentiment recovers. More investors recognise its value. The price rebounds to 50, passes 60, and eventually reaches 80.
Wang’s initial analysis may not have been wrong. His mistake was investing money he might need soon in an asset whose return timetable was completely uncertain.
Spare money does not simply mean money sitting unused in a bank account today. It means money you will not be forced to withdraw for a substantial period, even if the market falls sharply.
Rent, tuition, medical expenses, family emergency reserves, and everyday living costs are not truly spare money.
Even if your valuation is correct, you cannot control when the market will agree. A mispricing can persist for a week, a month, or years. A low price can fall further. With genuinely spare money, time can be your friend; with money needed for daily life, it can become your enemy.
What Wang lost was not necessarily his judgment of KC’s value. He lost the ability to wait for that value to be recognised.
6 · Good people, good businesses, better questions
All of these opportunities depend on actually finding a sound business like the fictional KC. In practice, what looks like a bargain can instead be a poor business. My manuscript puts the contrast more bluntly: sometimes you think you have found KC, but you have found “SB”.
Be a good person. Buy good businesses. Do the right things, and do things right.
But what makes something the right thing? That requires qualitative analysis. This is where the next part of value investing begins: with the business model, and with the timing, environment, and people that make it work.
I will continue the story by exploring how to value fundamentals, how to assess liquidity and its drivers, and what shapes the sentiment premium.
Editor’s note and further reading
This is an English reading version of CHIU’s ongoing Chinese manuscript. KC, Xiaoming, Wang, the house, and all prices are fictional teaching examples, not personal account values or a performance record. The three-part breakdown is the author’s conceptual framework, not an observable accounting identity. Valuation estimates can be mistaken and business value can deteriorate; a low-priced stock is not guaranteed to recover.
For Mr. Market, see Buffett’s 1987 shareholder letter, which attributes the metaphor to his teacher Benjamin Graham.