Countering randomness in the markets

AS in life, there is a certain degree of randomness in the stock market. That is why the experts' advice is to diversify, diversify, diversify.

But just like in the physical world, there are certain laws that govern the markets. Value is one central law. Value is referred to as the gravitational pull of the financial markets, in that prices in the financial markets can't deviate too greatly from the fundamental value of the assets in the real world. Over time, prices will converge near the fair value. Investors can eke out above market returns by exploiting significant deviations from fair value, ie buy when prices are way below fair value and sell when significantly above.

Let's take the example of a company which, net of all its liabilities, is valued at $50 million in the stock market. Let's say amongst its assets, it owns a piece of land that is currently valued at $100 million based on a recent transaction of a similar piece of land. At some point, someone will realise that he or she can fork out $50 million to buy the entire company and gain ownership of all the company's assets, including the piece of land which is worth $100 million. Owners of the company, if they want to, can then sell the company's assets to realise their fair value. Hence they will be willing to bid up the price of the company to closer to $100 million, assuming that they ascribe no value to the company's other assets. It is through this process that prices in the stock markets tend to converge around fair value over time. In addition to the value of assets owned by a company, the fair value of a company can also be estimated based on its earnings - current, as well as expected future earnings.