The single biggest reason why a stock goes up

When American banker J.P. Morgan was asked what he thought stock prices would do next, he sat up in his chair and said: ‘They will fluctuate'.

Platinum Asset Management (ASX:PTM) knows this first hand. In July 2010, it had been dragged down with the rest of the funds management sector in the face of various reviews into the financial services industry, losing more than a quarter of its value since the previous September.

We thought it was trading well below its underlying value and upgraded it to Long Term Buy at $4.60.

Over the following five years, sentiment changed and the stock rocketed to more than $9.00 by early 2015. We then recommended members Sell, locking in a 131% total return including dividends, or around 23% a year.

But the story doesn't end there. Declining funds under management, poor performance, and shrinking margins have since taken their toll. Platinum currently trades around $5.00 – down 44% since our Sell recommendation.

With stories like that, it may seem like we're good at timing the market. We're not. But where we do have some skill is in valuing businesses.

Margin of safety

As Benjamin Graham put it: ‘In the short run, the market is a voting machine, but in the long run it's a weighing machine.'

Stocks will bounce around for any number of reasons in the short term: positive news headlines, changing interest rates, the general economy, fads and fashions (we're looking at you, cannabis stocks). The list goes on.

Over very long periods, if a company increases its earnings, there's a good chance the share price will follow suit. But that isn't always the case. Microsoft, for example, has almost doubled its net profit since 2000, yet its share price is roughly where it was 17 years ago. Enthusiastic early investors were absolutely correct in their forecast for a booming software industry and growing profits. Where they went wrong was in overpaying.

The single most reliable reason why a stock goes up is that it is undervalued. What Benjamin Graham meant by his quote is that there's no way to tell what's going to happen to share prices in the short term. But what can be relied upon is that if the current share price is well below the intrinsic value of the company, you are buying with a margin of safety. And, over time, that gap between share price and intrinsic value tends to close as other investors catch on, the company buys back stock, a competitor makes a takeover bid, or capital is returned to shareholders.

Market fluctuations are your friend – they're a source of opportunity to find undervalued companies. When we upgraded Platinum, there was no shortage of bad news, and, when we downgraded it, investors were too enthusiastic. But headlines are a source of opportunity for the well-researched investor. Valuation is the only thing you can rely on – by using the company's intrinsic value as an anchor independent of its share price, you're more likely to buy low and sell high.