Chapter 8 pointed to an aspect of risk that goes beyond fundamental risk: price risk. The investor who buys a stock deemed underpriced faces price risk because the price can drop more; stocks that deviate from fundamental value can deviate further, at least in the short run. On the exit side, value investors are typically told to sell an underpriced stock when the price reaches “intrinsic value”; a stock that has “deviated from fundamental value” then “gravitates to fundamental value.” But the investor can sell too early: The stock can go up more, deviating further from value. This is often attributed to momentum investing by others. It is price risk.
The mantra of value investing says not to try to time buys and sells. It’s a tricky business, but so often the investor (after the fact) recognizes that he or she sold too early. One way to see the timing of a sale is to see the investor as having an option that pays off if the stock price goes up further and options have value; by selling the investor might be giving up option value. The same applies to a buy: There is option value in waiting. That resonates with the value investing notion of requiring substantial mispricing, a margin of safety, before buying.
However, yes, it’s a tricky business. The investor might be helped by an understanding of the reasons for the mispricing and for momentum investing. But recognize you are taking on price risk by delaying selling or buying: The option might not pay off. We need to understand better the drivers of mispricing but getting a handle on the “noise” of noise traders is a challenge. Behavioral finance theory might help but that is somewhat conjectural, particularly at the level of aggregate investor behavior.
On the timing issue, see
Andersson, H., K. Skogsvik, and S. Skogsvik. 2024. When to Buy and Sell a Mispriced Stock. At https://ssrn.com/abstract=5011787.
This paper sees the value of a stock to the fundamental investor not just one of fundamental valud but as an optimal stopping problem determining when to buy or sell.