Have you ever stared at the stock prices on your phone, watching those constantly changing numbers, and wondered: who actually sets these prices? Why do they change every second? Is there really a group of bigwigs in suits sitting in golden offices playing games to manipulate everything?
If you've had such doubts, or even feel the stock market is a mysterious maze you can never penetrate—congratulations, you've come to the right place.
Hello, I'm me. Today we will tear off the mysterious veil of Wall Street, using the most straightforward and accessible way to help you thoroughly understand the engine behind global wealth. This is not just a lesson; it might be your first step in understanding the money game. If you've stayed away because you couldn't understand stock prices, or lost money listening to some inside tip, please be sure to listen to this episode. If you find it useful, feel free to hit the like button first.
Let's officially—
A Story to See the Nature of the Stock Market
Imagine you live in a small town with a bakery. The bakery does great business, with long lines every day. One day the bakery owner says, "I want to sell some shares of this store so everyone can share future profits." So you spend 1,000 dollars to buy 1% of the store. Now you are a shareholder of this bakery.
The next day, your neighbor hears you bought shares and wants some too. But the owner has no more shares to sell, so the neighbor has to come to you and ask if you're willing to sell him your shares. You say, "I bought them for 1,000. If you want them, 1,200." The neighbor thinks the store's future will be even better, so he agrees. See? The stock price went from 1,000 to 1,200.
Another day, a rumor spreads in town that a cheaper bakery has opened next door. The old store's business might be affected. The neighbor panics and comes to you: "I don't want them anymore. Will you buy them back for 800?" You agree, so the stock price falls from 1,200 to 800.
This is the original form of the stock market. No mysterious black box, no suited manipulators, just you and your neighbor—one wants to buy, one wants to sell. The price jumps back and forth in this process.
Multiply this small town by tens of millions, replace the bakery with Apple, Tesla, TSMC, and replace the neighbor with billions of global investors, and you have today's stock market. Those numbers jumping every second on your phone are simply the transaction prices reached by countless ordinary people like you and your neighbor at that moment. No one can command what it must be; it's just the sum of all participants' emotions and judgments.
Behind the Price is the Leash of Value
But then the question arises: since price is determined by buyers and sellers, how can some people make money while others lose? How can some know in advance whether to buy or sell? What are they looking at? The answer is two words: value.
Stock price is like a dog on a leash. It runs around, sometimes ahead, sometimes behind, but the leash always holds the company's intrinsic value. The dog may run far due to excitement or shrink behind its owner due to fear, but as long as the owner moves forward, the dog will eventually follow. What you need to do isn't to predict which direction the dog will run next second, but to see clearly which direction the owner is going.
Three Basic Valuation Methods
So how do you see the owner? How do you estimate a company's intrinsic value? Let me introduce three most commonly used and basic methods. You don't need to be a math genius or have a finance degree; basic arithmetic is enough.
First: Discounted Cash Flow
This name sounds daunting, but the logic is very simple. Think: when you spend money to buy a company today, what are you buying? Not its factory, not its machinery, not its brand (though these count partly). What you're really buying is all the money the company will earn in future years. You discount each future year's profit back to today's value at a reasonable discount rate, sum them up—that's what the company should be worth.
For example, if someone says, "Lend me 1,000, I'll pay you back 1,000 in ten years," would you agree? Probably not. Because today's money is worth more than money ten years from now—inflation erodes purchasing power, and you could have used that money for other things over the ten years. So you need a discount. Like: "Lend me 1,000, pay me back 2,000 in ten years, then it's worthwhile." That discount rate is the discount. Company valuation works the same: future profits must be discounted; the further the profit, the larger the discount. If the calculated discounted value is far higher than the current stock price, it's worth buying; if far lower, it's too expensive.
Buffett once said: "Stock investing is actually simple: determine how much cash a company will generate over its remaining life, then buy it at a reasonable price." Sounds simple, but hard to do because you have to predict the future. Predicting the future is the hardest part. But you don't need to predict precisely; you just need to know roughly how much it's worth and whether it's far above the current price. Just like seeing a fat person—you don't need an exact weight to judge they're fat.
Second: Asset Replacement Method
This method suits companies with heavy assets, like banks, insurance, real estate, manufacturing. Its logic: how much would it cost to buy all the company's assets at current market prices? If the cost to rebuild the company is far higher than its stock price, you're buying those assets at a discount. You might say, "But those old machines and factories aren't worth that much." True, so asset replacement is usually adjusted with liquidation value—assuming the company closes immediately and sells assets piece by piece. If the stock price is below liquidation value, it's a classic "cigar butt" stock—like a discarded cigarette butt on the ground, you can pick it up for a free last puff. Buffett's early investment style was like this, hunting for such extremely undervalued stocks and waiting for the market to discover value. But this method is increasingly hard to use in today's tech era, because many tech companies have little tangible assets; their most valuable assets are code, data, and talent, which are nearly worthless in liquidation. This leads to our third method.
Third: P/E Ratio Comparison
The P/E ratio is stock price divided by earnings per share, essentially telling you how many years of profit it would take to recover your investment. For example, a stock priced at 100 yuan earns 5 yuan per share per year, so the P/E ratio is 20, meaning if you buy now, assuming constant profit, it takes 20 years to break even. Is a high or low number good? It can't be seen in isolation; it must be compared with peers in the same industry. If the industry average P/E is 25, and this company has 15, with no worse business conditions, it may be undervalued. Conversely, if the industry average is 15 and it's at 30, there may be a bubble. But P/E has limitations: it only looks at past and present profits, not the future. A company may have low profits now and a high P/E, but future profits could explode, making the current high P/E cheap. Amazon had an extremely high P/E for many years, but because it grew rapidly, early investors still made hundreds of times. So P/E can only be a reference, not the sole decision basis.
Why Do People Who Know Methods Still Lose Money?
After covering three valuation methods, you might be excited: "Great! With these methods, I can precisely bottom-fish and steadily make money!" I must pour cold water on you: if investing were that simple, there would be no poor people in the world. In fact, many people know these methods, even more professionally than I described, yet still lose their shirts in the stock market. Why? Because the stock market is not just an arithmetic game; it's also a psychological game. Your biggest enemy is never the market, manipulators, or insider traders, but yourself.
Let's return to the dog metaphor. The leash is actually loose; the dog can run far. In panic, it shrinks far behind its owner in fear, even breaking free into the bushes; in frenzy, it runs far ahead, out of sight. At such times, even if you clearly know which direction the owner is going, you start doubting yourself: "Did I misjudge? Did the owner turn around? Why is the dog still running outward?" This self-doubt makes you sell at the bottom and buy at the top.
That's why investment masters repeatedly emphasize: "Be fearful when others are greedy, be greedy when others are fearful." You've heard this countless times, but very few can truly practice it.
A Real Historical Case
Let me tell you a real historical case. In 1973-1974, the US stock market suffered a severe crash, with the S&P 500 falling nearly 50%. Many good companies' stocks fell to absurdly low levels. For example, The Washington Post—a media giant owning The Washington Post newspaper, Newsweek magazine, and several TV stations—saw its stock price fall to only 10 times its then earnings per share. That means if you bought, assuming constant profit, you'd recover your investment in 10 years. Meanwhile, Washington Post's profitability was growing about 15% annually. By the simplest valuation model, it was undervalued by at least three to four times. Buffett began buying heavily around this time. After he bought, the stock didn't rebound immediately; it continued to drop over 20% in 1974. Many panicked, thinking Buffett was wrong, that this time was different, that the media industry was doomed. But Buffett didn't sell; he even kept buying. Two years later the stock began to rise, and ten years later the investment brought him over 20 times return. If you had followed Buffett in 1973 but couldn't withstand the next two years of decline and sold at the bottom, you wouldn't have made money but would have lost big. See? Same stock, same buy price, different mindset—outcomes dramatically different.
So, what truly determines your investment success is not whether you can calculate P/E or find undervalued stocks, but whether you have an investment system that keeps you calm in storms and a mind not swayed by market sentiment.
Four Steps of an Investment System
So what does this system look like? Let me give it to you. Just follow these steps, and even if you only have a basic understanding of valuation methods, you can outperform most people in the long run.
Step 1: Build your circle of competence.
This is the concept most advocated by Buffett and Charlie Munger. Circle of competence simply means: only invest in companies you truly understand. You don't need to understand all industries; just one or two, then deeply research to become an expert in those. For example, if you're a programmer, you have a natural advantage in understanding software company business models; if you're a doctor, you may have deeper insight into pharmaceutical companies. If you know nothing about tech stocks, then study consumer stocks—companies behind products you use daily: Coca-Cola, P&G, Unilever. Their businesses are extremely simple: sell shampoo, detergent, beverages. You don't need to predict technological change; you just need to judge whether people will continue using these daily necessities—the answer is yes. So, don't touch what you don't understand—that's the first iron rule.
Step 2: Make a rough value estimate.
Use the valuation methods we discussed to roughly estimate the value of companies within your circle of competence. Remember, "rough." You don't need precision to two decimal places; just judge whether it's clearly overvalued, clearly undervalued, or reasonable. If you can't judge, skip it and wait for the next opportunity.
Step 3: Wait for a margin of safety.
Margin of safety means you buy at a price far below your estimated intrinsic value. Why "far"? Because your estimate may be wrong, and the company's future may have surprises. If you only buy when the stock price is 30% below your estimate, even if you're a bit off, you're unlikely to lose money. Conversely, if you buy at roughly the same price as your estimate, then if your estimate is even slightly off or market sentiment shifts, you'll lose money. Margin of safety is your insurance.
Step 4: Hold for the long term.
This is the hardest and most important step. Many people buy stocks like lottery tickets—buy today, check if it's up tomorrow, if not, switch to another. This approach prevents you from making big money, because big money comes from long-term holding. A good company's value doesn't release in a day or two, but over three to five years or even ten years. You need to give the company enough time to earn, grow, and prove your judgment correct. The longer you hold, the less market sentiment affects you, and the more the company's actual performance influences you.
These four steps look simple, right? But very few can truly follow them. Why? Because they go against human nature. Human nature likes quick success, instant gratification, buying today and hitting the daily limit tomorrow. What investing requires is precisely delayed gratification, patience—staying calm when others are crazy, staying confident when others are desperate.
Final Words
Finally, I want to say a few words to you on the other side of the screen. You don't need to become the next Buffett, nor do you need to double your money every year. You just need a little more patience, a little more discipline, and a little more respect for risk than most people. The stock market is not a place to get rich overnight, but it is a place to slowly become wealthy and eventually achieve financial freedom. The prerequisite is that you are willing to learn, willing to wait, and willing to grow together with good companies over the long years.
If today's video gave you a new understanding of the stock market, made you no longer afraid of those jumping numbers, and even gave you the courage to start investing, then please like, subscribe to me, and turn on the bell. Every like and subscription is your biggest encouragement to me and a vote for your own financial future.
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