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NAV vs. Stock Price

NAV vs. Stock Price -- how are they different?

Morningstar Analysts | 07-12-11 | E-mail Article


When a fund's Net Asset Value (NAV) is rising or reaches its all time high, you may think that the fund is getting expensive. So, you may decide to buy the fund later after its price comes down because the rule of thumb for investing is to "buy low".

NAVs and stock prices are similar in the sense that they both represent the price of a unit or share of an investment. If you multiply the stock price of a company with its total number of shares, you get the company's market capitalization. If you multiply the NAV of a fund with its total number of units issued, you get the fund's total net assets.

NAV & Valuation
However, a stock's price incorporates investors expectation of how a company will perform, thus reflecting the amount they are willing to pay for it in the market. In essence, they set a fair price for the company. Its market price can be a bargain (or undervalued) if investors believe the company should worth more, and it can be expensive (or overvalued) if investors feel the company does not worth that much. On the other hand, NAV is based on the current value of the fund's underlying assets. It does not relate to how much investors think the fund should worth. In short, there is no "fair" price for a fund.

NAV is not an indication of relative value either. When you compare two funds that have similar holdings and almost the same returns in the past, you may think that the one with higher NAV is "overvalued" and prefer the one with lower NAV for its "room to grow". Yet, the difference in the current NAVs depends on the age of the funds and their original NAVs at launch.

While a fund's NAV rises as its holdings appreciate, an increasing NAV does not necessarily mean the portfolio holds more "expensive" stocks. If a fund's NAV has increased dramatically as a result of rapid price changes of its holdings, there is turnover of the portfolio, and the fund may no longer hold the stocks that boosted its NAV in the first place.

Total Return
NAV gives you an idea of what your investment is worth each day. However, to measure accurately a fund's performance, it is necessary to examine its total return, which takes into account both the appreciation of the fund's holdings as well as any distributions that have been paid.

Suppose you pay $90 to buy 10 units of a fund at $9 per unit. After a few months, the fund's NAV rises to $12. Some stocks in the portfolio then pay out dividends and the fund makes $2 per-share income distribution. As a result, the NAV slips to $10. Your distribution of $20 ($2 x 10 units) is reinvested to buy 2 more units at the new (reinvestment) price at $10.

Given a current NAV of $10, your return based solely on NAV changes will be an increase of 11% (($10-9)/$9). However, you have reinvested for two more units of the fund after the income distribution. So, your investment is actually worth the $100 (current $10 NAV x 10 units bought) plus the $20 your two new units are worth, for a grand total of $120. Your total return is really 33% (($120-90)/$90).

NAV, Bid & Offer
Some funds provide daily quotes of bid and offer prices instead of NAVs. A fund's bid price equals to its NAV, provided that there is no redemption charge. The spread between the bid and offer prices is the subscription fee. For example, as at May 14, the Baring Global Resources Fund has a bid price of $12.14 and an offer price of $12.74. Discounting the offer price at its subscription charge of 5%, the fund's NAV equals to $12.13 ($12.74/(1+5%)), which is slightly different from its bid price due to rounding error. To calculate the bid price of a fund with redemption fee, simply discount the NAV at the fund's redemption charge.

There are cases, however, that the rounding difference widens the bid/offer spread by as much as 0.5%, costing investors an additional "rounding error" fee to complete a buy/sell transaction. Perhaps these fund companies can look for ways to reduce the errors and minimize the unintentional costs charged to investors!

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