Wall Street has gone nuts. It has lost track of how stock markets are supposed to work. I say we put an end to it and take advantage of the market’s apparent short-sightedness.

For decades, investors valued a company’s shares based on their estimates of the company’s net present value of future earnings. In other words, what is an infinite stream of future earnings worth to us today?

The key to valuations used to be the fact that all businesses are expected to be a “going concern,” meaning they will be around forever. But now, we are valuing stocks based on the assumption that companies may not be here next quarter, let alone next decade.

The action at Citigroup (NYSE:C) is a perfect example. Right now, with shares priced at $3.78, Wall Street is essentially telling us that it calculates the present value of all of Citi’s future earnings at just $21 billion. That figure is roughly the same amount the company earned in 2006, when share price was over $50.

The tide will turn

At today’s price, investors are telling us they believe it will be a long time, if ever, before Citi returns to the same kind of profitability. They are probably right. After this maelstrom of deleveraging, the bank has a long road ahead of it.

But to price this company like it is going out of business is a mistake. It will survive the financial crisis and its position as a “going concern” will become obvious once again.

I have been watching Citi’s action on the options market closely today. Right now, put trading activity outweighs call activity by a 2-to-1 margin, meaning lots of investors are protecting against the downside.

Frankly, I believe the action has more to do with the fact that today is an options expiration day than any fundamental changes in the company’s long-term outlook. Investors are rolling over their options and entering a new front-month contract.

The rapid selling of shares of Citi will soon stop and the frenzy will be over. When it does, anybody that bought shares at today’s ultra-low price will love their move.

Citi’s selling is overdone. Buy shares of the company anywhere below $4.00.

Source: The market’s fundamental error: Buy shares of Citi (NSYE:C)