Of Price and Value

“Price is what you pay, Value is what you get. – Warren Buffett

As buyers, we pay price to obtain value. And aim to pay less of price to obtain more of value. As sellers, we get paid a price to offer value. And aim to get paid more of the price to offer less of the value. The “Efficient Market Hypthoses” claims that, price as determined by the market, is and should be its value too, effectively claiming that they are synonymous. Value investing asserts that price and value differ significantly both in the manner they are defined and the way they are each determined.

One is set by the market, the crowd, the “herd” and its constituents, while the other is fundamental to the inherent qualities of an asset. Price is influenced by the emotions of the most greedy, the most scared or the most depressed person in the crowd. Value is a result of an individual, rational, unbiased estimation of the asset’s present nature, and its estimated future performance. Consider this story:

The master held out his palm in mid-air and asked the group of young and eager learners, “Is my palm’s position “high” or “low”? A few blurted enthusiastically “high.” Others mumbled “low.” Yet others chose to remain silent. After a long pause the teacher spoke again, “it is neither and both. Relative to the ground it is high, while compared to the ceiling it is low.” He then raised his palm yet a little higher and repeated the question. He continued: “relative to where my palm’s position earlier it could be now be said its higher, but again it can be called both or neither relative to other reference points.”

Let “value” then become an investor’s supreme reference point and his moral compass. Let him never conclude on an asset’s price being either high or low in the absence of knowing its corresponding intrinsic value.

“Price in the absence of value should mean nothing. Price in the presence of value should mean everything.” – Husain Kothari

This quote becomes a corollary to Buffet’s quote earlier. In value investing, price and value are inextricably linked and so to say, “joined at the hip”. The foundation of a great investment is laid when one pays a price far lower than its reasonably determined value.

We have already considered how the market sets prices all day influenced by its rational and/or its irrational behavior. And also the insignificance of these prices in the absence of their corresponding value. However, once “a reasonable range of the value” is determined, then a reference gets established with which to compare a price. At that point, price should mean everything for the value investor to ensure a great investment. If price is sufficiently lower than the value-range, then as a buyer it is perhaps a trigger to consider it a “buy”. As a seller, if the price is close or exceeding its value then it could signal a “sell”.

At one price, an asset could be a BUY, at another a HOLD and at a third a SELL. There isn’t an asset which is so poor in quality and not to be a great investment at a low enough price. Nor is there an asset of such great qualities not to prove itself a poor investment at a high enough price.

As prices fall the market’s “perception” of risk increases. In reality if it has diverged sufficiently from value, the “risk” has decreased and the potential for “reward” has increased since price in the long term will ultimately tend towards its value. A most important ingredient of a great investment is its “buy price”.

Finally, it is interesting to observe the INVERT situation. Value in the absence of Price continues to retain its significance and meaning. The market may stop quoting an asset’s price and yet the asset’s fundamentals would remain unaffected in the least. As Buffett notes, he buys a business on the assumption that they could close the stock market the next day and not reopen for five years.

I conclude with two interesting quotes:
“The market knows the price of everything and the value of nothing.” – Phil Fischer

“Valuation is the closest thing to the law of gravity we have in investing.” – James Montier

 

– Husain Kothari
13th January, 2013

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