Tag: stocks

Value vs Price

“Price is what you pay, value is what you get.”

Warren Buffett

Value and price are quite different things. Yet, value and price words are usually used as a synonymous, even by finance news writers.

Let’s try to understand the difference through an example.
Let’s imagine that you need a new smartphone, and you want a specific model of your beloved brand. You are hesitating, because the price is very high: after a brief check on online sites, you have realized that you should pay around 1000$.
Then Black Friday arrives and suddenly the price of that model drops to 600$ !

Did the value of the smartphone change?
NO.
The value of the the smartphone is always the same: same functions, same materials, same brand…. WHAT YOU GET is exactly the same

Did the price of the smartphone change?
YES.
The worth (or value) didn’t change, but the price decreased… WHAT YOU PAY has changed.

If you consider investing in stocks, things are pretty much the same: to GET a piece of ownership of a company which has a certain value you have to PAY a certain price.

To be a good value investor you have to behave like a business owner: you have to understand the company and you have to – after studying it – estimate its VALUE, and if you decide to make the investment then you buy a percentage interest in that business proportional to the number of share that you get.
To get a certain number of stock shares in a company, you have to pay a specific PRICE. For public companies, you pay when you buy from a stock exchange like the NYSE or the Nasdaq.

When you see all the crazy changing numbers ticking in red and green on your Yahoo Finance app or similar, you see the stock prices. Not the stock values. Do not confuse the 2 things.

Value investing consists in buying a stock when its price is (heavily) below its value. There are many implication of this; we will talk about the margin of safety and long-term impacts in another post.

Anyway, please remember: just looking at the price is not investing.

Why value investors do like stocks so much

“Auction-driven markets have this nuance where they either get euphoric or pessimistic, and they might do both in the same year. That’s what leads to distortions and mispricing, and that’s what we can take advantage of.”

Mohnish Pabrai

Value investing is usually focused on publicly traded stocks. There are a few reasons for this.

The asset class of public company stocks has historically outperformed other asset classes like bonds or commodities. The S&P 500 index (which tracks the stock price performance of the largest listed companies in the US) has in the average returned more than 10% per year in the last 50 years: we have already discussed about the power of long term compounding and so you can appreciate the importance of such a performance.

In addition to that, stock exchanges are auction-driven markets subject to boom-and-bust cycles. It means that these markets are subject to the impact of human psychology, and so stocks are often increasing in price during euphoric periods and heavily decreasing in price when pessimism is dominant. Just think of it as if a manic-depressive person called Mr Market would offer to sell you a stock for a very low price in a pessimistic day, while coming back to you the next day in an euphoric mood offering to buy from you the same stock of the previous day for a much higher price: this is the brilliant allegory used by Ben Graham, the “father” of value investing, to describe the irrationality of stock markets.

A good value investor is aware of the average long-term positive performance of publicly traded stocks and can obtain even better results than average, if able to use the irrationality of markets at his or her advantage in spite of surrendering to human cognitive biases.