Price and Value: Know the Difference

by | Value

Price & Value Scale

Understanding the difference between price and value is essential to successful value investing. However, it is not easy; it is very difficult. The difficulty is because of our behavior, not because the opportunities aren’t there or the information is not available. Many investors don’t differentiate between price and value.

“The stock market is filled with individuals who know the price of everything, but the value of nothing.”

Phillip Fisher

“Fallible, emotional people determine price; cold, hard cash determines value.”

Christopher C. Davis

“Individuals who cannot master their emotions are ill-suited to profit from the investment process.”

Benjamin Graham

My Goal Is 20-30% This Year

One of my thoughtful members asked me what advice I would have for an investor whose goal is to make 20 or 30% in the next year. My response is: the investor needs to reevaluate his goals.

I know that might sound unimaginative (or even harsh) but that kind of short-term goal causes behavioral errors. The key to long term success is to make investments when the odds of success are heavily in your favor.

“The most prolific buyers of stocks in bull markets are among the most reluctant buyers in bear markets.”

Jim Grant

“The single greatest edge an investor can have is a long term orientation.”

Seth Klarman

“All intelligent investing is value investing – acquiring more than you are paying for.”

Charlie Munger

Your investments should be based on the available opportunities. One of the most repeated investor errors is to take too much risk trying to make a large, or particular, return. Your investments should be based on the available price vs. the value.

Investors should have reasonable long term expectations for investment returns. Some years will be negative, other years will bring large gains.

The stock market (100% equities), starting from a median valuation, has delivered 6.5% real returns in the long run. Most investors buy high and sell low which causes the average investor return to be around 2% (after inflation). A disciplined investor can achieve higher than average returns by doing exactly the opposite of the average investor.

An investor who knows the price and understands its relationship to value has a huge advantage.  If an asset is worth $100 and I pay $120 for it, my risk is high. If I can pay $80 for $100 value, I have a *25% margin of safety.

*($100-$80) = $20/$80 = 25%)

Here are three of my favorite quotes on the subject from The Most Important Thing, by Howard Marks:

“Establishing a healthy relationship between fundamentals — value — and price is at the core of successful investing.”

“Awareness of the relationship between price and value—whether for a single security or an entire market — is an essential component of dealing successfully with risk.”

“It’s essential for investment success that we recognize the condition of the market and decide on our actions accordingly.”

That is why each issue of the Arbor Investment Planner Newsletters (including the Dividend Value Builder) incorporates a “Key Market Statistics” section. Every investor need to be cognizant of the market price vs. market value. This is my first guidepost of how aggressive my equity asset allocation should be.

Price and Value

If you are buying stocks just because everyone else is (they are going up) then you are playing with fire. You will eventually get burned. To be a successful investor you must differentiate, and understand the relationship, between price and value.

“In the end, how your investments behave is much less important than how you behave.”

Jason Zwieg

“Price is what you pay. Value is what you get.”

Warren Buffett

“The secret to investing is to figure out the value of something – and then pay a lot less.”

Joel Greenblatt

That means controlling your behavior. Buying stocks at bargain prices lowers your risk considerably. Buying stocks for more than their real value increases your risk exponentially.

The safest approach to outsize gains is to load up on stocks when the price is significantly below their value. The opposite is true when valuations are expensive. Loading up on stocks in March of 2009 was a completely different risk level than loading up today or in 1999-2000.

I’ll leave you with this quote from Warren Buffett:

    “We don’t have to be smarter than the rest. We have to be more disciplined that the rest.”

Value Investing Portfolio Management Guides

AAAMP Value Newsletter - Arbor Asset Allocation Model Portfolio (AAAMP), Trade Alerts

Dividend Value Builder - DVB Analyzer Newsletter, Treasure Trove Twelve Newsletter, DVB Portfolios Newsletter

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While Arbor Investment Planner has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, or completeness of third-party information presented herein. The sole purpose of this analysis is information. Nothing presented herein is, or is intended to constitute investment advice. Consult your financial advisor before making investment decisions.

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