People tend to express value by a price that we’re willing to pay. Therefore many, if not the most, people equate price and value. But are both really the same?
Recently I had a really nice conversation about investing. During our little chat we came to Bitcoin mining and crypto trading and to the question, why investors aren’t very interested in crypto currencies. Besides that many investors don’t trust cryptos, I told my chat partner that cryptos aren’t of interested because they have no real value. And investors are searching for value, not for short-term little profits.
During our little talk about that topic, my chat partner then said that one can only put a price on something by its value. Something without it has no price. This is a really interesting statement and I think worth looking a bit deeper. This statement sounds absolutely logical and it is in a certain way. But I believe we have to look at it more differentiated.
Does price needs value?
Well, this is a good question and not that easy to answer. Although I answered that one could find a lot of things which have a price but no value, I’m not still sure that I’m right. Thanks to my chat partner for not asking for examples. I think, it’s not a question of having or not having any, it’s more a question about what value means and what it has to do with price.
Value in relation to price, not price alone, must determine your investment decisions. (Seth Klarman)
Price is what you pay. Value is what you get. (Warren Buffett)
Different types of value?
According to my chat partner, one can only put a price on something by its value. So the first question has to be: What is this ominous thing and where does it come from?
Regarding my investment strategy, I distinguish between two different types: real and psychological value.
1. Real Value
This first one is based on something real. Let’s take a house, for example. Such a house consists of different materials: wood, bricks, insulation, windows and so on. Regardless of the price of the material, a house is worth something just because of its existence. Even if no-one would pay you any price for your home, you have still your house and the possibility to live in it. I would call it the value of use.
2. Psychological value
The second type has no real value, but a price. And the remarkable thing is that it is nothing worth without this price. That’s because its value is only based on psychology and this psychology is expressed in price. What does this mean? Well, it means that people think that something is or should be worth something. Whatever this something is, it has no own benefit.
Let’s take an example. Let’s take gold as it is often found in people’s portfolio. The value of ones gold bars is only determined by the people who “add” it to them. It’s the psychology of the people who give the gold a price based on fear about global economics, politics etc. If the fear is huge, the price of gold increases and therefore it’s worth much more. If there is less fear in people’s mind, the price/”value” declines. No price, no value. If you don’t need gold as a trade item (which is needed for setting a price and what is really behind holding gold), it has no use in your portfolio. (Surely, you can add a value of use to gold by making a nice piece of jewelry out of it.)
It’s the same with crypto currencies (as with any currency). They’re only worth what we ascribe to them. And that value is only based on our psychology which is expressed in the current price. Again, no price, no “value”.
As an investor and a stock picker, I’m investing in companies. I’m not trading shares. I buy companies in the form of shares. Companies (hopefully) have an intrinsic value. Goods or services generate this. People make something out of raw material which is in the end more worth than the material itself. So, people adding value to the product through their work. And that product is (again hopefully) of any use for anybody. This will increase the value of the company.
And even if no-one would pay any price for the shares of the company, you still have the company who sells its products or services and generates profit which you get as a dividend. And even if no-one would buy the products, you still would have the products to use. (Okay, this may not always be great, but it’s still better than having nothing.)
That’s why investors are looking for companies to buy and are not interested in trading stocks every day. Investors make money because of the value of a company and not because of buying and selling shares constantly. That’s why Warren Buffett said that investors lose nothing in falling markets. Because it’s usually the price that falls and not the value of the company. I wrote about this in my post “Don’t panic! – It’s just the market that’s dropping!”.
Price is not the same as real value!
We tend to express value by a price that we’re willing to pay. Therefore many, if not the most, people equate price and value. And the theory of efficient markets seems to agree with them. In short, the theory assumes that every available information is fully reflected in the price. Demand and supply are based on that information and determine the price. But both don’t say anything about value. They only say something about price. And this is different.