Price Vs Value

Price Is What You Pay, Value Is What You Get

In this lesson you will learn the crucial difference between price and value. Also, we’ll cover three types of value and how to differentiate them.

Summary:

  • Price is what you pay, value is what you get

  • There are three types of value: relative, absolute, and perceived value

  • Relative value examines what company is worth compared to its competitors

  • Absolute value estimates what a company is realistically worth based on its performance and the things it owns

  • Perceived value is the value people assign to something in their head

  • Stock prices reflect investors’ perception of reality, not necessarily reality itself

  • In the short run, a stock price says nothing about the value of the underlying company

  • In the long run, stock prices will eventually reflect the absolute value of a company

  • Benjamin Graham’s Mr. Market metaphor is a great way to think about investing and still applies in today’s world

Why Stocks Get Mispriced

In this lesson we will explore in detail why stocks get mispriced, how our mind sometimes works against us, and how this can cause stock market bubbles.

Summary:

  • On average, financial experts perform worse than a monkey when it comes to picking stocks

  • The Efficient Market Hypothesis an outdated theory which states it is impossible to ever perform better than the market average

  • Warren Buffett believes markets are efficient in the long run, but highly irrational in the short run and these irrational prices is what he exploits to consistently earn above average returns year after year

  • Irrational prices are caused by emotions and cognitive biases which cloud our decision making process

  • Behavioral Finance studies the effect of cognitive biases on our financial decisions

  • The cumulative effect of countless of irrational investment decisions can cause financial bubbles and crises

  • The best way to counter the effects of cognitive biases is by removing emotions from the equation by following the financial news less closely and by sticking to a strategy based purely on business facts

  • In order to earn above average returns, you have to do things differently from the crowd

  • Your emotions have the power to render your financial education and investment strategy completely useless, so having the right mindset is crucial to your investment success

Catalysts Of Value Realization

Today we will learn about certain special events which have the ability to push the stock price of an undervalued company closer to its absolute value. These so called catalysts of value realization do not only allow you to profit faster, but also reduce risk, because they often lead to a shorter holding period and are therefore better to predict.

Summary:

  • A catalyst for value realization is an event which has the potential to close the gap between price and value in an accelerated timescale.

  • Catalysts reduce risk because they often lead to shorter holding periods and therefore have outcomes which can be predicted with more certainty.

  • Examples of catalysts are liquidations, spinoffs, buybacks, takeovers, additions to an index, lawsuits, and investigations.

  • Each of these events has its own unique way of stimulating an upward price movement

  • Do not base your entire investment strategy on catalysts, but see them as a bonus

  • Two ways to find out about catalysts are by setting up automatic email updates using Google Alerts and by reading through company filings on the SEC website

  • Buying great companies at discount prices should remain the main focus of your investment strategy

  • Even if a catalyst seems to exist, this is no guarantee that things will play out the way you expect

Calculating The Intrinsic Value Of A Company + Spreadsheet

Every investor must learn to calculate the value of a company in order to know a bargain when they see one. In this lesson I will describe the theory behind these "intrinsic value" calculations. This lesson contains additional material in the form of an Excel file with three intrinsic valuation models.

Summary:

  • Intrinsic value is simply a different word for absolute value

  • Every investor must learn to calculate the value of a company in order to know a bargain when they see one

  • There is no simple formula to precisely calculate the intrinsic value, it is always an estimate based on several assumptions, like future growth rates

  • Being conservative in your estimates is the only way to protect yourself from major losses

  • You might miss a few great opportunities by being conservative, but you will also avoid many mistakes this way

  • There are several ways to calculate the intrinsic value of a stock, and none of them is perfect

  • You should combine the results of the different valuation models and then lean towards the more conservative estimate

  • Book value does not offer an accurate representation of the true value of a company’s assets

  • One dollar today is worth more than one dollar in the future

  • The present value of a future sum of money is called the Net Present Value

  • The imaginary interest rate used to calculate the Net Present Value is called the discount rate

  • Some companies are to complex or unpredictable to value with any degree of accuracy

  • Spreadsheets are a great way to speed up intrinsic value calculations, but you should use them with care

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