Most people won’t be able to distinguish the differences between price and value. To them, they are the same. In reality, it is not the same. If price and value is the same then we would not need to consider so much when it comes to purchasing anything in our whole life. We just walk to the stores and pay for what we need. In fact, the former sentence got a catch in between the lines. You see, what I need is not what you need. So how can the value be the same for everyone? Why is this question important in the first place? If we are able to answer this, we will be able to unlock the fundamental concept of value investing.
The whole idea of successful value investing lies in the ability to determine the reasonable value of an asset and then pay a much discounted price to its value. In this post, I would just like to throw some questions to make all of us think a little bit further with regards to value and price relationship. Let me start with a personal computer as an example. What is the value of a personal computer? The listed price of a computer laptop would be around $4000, but what is the real value? This question itself has no answer to it. The value differs from one to another. In the hand of a housewife, it will probably valued around $2000 but to a computer software entrepreneur, it would be valued more as it will provide him the tools to make a million dollars. If you happen to be a housewife, please don’t stone me. Listen further. If the housewife is using the laptop to build a successful blog on cooking recipe, it would be worth a lot more than the selling price. Well, if you asked a bunch of value investors on what is the value of Microsoft shares and you will get a whole lot of different answers. You see? Value lies in the eyes of beholder.
Now, can we agree to the fact that price is not value and value is not price? Price is what you pay. Value is what you get. If an asset is selling for a price that is under the actual value, we would say that it is an undervalued asset. If an asset is selling for a price that is over the actual value, we would call it an overvalued asset. Get to know these terms well. So, the whole fundamental of concept of value investing lies in the asset valuation and then buy it when it is undervalued and sell it when it is overvalued. There is a twist to that. Value doesn’t stay the same. An example to this would be an apple. A sweet tasting apple would be valued differently today as compared to a week later when the freshness is gone. Time is also a variable in valuation. When an asset value appreciate over time, we called it an appreciating asset and a depreciating asset is it losses value over time. Now, can we see another secret of investing here? The secret lesson here is to purchase an asset that not only at a discounted price but also will continue to grow its value over time. This is called growth investing.
- Investment Wisdom #1: Pay for an asset at a discounted price to its present value.
- Investment Wisdom #2: Only purchase an asset if it grows its value over time.
- Investment Wisdom #3: Be conservative when performing any asset valuation and factor in the risks in the discount rate.
Follow the above investment wisdom and we will be on a safe journey to financial prosperity. Of course, there are more to it than what appears in the eyes. It is always easier to say than to do it. But it is possible if we know how. We will talk about various valuation methods in other posts. By the way, the Investment Wisdom #2 is not easy to follow. Most people will do the opposite of it due to the fact that human are greedy by nature. Till then, take care and wish you all the best in your investment endeavors.
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