Price vs. Value: The Art of Investing

by kungfugirl on November 29, 2012

Dorian Grey

“So sorry I am late, Dorian. I went to look after a piece of old brocade in Wardour Street and had to bargain for hours for it. Nowadays people know the price of everything and the value of nothing.” – Oscar Wilde, The Picture of Dorian Gray, Chapter 4

Ahhhh yes, the age-old question…how on earth do you determine what something is truly worth, particularly an investment?

Just what IS value exactly, and how does it differ from price?

The dictionary defines price as: “The amount of money expected, required, or given in payment for something.”

And value as: “The regard that something is held to deserve; the importance or preciousness of something.”

In other words, price is objective—it’s simply the intersection of supply and demand.

But value is subjective—different items have different values to different people. That is why two people can look at the same item and one will think it is a bargain, while the other will think it is a rip off.

VW Bug

Bargain? Or rip off? :)

The price of the item does not necessarily represent the value of the item to a given person.

As consumers, we seem to instinctively “get” this. We understand that “one man’s trash is another man’s treasure,” and we buy consumer products using emotion… “Don’t you just LOVE that red sweater?” or “This is the house I have always dreamed of!”

We make subjective, emotional decisions about what is valuable to us, even with mundane items such as groceries—some will pay almost any price to buy their favorite brand name or to purchase organic, local oranges, for example, while others believe that an orange is an orange is an orange and will buy the generic “brand” every time.

Most of us continually shop for the best deal when purchasing consumer items—looking for that 50% off sale and making tough decisions on whether quality trumps price to us in any given situation.

However, as investors…we pretty much suck at determining value!

In fact, this is one of the most common mistakes we individual investors make—confusing the price of an asset with the value of the asset…and sometimes not even bothering to determine the value of the investment in the first place!

This is one of the big issues I have with CNBC and most mainstream media—they do a wonderful job reporting on price (just glance at that live ticker scrolling across the screen—continuous live price updates on all sorts of stocks, bonds, and commodities), but spend almost no time helping to educate investors on value.

Jim Cramer Buy Buy Buy

Just because it's "cheap" does not mean it's a good value!

The above screenshot image of Jim Cramer is is from a mid-May 2007 clip…Toyota stock is still down more than 40% since then:

Toyota Chart

Ouch...

I honestly don’t mean to pick on Jim Cramer (at least not too much…)—he’s a smart guy, and I realize you can pick lots of individual stocks in 2007 and look at them today and cringe, though the S&P 500 has since recovered.

But what I do want to point out is that just because something is “cheap” doesn’t mean it’s a good value—many, many things in life are “cheap” but represent terrible value, and many “cheap” stocks become even cheaper (Enron, Worldcom…)

There is a big difference between price and value, and value is what we as investors need to get better at determining. This is what separates the “smart money” from the “dumb money” (and we want to be the “smart money”!)

So…how can you be the smart money?

“Smart money” investors inherently understand the importance of value, work to determine and analyze the value of their investments, and discern the difference between value and price.

This is why the legendary Benjamin Graham, author of The Intelligent Investor, is known as the godfather of value investing, not price investing, and the vast majority of that book (also known as the Bible of Investing) is dedicated to how he believes one should value stocks.

Warren Buffett understands this distinction, too, saying, “Price is what you pay. Value is what you get. The dumbest reason in the world to buy a stock is because it is going up.” – Warren Buffett

And in Robert Kiyosaki’s book, Conspiracy of the Rich, he explains why chasing the price of gold or silver is “a fool’s errand” and why buying based on price alone “is not the mark of a smart investor”. – Robert Kiyosaki

Determining and understanding the value of your investments is an essential part of your investment thesis.

You wouldn’t buy a car without first understanding the value it would bring to you and what the important characteristics were that you wanted to consider—maybe you have a large family and want a minivan, or you love to ski and want an SUV, or you’re concerned about gas mileage and want a Volt or a Prius, or you need to park it in tiny spots so want a Miata…or maybe you’re in construction and need a truck!

Whatever your personal needs/wants/desires are, you probably spend a decent amount of time researching the latest models, maybe reading Consumer Reports to get the safety and drive test results, deciding on “new vs. used”, shopping around for the best dealer and the best price, checking the impact it will have on your insurance, and then making your purchase.

Your investment purchases should be no different (other than you probably don’t emotionally “long” for those shares of JuniorMiningCo. X or municipal bond Y like you do for that new Harley-Davidson motorcycle or Manolo Blahnik shoes you’ve got your eye on!)

But you do need to spend some time valuing your investments, just like the “smart money”.

This is a two-part exercise:

  1. What do you believe the value of the investment is?
  2. What is the value of the investment to you?

Depending on the asset class, there are many ways to go about determining its value.

If you’re interested in income-producing real estate, it’s time to learn about cap rates and net operating income (if that sounds tricky, don’t worry…trust me, if you can grasp third-grade math, you’re all set!)

If you’re interested in valuing equities, you should definitely read Graham’s book, learn to read financial statements, and understand concepts such as net working capital, price-to-earnings, price-to-book, etc. (Also not tricky…again, think third-grade math!)

If you’re interested in valuing gold, you should brush up on your history a bit—what happened during the last bull market in the 1970’s? Do you believe gold is money and has intrinsic value in and of itself? What do people use gold for and what are its supply and demand fundamentals?

And so on.

And in case you are thinking, “oh but Kung Fu Girl, that sounds like too much WORK…”, I want you to remember one other important economic term—opportunity cost!

What is your opportunity cost of NOT learning to properly value your investments?

That’s right…PROFITS!!!   :)

The second question is equally important—I often stress here on Kung Fu Finance the importance of knowing yourself (“Know Thyself, Grasshopper!”).

What is this particular asset worth to YOU? For example gold may represent your future safety and security if fiat currencies collapse, a given real estate property might represent a future retirement income stream, and a junior mining stock might have value to you for its speculative potential.

Boring finance types would possibly term this “asset allocation” :) but I believe it goes deeper than that…ask yourself why on earth you are investing in this particular asset in the first place…what value do you expect it to bring to YOU?

If you can master this distinction between price and value, you will become a true master investor and instantly put yourself ahead of 99% of the population.

And that’s what I want for you!

Please let me know what you think about price and value in the comments!

Thank you as always for reading, and for being an awesome Kung Fu Finance subscriber!

To your financial success,

— Kung Fu Girl

 

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About the Author:

Susan Fujii, aka , is an SEC Accredited Investor who believes that anyone can learn to be financially independent.

Susan has authored 199 posts on Kung Fu Finance, and you can connect with her on .

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