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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{ 8 comments… read them below or add one }

Honolulu Aunty November 29, 2012 at 2:34 pm

Aloha KFG!

As always, a great article which gets me thinking.

One of the factors in determining what something is worth is time. With our real estate investing, our cash flow is okay and not too exciting, month to month. At the year’s end and when we have our tax return prepared, it still is just okay, and not too exciting.

However, what makes our real estate exciting is taking a long term view of it – say 10 years from now, and even 30 years from now (Aunty will be 90 years old by then, lol!) when it is our legacy and estate for our kids and grandkids so they have a perpetual source of income that is better than okay, though still not too exciting.

I’ve almost sworn off stock and options investing because of our track record – and have learned that cheap doesn’t mean a good buy the hard way.

I would say we invest in real estate for value, and in stocks for price. I feel that we are better off investing for value, and leave our guessing at pricing of stocks for others.

Would appreciate any advice you would have for people like us.

Mahalo in advance,

Aunty

Reply

kungfugirl November 30, 2012 at 10:47 pm

Hi Aunty!

Thank you for your comment, and yes, time is very important, especially with real estate. We do a projected cash flow analysis of our properties over 5 to 10 years, because you can make assumptions about rent increases (and of course, sadly, maintenance increases, too). Hopefully you’re locked into a great low-interest rate mortgage, so at least that will be a fixed cost! :)

Positive cash flow in real estate, even if very small, is still something to definitely celebrate, because despite what all the pundits say, it is NOT easy to come by. You have to look at a zillion properties, choose the best of the best, get it properly financed, find great (or at least good) tenants, get it properly managed, etc….it’s not easy, but on the flip side, you have so much more control than you do over a publicly-traded stock! I can complain to John Chambers, for example, if I’m not happy about the way he’s running things at Cisco, but I have zero control over what he does with the company.

Stock investing can be very lucrative, but only if you are well-versed in understanding business and well-versed in valuing companies (which is in itself an art, and different methods are used for different types of companies, and by different investors). Options can be terrific, but only if you have the time to dedicate to them (as you know).

I’m not sure what advice you’re looking for…I think you’re doing great! “Great” probably does not equal “exciting”, though, so maybe that is what you mean. :)

The dirty little truth about investing though is that much of it is not “exciting”. It’s mastery vs. instant riches…choosing the asset classes that you enjoy and that have the most promise to take you to your goals (e.g. real estate) and then letting the beauty of inflation (higher rents) and fixed rate mortgages and other deductions work their magic. Five years from now, your monthly cash flow from your properties has the potential to be MUCH higher than it is now! So that’s exciting!!! :)

Thanks for your comment, and let me know if I answered your question!
– KFG

PS– how is the Nerium business going? I hope well!!!

Reply

George from Denver November 29, 2012 at 3:20 pm

I loved reading Oscar Wilde in my early adulthood. He went through life dropping these little throw-away quips–verbal bon mots as it were–and they all seemed like “classics.” Knowing “the price of everything and the value of nothing” is usually used as the modern definition of a cynic, but thank you for reminding us where it really came from.
This reminds me of an old girlfriend, a real Jewish American Princess (got the requisite three charge cards at her bat mitzva) from NYC. We flew to New York so she could show me off to her aunts (her parents were dead) for their approval. Along the way we wound up in the garment district (she needed some new business clothes) where she proceeded to engage in a furious bargaining session with an old Hasid. There came a pause in the negotiations, and she apparently couldn’t get any traction in the deal (the old man had a smirk on his face; he knew she really, really wanted those four suits). My girlfriend smiled, and calmly said, “I’m in my time of month, and, if you don’t give me the suits at my offer, I’ll touch you.”
The old man blanched, and cursed her and made the deal. Apparently, the Hasidic view of a woman in her period is fairly “Biblical,” and involved going home, performing purification ceremonies, and losing the rest of the day to any business.
The thrust of the story is about the difference between value and price. Both parties to the voluntary trade knew the merchandise had value; the bargaining led to a stalemate which was broken when the seller admitted that his time had more value than to lose it to a purification ceremony (thus losing an opportunity for more sales).
We went on to lunch with her aunts who had come into the City from their homes in Westchester County. They loved me–apparently, this was the kiss of death–and we parted amicably after we got back to Denver. Then again it could have been the medical exam she had with the old family doctor; she died a few months later of an inoperable brain tumor.
This was a great article. Brought back some old memories, and reinforced some lessons I learned a long time ago–like women are more ruthless than men…

Reply

kungfugirl November 30, 2012 at 10:52 pm

Hi George!

Thank you for your story! And wow, what a great story…except I’m not sure we women are more ruthless than men, LOL (but then again, who knows….?) ;)

Thanks so much for your kind words. It *is* interesting how many things influence our perception of value to us! E.g. the merchant’s time as you mention in your story, or people being superstitious and afraid to buy homes that have had people die in them, etc….it’s fascinating.

Maybe that’s one reason I like gold and silver so much, if truth be told…sure, unemotionally and logically it makes so much *sense* (one glance at our balance sheet and/or the chart of the U.S. dollar since its inception reinforces my belief in gold and silver in a nanosecond!) but also it could easily be an “emotional” purchase…I had better be careful there, lest visions of pirates and treasure get stuck in my head!

Thanks so much for your comment, and happy weekend!
– KFG

Reply

Jimmy November 29, 2012 at 6:34 pm

It’s good to make investors aware of the difference in price and value. As a long time real estate appraiser,investor and broker , there is often confusion
in the “right” price and usually an investor’s personal bias and not looking at the market or completing an objective due diligence causes overpaying or poor selection in real estate transactions.

A second opinion from a trusted advisor or professional may be a smart move..

Reply

kungfugirl November 30, 2012 at 10:54 pm

Hi Jimmy,

Definitely; great point! The ol’ difference between the “pro forma” (or the “how wonderful life *could* be if only…” statement) and the actual due diligence…LOL. GREAT idea to get a second opinion from a trusted advisor or professional.

Thank you!
– KFG

Reply

Josh November 30, 2012 at 8:48 am

A couple of weeks ago, I saw a post about the 777 million shares of Facebook being released on top of the 1.3 billion shares already released. All of these are worth $20. Does that mean the company’s stock market value is $40 billion? They have little assets; is their profit ratio that high? Am I missing something? What is the real value?

Reply

Rich@Money Wise Pastor December 3, 2012 at 1:37 pm

I’m really glad to read your post because it prompted me to add this difference between cost vs. value to the list of things I want to teach my teenage boys as I work to equip them to be entrepreneurs. This is a key concept that many do not understand.

Reply

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