Price is what you pay, value is what you get

“Price is what you pay, value is what you get” 

– A quote from Warren Buffett’s 2008 letter to shareholders

Whenever you buy a product or service, be it groceries, clothing, furniture, a car, a house or even stocks, the price is what you pay but what you are really buying is what you get.  I.e. you are buying the perceived benefit of what you have bought.

 

With investing, value is based on a business’ ability to grow earnings and increase cash flow.  Therefore, when you invest in a business on the stock market, what you are really buying is that particular business’ ability to both earn and generate cash.  The higher a business’ ability to earn, the higher the share price will go in the long run.  And so it makes sense that every buy decision made in the stock market is done with the belief that the stock price of that particular company will ‘go up’.

In times of uncertainty and pessimism (think Europe currently), stock prices are often lower than the underlying value of the business.  It is times of uncertainty that make stocks a bargain.

An investor’s goal

My goal as an investor is to uncover opportunities where the price of a stock is lower than my estimate of intrinsic value, with that intrinsic value rising in the coming years.  Then patiently wait for the market to recognize the value.

I am looking for opportunities to pay 50¢ for a $1 of value, with that $1 in value rising in the coming years while waiting for the market to see what I see.  And that usually happens when the uncertainty subsides.  When the uncertainty subsides (current thinking: Europe fixed), the market will become “bullish” and price the stock more positively.

So, just like when I go shopping for groceries looking for ‘specials’ or buying quality clothing that is ‘on sale’, I am also looking to buy good quality stocks when they are on special or having a “two-for-one” sale.

The stock market does not display a ‘half price sale’ sign

The difference with the stock market is that it does not advertise a product as on sale or advertise the special this week.  The price creates the opportunity and knowing the distinction between the price you pay for the value you will get gives more certainty to buy/sell stock market decisions.

By the way, keep an eye out for Warren Buffett’s 2011 letter to Berkshire Hathaway shareholders which should be released in the next week or so.  The letters are quite lengthy but well worth the read, as each letter is a financial library within itself.  If your interested, here is the link to the pdf of the Berkshire Hathaway annual report which includes the 2011 letter.

 
This article is published by Dean Mico.

The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

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