What is value if it isn’t priced? There are so many ways of describing value -and many are mathematical – but suffices to say, value is not relative; rather it is absolute. Over time, price and value tend to approximate one another. The price you pay for an asset should over time migrate up or down to the absolute value of that investment. For example, in the midst of the credit crises, real estate prices went down precipitously, but the value of real estate remained largely intact. Most real estate owners didn’t need to sell their home, so the price was irrelevant; the value in terms of shelter remained constant. Over the last decade prices for real estate in the US have migrated higher and now more closely reflect value. Based on different types of perception, we can also state that a hammer can help you make a home, therefore, that hammer has value as a tool. If a house provides shelter that would otherwise require rent to occupy, that house has value. In this brief dispatch, we will see that price is a fickle thing, but value is not.
Market prices are largely based upon the flow of money moving on a daily basis through our capital markets. Some investment sectors fall out of favor, and prices fall. Sometimes the entire market is out of favor and money flows through the exits and prices fall. Prices are set by the short-term movement of the dollars flowing throughout the market. A great analogy for this type of movement is someone walking a dog on a long leash at a park. The dog will move with nervous energy all over the place, sometimes extending and even pulling on the leash in multiple directions. The dog is like market prices, moving up and down in a helter-skelter fashion. Now, if you want to know the direction of the dog as it moves through the park you need to watch the owner. The owner represents value. Prices will move all over the place, but the direction of the dog will largely be determined by the movement of the owner over longer periods of time.
As of this writing, the market has declined steeply into a bear market. But the investor knows that price declines create opportunities. Just as deeply discounted items in retail create opportunities to buy at low prices, so do bear markets create opportunities to buy great businesses below fair value. The entire idea of investing is based on a long-term approach to owning assets that over time will generate a decent return for the owner. There are times when investors lose sight of this, and rely heavily upon trading assets furiously to create the illusion of profits, but ultimately this is not investing. The trading of assets that go up and down is speculation, and typically ends in loses. We are watching this unfold in real-time as certain sectors of the market, including speculative stocks and cryptocurrencies.
This cognitive exercise points to the question we began with, “what is value if it isn’t priced?” All assets that can either be used to produce cash, or produce cash themselves, have value. If a company pays you a percentage of cash profits in the form of dividends, that stock has value as a cash producing asset. The only reason an investor would commit their hard-earned money to buy an asset would be the potential for that asset to produce something of value over time. Bear Markets create a disconnect between price and value which allows prudent investors, who understands value, to take advantage of these disconnects and commit capital at favorable terms thereby compounding their wealth.