Difference between price and value? An important distinction that can makes fools out of a rational people. Value is the certain value derived from an asset while Price is the perceived value one derives from an asset.
When you invest money, lend debt, or deposit money in a savings account you do so expecting a return. Rationally, the value for a company’s stock is based on the present value of the future earnings, or dividends returned to the stock holder. Say, a stock returns $1 for the next 100 years, its present value should be $100 (assuming 0% interest rate). That’s value! and its generally rational.
Value: Rationally justified but generally uncertain.
But there is always uncertainty surrounding the the future of a company and this translates to differneces in expectation of the value of that company. This differnece in expectation of the value of an asset is what leads to price discovery: the fluctuations of market price of an asset due to the purchase or sale of an asset based on the percieved differnece between its value and its current market price.
Price discovery: the fluctuations of market price of an asset due to the purchase or sale of an asset based on the percieved differnece between its value and its current market price.
Price is simply what someone is willing to pay for an asset or stock. And this is largely a factor of sentiment ( positive or negative) and demand for a stock.
A classic example of this: The government giving its citizens $1,200 stimulus checks who inturn not knowing what to spend it on, deposit it in their Robinhood trading account and start buying stocks of tech companies. Hence we can see rallies in the stock prices of companies, where people are buying stocks without any fundamental change in earnings potential of the company. Here the value of the stock/stocks havent changed because its potential future earnings haven’t changed. It’s just that giving people more money(increasing the money supply) means they need to find a place to put it, and by putting it in stock markets the price of a stock can rise are more people flock to the same asset.
MG’s Rule: Never bet against the herd. even if you are certain of it. Why? Because the markets can remain irrational far longer than you can remain liquid.John Maynard Keynes (i think),
Not adhering to the above rule has made rational fool out of me many times in the past, something I hope I’ve learned from.
Price and money supply: If for some reason you print trillions of dollars (increase the supply of money) and give it to the hands of Americans they will need to put it somewhere. Some will store it in their bank accounts and some will invest it in assets (like houses, stocks, bonds). In doing this activity, we drive up the ‘price’ of an asset despite its inherent ‘value’ ever changing.
Price and sentiment: think herd mentality.
The increasing belief in a particular sentiment the more you are going to see continued price action, aka same directional movement. This is the impact of herd mentality, the price of a stock or a sector of stocks can go up simply because the general public has developed a growing sentiment toward that stock or sector. More importantly, a negative sentiment in one sector or asset class can result positive sentiment toward another sector or asset class as investors who withdraw from one investment need to find another investment to target their required return on investment.
Leveraging price changes due to sentiment is a key strategy when investing in a volatile period or structurally changing period. We will discuss more of how this plays into my investment portfolio’s decisions.
- The price of an asset is not the same as it’s value.
- Sentiment change can result in large capital flows resulting in significant price action without any changes in the underlying asset quality.
- Underpriced assets can be as attractive investment opportunities as Undervalued assets.