Value vs. Price - a simple explanation

Why is the market always against me?

As soon as I hear a tip and buy the stock, the stock goes down shortly after. When I cut my losses, the stock accelerates upwards.

Why?

When I started more than 10 years ago, I was not investing.

I was trading stocks by following tips. I did not calculate the intrinsic value of the company and make sure to have a margin of safety first.

Only after learning about value investing and portfolio management techniques, I stopped losing money.

One of the most important concepts to understand in value investing is value vs. price.

Value and price are not the same thing.

• Price is the amount that a buyer is willing to pay for an asset at a given time.

• Value refers to the true worth of an asset, the intrinsic value.

Let's explore these in more detail:

When we talk about price, we mean the amount of money someone is willing to pay for something.

It's like going to the store and seeing a toy you want. The price is how much money you need to give to the store to take the toy home with you.

• But sometimes the price of something is too high, so you decide not to buy it.

• Other times, you might want something very much, so you're willing to pay a higher price for it.

So price is how much someone is willing to pay for something. And it can change depending on lots of different factors.

When we talk about the value of something, we mean how much it's actually worth.

Not how much someone is willing to pay for it.

So, a toy might cost 10 dollars at the store, but its value might only be 5 dollars because it's not a great quality toy.

Value investors try to find things that are worth more than what people are paying for them.

The intrinsic value of something is important because it's the true worth of the thing.

It is not what someone is willing to pay for it.

Imagine you found a very rare toy that collectors love and is actually worth 20 dollars.

• The actual intrinsic value of the toy is 20 dollars. 

• But the store is only selling it for 10 dollars.

You would have found a bargain!

If you proceed to buy it for 10 dollars, you will have a very high chance to find a collector and sell it for 20 dollars. Your chance of making a profit is very high.

You have a good margin of safety. 

Market inefficiencies and behavioral biases can cause prices to diverge from intrinsic values. This creates opportunities for skilled value investors to profit.

Value investors can generate strong returns over time by focusing on the value of an asset. Short-term price fluctuations are usually ignored.

The bigger the gap between intrinsic value and price, the greater the margin of safety.

We should invest in an asset when the price is much lower compared to its intrinsic value, and wait.

Like a pendulum, price will return to its intrinsic value over time. And sometimes even swing to higher extremes.

When this happens, it will be time to sell the investment when that happens, locking in profits.

Invest in quality business when we have a good margin of safety, and be patient. We can achieve higher probability of success in the long run.

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