Price versus Value
The definition of a cynic is, according to Oscar Wilde, “A man who knows the price of everything, and the value of nothing.”
Understanding the difference between price versus value can result in social and economic outcomes that are remarkably different than those experienced by a cynic. A cynic is more likely to be inclined toward a world view that the system of capital markets is rigged, lacking value, and the only way to win is to game it – to speculate. Distinguishing the difference between price versus value is the very nature of intelligent investing and by extension, a conduit toward a higher social purpose.
The price we pay for something can be the single largest influence on the value we get. The existence of a price/value relationship does not imply that price and value are interchangeable with each other. Value is not synonymous with price, or the cost of a service. We can’t judge a book by the price on its cover and the same holds true for an investment or investment advice.
A Three Dressed Up As A Nine
As the Canadian band Trooper said, “Wearing $1,200 you looked a whole lot better from 20 feet away – you’re just a three dressed up as a nine and you’re only wasting my time!”
Developing an understanding of value is challenging and despite all the transparency with plain and true disclosure, value remains hard to see. The tools of deceit are often appearances; people are easily duped by fancy cars, watches, fine suits, office towers, educational credentials, qualifications, and the cache of success. Group speak and industry jargon, numbers, charts, and marketing brochures mystify and muddle value and we can also add manners of indifference, superiority, or even arrogance.
Gaming the system is nothing new and its widespread appeal is embraced by cynics on either side of a transaction. With such an enthusiastic following, the spin isn’t likely to go away any time soon.
When we become lazy with our value assessments we often do more harm than good. We choose the wrong people, the wrong investments, and we compromise our own integrity. In the rush to appear with “smarts”, we judge quickly and act fast. A lack of interest, a multitude of distractions, or complete lack of understanding are a perfect recipe for mediocrity or worse, investment losses and underperformance.
Cynical behavior is reinforced with more cynicism and it perpetuates onto itself.
As a society we have adopted a deep and narrow mindset with regard to specialization and developing expertise, often at the expense of peripheral vision. Instead of drawing from a broad palette of ideas, we can easily become trapped with our own cognitive bias and self-limiting beliefs. We can develop an overconfident view of our abilities and the future.
When we are too busy for due diligence, or when it no longer seems to matter, its as though we will make progress by running before we learn to crawl. The inevitable conclusion is progress takes longer when it is rushed and it may never come at all if we don’t learn how to do it right in the first place.
When people give up on the idea of doing better than average it makes it easier for the rest of us to find value and outperform. The herd on Wall Street or Bay Street set the prices and on the margins it includes bidding by the most emotional person, the greediest person, or the most depressed person. Rational thinking among a large group is often replaced by a narrow mindset. The bid prices are often nonsense and yet where you find a buyer, there will be a seller.
Trust Yourself, Believe in You
We can’t rely on the widespread acceptance of our peers any more than we can rely on big brother, a nanny state, some big institution, or regulation. Regulation is intended to maintain confidence in capital market systems and yet relying on regulation in the absence of developing understanding can have disastrous consequences. Regulators are as human as the rest of us and equally vulnerable to following institutional imperatives and adopting lemming-like behavior.
In a world where attention spans are pacified with sound bites, this message with 700 words so far, may already exceed the acceptable norms. If so, I thank you for your attention and hope you will enjoy another thought provoking article again some time in the future. If your mind is open to further closing the gap on price versus value, as entertaining as it may be to enjoy this narrative, it serves no purpose in the absence of solutions. Where do we start looking for solutions if not with the master of value, the Sage, the Oracle of Omaha.
Warren Buffett has said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Buffett has summed up by saying, “Price is what you pay, value is what you get.”
Simple, but not easy; sounds too good to be true. A sheep in sheep’s clothing is another betrayal to the sceptic. Finding good value in the absence of all the hype and fancy appearances is chicken soup for the soul of the value investor.
We start with a narrowly defined circle of competence. You don’t have a competency if you don’t know the edge of it. It is far more important to know yourself and what you are good at than leveraging up on your single lifetime of experience with the power of Google, the internet, and whole bunch of random ideas that substitute for complete understanding. You can travel the world and meet lots of wonderfully different, intelligent and entirely successful people, and still not know jack squat!
Value is found in a neighborhood, not at an address! The specifics are rather subjective. Even simplicity can be deceiving. Relative value can be an intensely grotesque aberration, so we need to use sensible and informed analysis. Here is how it is done.
Buying a Business
When we’re looking for a business investment, we want a quality business, preferably bought at a discount. We are willing to pay up for quality as long as we have a good understanding of what quality looks like. We want to be sure about what we’re doing so determining quality starts with a business we completely understand. We want a business with a history of shareholder earnings, part of a long term growth industry, run by honest and competent people, and operating with barriers to entry – a deep, wide and protective moat. We like it when our businesses have the flexibility to raise prices for their products or services because unlike commodities, which drive sales with price reductions, price increases supported by adding value go straight into profit.
The price we pay is clearly important while value is less obvious and potentially much more significant.
If business valuation is beyond our circle of competence, we source it out. We still have to know who we want – or at least the skill set of the individual we’re looking for.
Choosing a Portfolio Manager
When we’re hiring a portfolio manager to oversee our security selections, we’re looking for a walk that matches the talk. We are comforted by tenure – time at the helm, we want high conviction, we want to see their skin in the game, eating their own cooking, and we don’t want to pay management fees for someone to look and behave like an index. We prefer low turnover and fewer decisions – we’re prepared to wait and we’re not passing judgement on a quarter by quarter basis. We would like to benefit from operational scale and keep the cost of management reasonable.
If selecting investment management expertise isn’t your thing, then you work with a financial advisor. You want to be clear on your objectives and what you need. What is the cost of guidance or the absence of guidance? What other services can you expect? How will your money be managed?
A financial advisor can’t reliably predict the general direction of markets in the short term. There is no way to know where interest rates are going next, what will be the next hot sector, the direction of the dollar, or the winner of the next election – not that it matters. We haven’t a clue about the next major calamity in global markets. In our defense, I think we’re just as good at not knowing as with most others who may think they know.
What a financial advisor can do is develop understanding by offering to meet with you, spending time with you, getting to know you. A financial advisor will strive to understand your vulnerabilities, manage risks, develop a plan, offer solutions, integrate tax and accounting, and wills and estate planning. An exceptional financial advisor will make sure at the end of your days, the people you care about are not left with a compromised final impression of you.
In short, a great advisor team will have your back – you’re not left alone to play hit and miss. As it is with a good SCUBA dive master, your advisor can lead you to find a seahorse the size of your baby finger amid a huge ocean full of fish and fish that look like plants. We all need to see the seahorse! Tiny things can make a big difference.
Keep in mind, monitoring money managers is ongoing and it is an infinitely patient exercise. Finding the right financial solutions is as much an art as it is a science – look for creativity and intelligent design while favoring the time tested, tried and true. Esoteric, fashionable, and trendsetting are not where you want to be with your money or with your advisor.
Investors need to start off with a long term mindset – 5-10 years is just the beginning. Be prepared to plant shade trees even though you may never sit under them. We are prepared to patiently commit capital to wonderful businesses and there is a great social purpose for our behavior. Our businesses serve the needs and wants of humanity, the use of our capital is making lives safer or easier. We are rewarded individually as investors and as a society when value is present and understood. Seek the truth!
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