When Price and Value are worlds apart
Is Warren Buffet's "value investing" dead?
A summary of this piece:
Value investing is a beautiful, beautiful thing.
But it generally hinges on the price of a share having some correlation to the value proposition of a company.
That premise barely holds today. Consider massive quantitative easing/tightening. Or stock-buy backs. These have nothing to do with a company’s value proposition, and yet everything to do with its share price.
The current system isn’t designed to give the average value investor a good chance to preserve or make money.
Overall, a mindset where investing is done without at all considering real value is growing. This is to be expected.
Let’s dive in.
Value investing. This strategy suggests that informed individual who invests in companies with genuine long-term value propositions is very likely to make money.
Probably the most famous advocate for this investing strategy is Billionaire and one-quarter Coca-Cola Warren Buffet. His quotes on value investing are legendary. Some examples below:
“Never invest in a business you cannot understand.”
“If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”
“Price is what you pay, value is what you get.”
Personally, I love this idea of investing where you can observe value. Wouldn’t it be beautiful and fair if whether or not someone made money largely hinged on if they’d put in the effort to identify value? If they’d done a good job, they had a great shot at sustaining or even growing their wealth over time.
In this piece, I seek to explore a central concept in value investing: the relationship between share prices and value. Specifically: do share prices move in tandem with the actual value offered by a company?
Prices are signals. Until they cease to represent value.
A rising share price should indicate that the company’s progressing, whereas a falling one should signal that things aren’t going that great.
But that’s extremely different from what’s happening in reality. It is no longer the value proposition of a company that exerts the greatest influence on share price, but rather, things that are completely unrelated to a company’s value proposition.
There are many factors causing this, but let’s examine a few simple and direct ones.
Consider stock buy-backs.
As per the above, companies have consistently bought back some of their stock to increase the price of their shares over the past five years. This hit a record high in the end of 2021: companies bought back over USD 250 Billion of their OWN stock. Meaning: buy-backs are pushing share prices upwards, and this is happening more and more. In fact, we’re projected to be heading towards a new record quite soon.
Don’t get me wrong — buy-backs aren’t entirely bad. But you have to admit that they prove that share price does not correlate with value. And more fundamentally, is the average investor incentivized to look around for value, or to invest in a “safer” company like Apple with ample funds? Since he/she knows that no matter what, Apple has the reserves to keep pushing stock prices up, I’d argue that it’s usually the latter.
And this option also happens to be where the correlation breaks.
Consider another — and more hot — factor: government intervention. The Fed pumped up its Balance Sheet (i.e. money printing) in 2020. Obviously, one of the goals of such pumping (i.e. QE) was to bolster assets like shares. It worked. Subsequently, we can observe a jarring correlation between the balance sheet and the S&P 500.
Most obvious is what’s happening to asset prices today. Government policy — namely quantitative tightening, combined with rising interest rates — is largely driving prices. Not the value proposition of a company.
The average Joe’s deadlock.
On one hand, we have a stock market that is in no way an accurate representation of the value it actually represents. On the other hand, for the preservation of wealth, hoarding your money in cash is just not going to do it. The inflation monster is real, and it’s hungry.
That picture was taken in Venezuela. Guess what this car is made out of?
So what does the average Joe do? Remember: the average Joe is no angel investor with insider info. He invests in some S&P 500 index fund, given that the government has an incentive to keep propping up the nation’s top stocks. Or: he gets into trading, etc., betting on becoming rich in a short period of time to keep up with the increasing costs of living.
These are in not at all equivalent to value-investing, because they’re missing the “looking for genuine value and thinking with your own head” part. But you can’t blame people for doing this, because there’s a really compelling case for ignoring value altogether.
The result? Booms and busts, and a gradual loss of faith and trust in the system. But more fundamentally and scarily:
The normalization of investing without thinking about real value.
What’s real value? Real value can mean examining how much money a company’s making on a daily basis. Real value can also mean how much potential a company has to grow in the long-term, even if it means making losses today. “Real value” is subjective, and that’s OK.
However, it becomes concerning when the idea of “real value” becomes increasingly ignored. Granted: scandals still make stocks crash, and breathtaking innovations still help companies boom. But increasingly so, it is not value that drives price.
This sets up a few things. A system distributing funding and opportunity where there’s room for short-term profit at the risk of long-term prosperity. A future with no investors and infinite traders. I believe that these tend to be bad things and simply aren’t sustainable.
The stock market was an amazing creation. It still holds the potential to create win-win situations, and that too in a sustainable way. But work remains to be done in creating a system where price correlates with value. A system with fewer booms and busts, and a system where genuine value has better odds of success. A system where Buffet’s words can hold strong relevance.
How do we transition into such a system? Should governments stop intervening? Should everyone trust no one? Well, it’s not that simple, and it has to do a lot more with psychology than economics. We’ll explore this further in a future article. (Coming soon, in fact!)
I’ll be back soon. Have a great week ahead. And if you’ve made it up till here, thank you. It means the world to me.
Till next time,
Ja ne!
P.S. I created this newsletter to share, get roasted, and learn along the way. So if there’s anything you feel that I got wrong, or you’ve feedback in general, do let me know in the comments or DM me on Twitter!
P.P.S. This is in no way financial advice. I just like to write stuff. Think with your own heads!
“Value” has always been evolving, from Benjamin Graham to Buffet/Munger to Cathie Wood. A successful investor has to adapt and not get stuck in the past.