Saturday, February 12, 2011

Volume 3 Issue 6: Intelligent Investing

Price vs Value

While in our everyday life, we very often use the above two words interchangeably, in reality, they are very much separated like night and day. We may even believe that price is a good indication of value, but more often than not, we would be wrong. Let me explain.

It is intuitive enough that the price of a good is represented by the monetary value of a payment or receipt of for that good. In simple terms, it's pretty much the price that a seller is willing to accept for a good he is selling or the price that a buyer is willing to pay for a good that he wants.

Value, on the other hand, is a completely different monster. I'm just going to throw out a few examples. First, sentimental value. Imagine that your mother gave you a RM200 watch for your 21st birthday. The price may be worth RM200. Assuming a stranger walks along and asks to buy that watch from you for RM250. You may or may not wish to sell it, but I reckon any self-respecting child of their mother would not sell the watch for almost any price. This shows that the value of that watch to you far exceeds its price.

Second, earnings potential. Think of the proverbial goose that lays golden eggs. How much would you sell that goose? Would it be at the cost of three of its eggs? Five of its eggs? Ten of its eggs? While the goose may be traded for price, its value to different people may be different. For some people, they may be in urgent need of cash and would prefer receiving the price of five golden eggs in exchange for the golden goose. Some others who are in less need of cash at the present may only wish to part with their goose if offered the price of ten golden eggs.

This brings us back to value investing. The price of a stock is only the monetary value it is being traded at in the stock market. Whatever its intrinsic value is, depends greatly on the person who values the stock. In value investing, we hope to find geese that lay golden eggs and we hope to pay a very cheap price for them.

If you believe that no one is stupid enough to sell you a goose that would lay a golden egg, think again. The stock market is pretty much like a goose farm with a bunch of geese running around in every direction. And the people who trade shares are pretty much like a clueless goose farm owner who tends to the whole bunch of geese that run around in his farm. The key for a value investor is in finding the golden goose. To do that, one must be patient, and must study the geese very well. Of course it would be impractical to wait for every single goose to lay and egg before we the golden one.

Thorough research should guide you to determine with some amount of certainty what a golden goose would look like and how they are separated from the normal geese. This is pretty much stock picking for you. For those who are unaware of their special abilities, they may sell the goose to you at a cheap price.

P/S: I have put the transaction for the Mainstreeter Portfolio on hold simply because the KLCI is in a correction phase and there seems to be a lot of panic selling. This is the time where opportunity arises and we must remain vigilant to take advantage of it. For now, we would still opt to hold cash while waiting for a price of geese to drop.

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