This article was from Mr. Ge Ba’s feedback my blog post “Misunderstanding of price and value“.
Many people confuse “value” and “price”. In fact, if you think about it carefully, there are many of our own practices that also help you “confuse” the two. Let me cite three examples below.
“Stock price” is used to serve us, not to guide us
Example 1. https://youtu.be/Gm1FqNO4taM?t=769 Buffett said that “stock price” is used to serve us, not to guide us. Value investors need to roughly calculate the company’s “value/intrinsic value” before investing in that company. But I remember Andy has a 30% stop loss principle (according to Andy and it seems to have helped you a lot). This is where the “price” guides us nominally. In fact, Andy thinks about it carefully.
You shouldn’t stop the loss because the stock price dropped 30%, it should be because the “intrinsic value” has also fallen (the reason for buying disappeared, remember your “Applied Optoelectronics”?) You just stop the loss. Otherwise, when all the facts are the same and the stock price has dropped by 30%, growth value investors should be a big buy (provided that you have thoroughly understood the company to buy).
So “using the stock price to drop by X percent” to stop the loss is basically acknowledging that Mr. Market may know something we don’t know, so we let the stock price guide us. This is to confuse the basic concepts of “price” and “value”. Yes, it should be to tell everyone: “Intrinsic value has dropped by X percent” to stop the loss is a reasonable statement. Just because of the situation of “stock price has dropped by X percent”, it is time to enter the market.
You can take a look at the 2021 Berkshire Hathaway’s Annual Meeting. Buffett’s calculation of Precision Castparts’s average earning power for 2016 was wrong, which led to a wrong calculation of the intrinsic value and bought it more expensively (although this company is still a good company, so Buffett did not stop loss), you will understand that Buffett is calculating “intrinsic value”: https://youtu.be/npRYd31diFo?t=8159
Use “price” to calculate investment performance
Example (2): Use “price” to calculate our investment performance every year. I remember that Andy suggested that everyone should calculate their investment performance every year, but I carefully looked at Andy’s way of calculating performance, and it seemed to use market prices to define our performance (I hope I’m not mistaken). This is also very confusing. The “value” of the company has not changed significantly, but the “price” will be. So we are diligent in calculating our performance this year. In fact, it is just the company you bought, and everyone suddenly wanted it.
Similarly, when your performance is not good, as long as you are sure that the intrinsic value of the company you are buying is rising, why bother to doubt yourself? Especially for long-term “growth value investors”, when you decide to buy a company, the stock market will not open for five years, you must not worry, as long as the company continues to increase its “value.”
Ge-Ba feels that it is meaningless to use “price” to calculate short-term performance (I also think that the one-year period is short). On the contrary, it confuses our willpower because when you first bought, you were holding “ten years”. The mentality is deciding (or are you all?), what does short-term price fluctuations have to do with value investors? Why use the short-term performance calculated by the “price” to make yourself doubt life?
“Price” should only be relevant to investors when it is “buy” and “sell”, and it should have nothing to do with us at other times. It’s just that when everyone in the market compares their annual “price” performance with you, how can you keep yourself out of the way? How to keep your sobriety and not be influenced by the market? So Ge-Ba doesn’t calculate my annual “price” performance. If I really want to do it every year, it will also calculate my look through ROE. Although this method is not perfect, it helps me to be clear.
The term of “Value”
Example (3): The term Valuation. The intrinsic value of a company means that the company “from now to the end of the world, can generate the discounted value of the sum of all cash flows in and out”, so when we calculate this data, we calculate the “value” of the company. Many people say that he uses P/B, P/E to “valuate”. This is another very confusing statement. P is the price (price), using the “price comparison method” of prices, of course the comparison is “price”, not “value”, that is to say, using P/B, P/E is for “appraisal” rather than “appraisal”. Value”, even if these two nouns can be expressed in English by valuation.
Why is it necessary to make a hard distinction between “valuation” and “valuation” methods? Are you talking about it? ! If you use the “discounted cash flow method” to “valuate” people, you should be greatly overvalued in the past few years, because no matter how you lower the discount rate (conservative), you will find the “stock price.” It is often higher than the intrinsic value you can calculate conservatively. It means that you have no company to buy and no way to invest, because now the market is flooded with funds, coupled with the competition between SPACs and private equity funds, it is super difficult to be able to invest at a “price” lower than the company’s intrinsic value.
What to do? The DCF method doesn’t work, and the mountain doesn’t turn around. Then I simply use P/B, P/E to estimate it. What to estimate? Estimate the “price”. Therefore, PE multiple is slowly increasing. You buy such a high price. Anyway, I will follow, as long as I can find the next person who buys higher than me. At least I will not be empty-handed in the market by others. “Price performance “Compared. As a result, the “buy when the price falls below the intrinsic value” of “value investment” becomes the “price investment” of “compared with everyone’s bid”, otherwise you will be waiting for cash and low (price) performance.
“Valuation (estimate the price — here is what Ge-Ba means)” and “valuation” are two very different concepts (DCF vs. PE PB) with different connotations, but they are mixed and very confusing. Value investing is to carefully understand the competitive connotation of a company, estimate the “intrinsic value”, and then patiently wait for the “price” to appear, instead of switching to PB, PE, and another method of “valuing”, everyone can bid higher than who can. As for whether the company I bought is worth the price, it is not that important.
But in theory, if you can’t buy it, just wait in cash. What’s wrong with this? However, the “price” performance comparison method of “Example 2” mentioned above will make it ugly for those who do this. In particular, many “growth stocks” cannot estimate “intrinsic value” (not “valuable”) at all, so naturally everyone changes to the “valuation” method.
It’s not easy
The above three examples are where Ge-Ba was most often confused about “value” and “price” when he formed my investment concept. Even what many masters said was often paradoxical. If you want to control the concept clearly, Ge-Ba thinks it’s not easy.
This article is a public palindrome from Mr. Ge-ba’s for my blog post “Misunderstanding of price and value“ . The content is very exciting. In case you miss this palindrome. I reprint the original work of Mr. Ge-Ba here and share it with you. I would like to thank Mr. Ge-Ba for taking the time to write this article and sharing it publicly. Thank you.
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