There’s No Such Thing as Value

One of the foundations of investment analysis is the dichotomy between a stock’s price and its value; the idea that a stock’s price hops above and below its rightful value. But I’ll let you in on a little secret: there’s no such thing as value. There’s no magic value gnome hiding underneath each stock. Instead, there’s only price.

Value is a fiction, but a highly useful one. It’s an excellent way for us to think about a stock.

Telling us that a stock is below its value doesn’t tell us much. What if the stock’s value falls? Or what if the price/value gap grows wider? The price/value dichotomy is further complicated by the fact that price itself can impact value. For example, an elevated share price can make it easier for a company to raise money.

With any investment analysis, your constants are most likely highly contextual, and as a result, they’ll do a poor job of predicting out-of-sample results. That doesn’t bother me so much, and it’s also why I don’t much care for price targets. For all their sophistication, valuation models aren’t reality. They’re merely a blurry and highly conditional image of reality.

The proper job of an analyst is to judge possible outcomes and their impact. Value is a tool, but it must always be seen within the context of if/then scenarios. Too often, modelers become enthralled by their model and don’t look at what the underlying message is. I always cringe whenever I see some perma-bear claim the S&P 500 is over-priced by a massive amount. The statement, by itself, is meaningless. I don’t know if he’s right, but I know for certain that his model has a wide error range.

This is a subtle message to convey. Investments analysts should have a proper respect for reality, and a proper suspicion of make-believe.

Posted by on March 27th, 2014 at 9:23 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.