Price and value are two different things – just ask Canva investors – Roger Montgomery
With the stock price of tech stocks having skyrocketed in recent months, there are perhaps few better times than now to revisit the important difference between Price and Assess. It may surprise investors that every company has real value or a real value that may bear no resemblance to the price currently being traded.
Witness, for example, the recent news that US investment giant Franklin Templeton, T. Rowe Price and Capital Group have written down their stake in unlisted graphic design platform provider Canva. With operating revenue of US$1 billion, institutional funds had poured money into the tech ‘unicorn’ valuing the company at US$40 billion by September 2021.
With listed tech companies like Zoom Video down 81% from recent highs, and with Pinterest down 77%, Lyft down 77% from its high, and Netflix, Facebook (Meta) and Amazon also down, it’s perfectly logical that private equity investors face the reality of falling market prices.
Incidentally, many investors, including Australia’s Future Fund, have invested heavily in private equity funds, and directly encouraged by the fallacy that less frequent assessment of mark-to-market valuations would allow them to post better performance figures than their pure stocks or bonds. market peers.
Interest rates act like gravity
However, the reality is that rising interest rates act as gravity on the value of all assets. The decline in value of listed companies should not be specific to listed entities. Just because a group of people sit around a room and agree on a valuation at which they will pour money into an unlisted company does not mean that is the value of that company.
Thus we come to the point where an explanation of the difference in price and value is required.
What is an asset worth? What is land worth? What is a business or a share of a business worth? An asset, what is it worth?
You will often have heard the axiom “It’s worth what someone will pay for it“, Where ‘It’s worth what you can get.”
This axiom is actually incorrect. The price is what someone will pay. Value or worth is something entirely different.
In Berkshire Hathaway’s 2009 Annual Report, Warren Buffett wrote; “Long ago, Ben Graham taught me that “the price is what you pay; value is what you get‘.”
Price and value are two different things
At an auction for a property that sells for an insane or unexpected price, observers will grumble; “It’s not worth it!”
We inherently understand that value and price are two different things.
Is $1 billion in revenue tech company Canva worth $40 billion? Of course not. Few, if any, companies are worth 40 times their revenue. Forty billion US dollars was what someone was willing to pay, but that price is not what Canva is worth.
In the stock market, efficiency is often observable, but the market is not always efficient. It does not always correctly assess the value of a company. This is because not all information about a company is distributed evenly, fairly, or even quickly, and the people who respond to that information are not always rational. Therefore, the stock price may not always reflect the true value of the underlying business.
Of course, inefficiency, which produces volatility, offers investors, often those with longer investment horizons, the opportunity to realize outsized returns.
But more importantly and fortunately, even if a company can be popular or unpopular in the short term, the market ends up doing it right. Over time, price tends to converge with the true value of a business.
These two facts mean that you can take advantage of market irrationality in the short term to be rewarded in the long term.
Buffett once said, predicting rain doesn’t count, building arches does. I deliberately borrow the expression for a use for which it was not intended, but it fits nonetheless. Predicting the stock price is impossible, at least in the short term. Intrinsic value is the ship that helps navigate the sometimes tumultuous changes in stock prices.
If you know the intrinsic value of a business, you can navigate clearly through thunder and high seas, gloom and hype. Your stock portfolio may still be rocked by the twin tides of fashion and sentiment, but with each rise and fall you are in a position to strengthen it, buying further below intrinsic value and possibly selling when stock prices are way above.
Say you have your eye on a company and its stock goes from $15 to $8. Should I buy now? What happens if you buy at $8 and the stock drops to $6? Suppose you decide to buy more. What if they go down even further to $5 or even $3? When exactly do you buy?
Only if you are convinced that the company is actually worth $8 per share can you see a drop in the share price – from $15.00 to $8.00, for example – for what it is: a tremendous opportunity. The correct answer is to buy more. If you’re like me and love chocolate, then surely it makes sense to order more when your favorite block is on ‘special’ at the supermarket? It’s the same with stocks.
Treat buying stocks the same way you buy groceries
Basically, you want the stock price to drop so you can buy more of it. Stock price declines, especially those that occur when everyone around you sees nothing but gloom and doom, are precisely what you want.
The hard part of investing isn’t identifying the right companies you’d like to own. The hard part is knowing when to buy, as the prices of all these companies fluctuate amid noise and influences that may or may not impact their business.
No one should miss buying shares in big companies for fear that the shares will go down even further. And there is also no need to panic and sell at depressed prices. But such rational behavior requires that you have something other than price to look at. You need to know the value of the company and its shares.
As Canva investors are now finding out, and as other private equity investors hope to avoid but can’t, what someone was willing to pay for a company last year may not have corresponded to what it was worth. And as the price investors are willing to pay falls today, the difference between price and value is now obvious.