Two Theories of Price and Value. Warren Buffett And Benjamin Graham

Dear Reader,

There are basically two theories of price and value. One theory postulates is that value, price , of something is what someone pays for it. This is basically Keynesian economic theory.

The second theory says is that value is what during time proves to be the equilibrium price. Or as arguably the world's greatest investor Warren Buffett says "Price is what you pay, value is what you get". His teacher Benjamin Graham says that the stock market in the long run is like  a voting machine. This second theory is basically classical economic theory that the "invisible hand" of the market over time determines "the right" price.

Where is the truth? Basically, both theories are true, but at different times. Technology entrepreneurs that sold their stock in 2000 - 2001 and became millionaires or even billionaires would certainly take a look at the theory that price is what someone pays for your company. Especially, after the 2001 dot-com stock market crash. This sort of thinking is predicated on the fact that there are no catastrophic risks. This has been true, at least since the Great Depression in the 1930s. If you put your money in the bank and the bank does not fail you are still a billionaire. The same is valid for real estate investments, when the price of real estate does not crash.

Here Warren Buffett and Benjamin Graham would beg to differ. Warren Buffett seems to believe, obviously correctly judging by his net worth, that value is created by owning companies and increasing their value. Warren Buffett, like his teacher Benjamin Graham, thinks that value is realized over time. Warren Buffett looks for companies with a durable competitive advantage. That is, value is fixed and stable and can grow over time if the company has an edge and is managed right. Buffett and Graham's favorite holding period is "forever". Again value is perceived as stable and growing over time.

GameStop recent stock's frenzy is a case in point. In the space of one month the price of GameStop's stock went from 18 USD to 340 USD and then back to 40 USD. If someone bought at 18 USD and sold at 340 USD he would certainly say that price is what someone pays. If, however, an investor bought at 340 USD and now the price of GameStop's stock is at 40 USD would rue his decision and side with Warren Buffett and Benjamin Graham.

To employ successfully the "price is what someone pays" theory one should be very fast and agile. To be successful with the long-term intrinsic value theory one should make very rigorous analyses and be patient. Combining the two approaches is the best option, but extremely difficult due to people's psyche.

I personally side more with Buffett and Graham. Because if you enter at the top then your losses could be 80 % of your initial investment. While the margin of safety advocated by Buffett and Graham at least provides that you will not loose your net worth. That is, you avoid catastrophes.

Disclaimer: The blogposts and comments on this blog and posts on social networks(Twitter, LinkedIn, Facebook etc.) are not investment recommendation, are provided solely for informational purposes, and do not constitute an offer or solicitation to buy or sell any securities. The opinions expressed on the blog are Petar Posledovich's. Petar Posledovich does not guarantee the accuracy of the information presented on this blog and social networks. The information presented is "as is".

Petar Vladimirov Posledovich is not liable for any investment losses incurred by reading and interpreting blogposts on this blog and posts on social networks.

Conflicts of interest: I may possess some of the securities, currencies or their derivatives mentioned in the blogpost and posts on social networks(Twitter, LinkedIn etc.)!

Respectfully yours,

Petar Posledovich