Some of the grandmasters in investing have always taught us that the price and value of an asset are 2 fundamentally different things. Value is something that can be calculated, for example with the Discounted Cashflow Model (DCM), and the price is based on supply and demand.
This is also what we use to determine our investments. Whether a stock is undervalued or not, and is fundamentally sound. And moreover, if the value would be higher than the price being paid for it.
But there are also other theories, which state that the value is equal to price. Like when the value of an asset is based on the price that others are willing to pay. Or as Oskar Morgenstern says it:
“A thing is only worth what someone else will pay for it.”
What’s the deal on this?
A little background story
Mr. Divnomics follows an education in financial service management. Last week he had a class in wealth management? When he got home that day, we tried to answer this question: what’s the difference between value and price?
Why? Because of a discussion started on this subject in his class, the teacher asked him to ground his statement on how value and price are two different elements. On a side note, I love when a teacher can build up these discussions. We even talked about for about an hour that night at home!
This discussion was ignited by this lesson about value and price being the same thing. And of course, my other half did not agree. He was the only one in the class to challenge this idea and made arguments for another view on the matter. The others were not to be convinced and the outcome was that Mr. Divnomics had to come with better arguments. So, what’s the deal with that? Is there something we overlooked, not heard about or is there a different theory we just don’t follow? Is it just a matter of interpretation or is there only one way possible?
We were put to doubt when we thought of multiple situations where price and value were both subject to a transaction or correlated to an asset. Like,
- If you want to sell your house and an assessor initially values it at 300.000 euro, and in the end, you agree to a sale on 280.000 euro. What is the value of the house? Is that still the 300.000 or the 280.000 you got for it?
- You scrutinize a stock and notice various analysts that shed their light on the same company and valued the stock ranging from 120 to 150. Your own expectation (using the Dividend Discount Model) is around 135. The price at that moment is 115 euro. Again, what is the value of the stock?
- How can you determine the value of art? Is it the same as an expert’s taxation, or what others are willing to pay for it?What if you notice a piece of art and think of how much it should be worth. And you only see some red, yellow and blue areas on the white canvas. Another buyer would want to buy it for 10.000 euro. It seems to be a rare piece. What’s the value of the painting?
And what if you’d know who painted it?
Then we thought of the following. Are price and value viewed differently depending on the underlying asset? Could price and value be the same for a painting or a house? And might it be different for a financial asset, like a stock?
In order to come back to the class in 3,5 weeks time, we have to come back with some proven argument to not only convince Mr. Divnomics classmates but his teacher as well. And what better way to ask you, dear money enthusiasts, for your opinion?
So, I want to ask you the same question:
Is there a difference between value and price? What do you think?