How Value and Price Are The Same, Yet Entirely Different…

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A few weeks ago a question about value and price that Mr. Divnomics had in one of his classes set off an interesting discussion. We talked about this subject and questioned ourselves if value and price were actually the same things. Or are based on different kinds of fundamentals. The outcome of that class was that price and value were the same things, which we both disagreed on. His teacher loved the discussion going forward and had planned a new discussion on the next class with some upfront preparation.

In order to get some more thoughts and opinions on this topic, I wrote a blog post on our thoughts of the matter. And there were great replies that made us think about our view towards value and price.

Last weekend the second class took place, and another discussion with the group got to a very interesting conclusion.

A quick look back

The discussion started with the class Wealth Management Mr. Divnomics is following. They asked the question if price and value were the same. The whole class answered with yes, except for my lovely boyfriend of course. At home, we talked about the subject some more and came to the conclusion that price and value are often seen as the same concept, but we had some thoughts that spoke against it. Like when you sell a home, the price you get can ultimately be different than the value the real estate agent had calculated for it. To be clear, there are different types of value to be found. In this article, I’m talking about market value.

I wrote a blog post about our thoughts on the matter, in the hopes gaining more insights from readers how they looked at it. And we searched online to get more info on the matter. So, when the next class was attended he would be more prepared to answer.

Reader thoughts

Based on the comments, most of you were on the same page: Price and Value are mostly the same. Most of you stated that when you buy something for a certain price, this also determines the value of the underlying asset. With one difference: the definition of value is adherent to the perception of the one that is given value to an asset. Or as Full Time Finance said:

The issue is, value is relative. Every person has a different value for something and your value and thus the price your willing to pay may be different than someone else.However, there is an aspect that price in the market is determined by the intersection of the supply and demand curve. This means the price something sells at is usually the aggregate of the market’s view of value, rather than your individual value. That’s where the difference lies.

And Michiel mentioned something else that was very interesting: the water-diamond paradox.

It’s also known as the paradox of value and is the apparent contradiction that, although water is, on the whole, more useful, in terms of survival than diamonds, diamonds command a higher price in the market. – according to Wikipedia

Once that was explained by Smith, the founder of this principle, that the value of an asset was determined by the amount of labor that was needed to acquire it. Water, for example, is very easy to come by, whereas diamonds are very rare and not more labor in order to get a hold on. The paradox lies in the explanation that water has a high value in use, many people need it to survive. And diamonds has a low value in use, but a high value in exchange. People are willing to open up their wallet for it.

Price in this view was correlated to the labor that was needed. On the other hand, in the more mainstream economics people explain value as determined by the view of the consumer, if the demand is higher the value will increase accordingly.

Further insights on Value and Price

In the financial industry, you have different theories that claim either to be one side or the other when it comes to price and value. The first is that price and value are equal, and the other claims they’re not. One of these theories is called the castles in the air theory. Burton G. Malkiel mentions these approach on value in his book, A Random Walk Down Wall Street, and explains them like this:

Castles in the air

The castle in the air theory of investing concentrates on psychic values. John Mayard Keynes, a famous economist was of the opinion that professional investors prefer to devote their energies not to estimating intrinsic values, but rather to analyze how the crowd of investors is likely to behave in the future. And how during periods of optimism they tend to build their hopes into castles in the air.”

In other words. People tend to valuate an asset based on how others perceive it. For instance, when you have to value art. You don’t valuate that painting based on how much effort (labor) it took the artists, rather than you anticipate on how the public will react to it. If you think the common people will perceive the painting as a masterpiece, you will give a high value. And the other way around. It all depends on what the fool is willing to pay for it.

Oskar Morgenstern argued even that searching for intrinsic value was nothing more than an illusion and impossible to catch. The value of an asset if determined by an actual transition, or:

Res tantum valet quantum vend potest – A thing is only worth what someone else will pay for it.

For a while now we are following the online lessons of Aswath Damodaran on Youtube, a professor in corporate finance and valuation at the Stern School of Business in New York. In one of his video’s, he’s getting to the core of price and value.

He’s claiming that many are using the terms value and price interchangeable. Which is only possible when markets are behaving in an efficient manner. And we all know, markets aren’t in any way behaving efficiently and actually do make mistakes, a lot.

Concluding

Basically, there are two types of valuation, intrinsic and fundamental. Where intrinsic value is a function of the expected cash flow, future growth, and possible risk. The fundamental value is about the intersection of supply and demand.

Price, however, is not the same as value. This was eventually the same outcome of the class Mr. Divnomics attended last weekend. The discussion began with the statement that price and value were the same things, concerned with market conditions. This is because markets don’t work efficiently.

So, the conclusion of that lesson was that price and value are the same when markets behave efficiently. But because markets do not behave like that, price and value can differ. However, the calculation of value is always subjective.

16 thoughts on “How Value and Price Are The Same, Yet Entirely Different…

  1. Where things get interesting is with the question of value being subjective. Is an over priced market inefficient or is the over priced market so because your seeing the value through the lens of a different time. If we look at Schiller’s concepts of bubbles the problem rears its head. It’s only possible to tell there was a bubble for sure after it occurs. So was it incorrectly valued or did the value change? Philosophy starts to intersect with economics.

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    • Interesting view. I aways included that the market was inefficient because it was based on human behavior. It’s true that a bubble is only known after it has happened. The value can change, but simultaneously it can still be incorrect.

      Like the thought of adding philosophy into the discussion 🙂

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  2. Hello mr and mrs Divnomics,

    I’m glad I met you both at the Bloggers Meet-up yesterday. Your presentation really made me think about the cultural acceptance of the concept FI in the dutch community. Good job! And i’m happy i’m now aware of your blog. I’m looking forward to reading your posts. From what I’ve read so far, it great quality writing.

    I didn’t have time to say goodbye to you because I lost track of time. But I really enjoyed myself.

    Thank you both for the interesting conversations and sharing your thoughts. Looking forward to meeting you again in the future. Good luck with your real estate adventures this year!

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    • Hi there, Gelddromer. Same here, we really enjoyed meeting and talking with you. Glad to hear that we were able to provide some food for thought. It’s really nice to know more of the Dutch bloggers in the community (who actually write in Dutch) including yours. Will definitely follow along on your stories.

      We will probably see each other on the next meet-up! Thanks for the kind words 🙂

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  3. One extra thought that came to my mind: the value can be different for each of us.

    Imagine a company A wanting to buy company B. Depending on the synergies they see, they can put a whole other value on it that company C that also wants to buy company B. Reasons could be extension of the business model or geography, synergies by reducing it costs, more buying power.

    Look at amazon: they paid 27 pct above the market price. they clearly see a great value in the company

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    • True. But isn’t it that the calculation method will be the same, only the outcome is different? As for future growth, possible risks, and cash flows? This is a really good example that shows that value is subjective.

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      • The outcome will be different because the assumptions will be different. A might have in mind to move the clients to its own platform where C might think to use the company to diversify. That could lead to a different underlying assumptions on running costs and thus profit.

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      • You are right that the motivations and further plans can change the perception on price by the one that tries to take over the company.

        The running costs you mention are based on a future situation and possible outcome. Isn’t it so that the current value will be based on the actual running costs at that moment?

        Isn’t so that you have a value based on specific metrics and a perception on how to look at those metrics. Whereas the eventual take over price will be including the possible profit when comapny process will be adjusted?

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      • I do think that a company looks at the I tegration cost and post integration cash flows when they assess the value.

        It is fun to discuss,in reality I have never done such an exercise

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  4. Had to read this post twice (it is Monday morning after all) before it sank in a bit. Interesting stuff!
    P.s. was very nice seeing and talking to you guys again last Saturday during the meet up!

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  5. Hey Divnomics,

    interesting articles, tx for sharing your thoughts.- in my opinion price and value are definitely not the same.
    Marekt-Price is determined by so many pschycological and other factors (fear, greed, euphoria, panic etc etc) that it can be very different than the underlying value. I think it was Buffett who said: “price is what you pay, value is what you get”. I agree that by valueing a business / stock some subjective components are involved, but it can be done more efficient and without emotions.
    If you look for example at the biotech bubble or the tech bubble around 1999-2000 where some stocks had astronomical P/E, had no real business model, didn’t earn a dollar, but had a market cap of billions. Or on the contrary the financial crisis in 2008/2009 where the market price of rock solid companys went down 40-50% although the underlying business was highly profitable and the even raised their dividends. – Mr. Market set prices, but the value was different in that time span…later Mr. Market corrected the prices, a lot biotechs and techs came down to earth, some vanished and after 2008/2009 the solid companys rebounded. It illustrates that price and value can differ.

    Kind Regards,
    DividendSolutions

    Like

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