Price and Value are two different things – just ask Canva investors
With the share prices of tech stocks having cratered in recent months, there are perhaps few more opportune times than now to revisit the important difference between Price and Value. It may surprise investors that every business has a real worth or a true value that may bear no resemblance to the currently traded price.
Witness for example, the recent news that U.S. investment giant Franklin Templeton, T. Rowe Price and Capital Group have slashed the value of their stake in unlisted graphic design platform provider Canva. With operating revenues of US$1 billion, institutional funds had tipped money into the tech ‘unicorn’ valuing the business at US$40 billion in September 2021.
With listed tech companies like Zoom Video falling 81 per cent from recent highs, and with Pinterest down 77 per cent, Lyft 77 per cent off its high and Netflix, Facebook (Meta) and Amazon also down, it makes perfect sense that private equity investors face the reality of falling market prices.
As an aside, many investors including Australia’s Future Fund have invested heavily in private equity funds, and directly, encouraged by the fallacy that the less frequent marking-to-market of valuations would enable them to post better performance numbers than their pure equity or bond market peers.
Interest rates act like gravity
The reality however is rising interest rates act like gravity on the value of all assets. The fall in the value of listed businesses should not be unique to listed entities. Just because a group of people sit around a room and agree on a valuation at which they will tip money into an unlisted business does not mean that is the value of that business.
And so we arrive at the point where an explanation of the difference in price and value is required.
What is any asset worth? What is a plot of land worth? What is a business worth or a share a company? Any asset, what is it worth?
You will have often heard the axiom “It’s worth what someone will pay for it”, or ‘It’s worth what you can get for it.”
That axiom is in fact incorrect. Price is what someone will pay. Value or worth, is something entirely different.
In the 2009 Berkshire Hathaway Annual Report, Warren Buffett wrote; “Long ago, Ben Graham taught me that ‘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 at an insane or unexpected price, observers will grumble; “It’s not worth that!”
We intrinsically understand that value and price are two different things.
Is the tech company Canva, generating one billion US dollars of revenue, worth US$40 billion? Of course not. Few businesses, if any, are worth 40 times revenue. Forty billion US dollars was what someone was prepared to pay but that price is not what Canva is worth.
In the stock market, efficiency is frequently observable, but the market is not always efficient. It doesn’t always correctly evaluate a company’s worth. This is because all the information about a company isn’t disseminated evenly, equitably or even quickly, and the individuals responding to that information are not always rational. Therefore, the share price cannot always reflect the true value of the underlying business.
Of course, the inefficiency, which produces volatility, provides investors, often those with a longer investment horizon, the opportunity to make outsized returns.
Importantly and thankfully, however, while a company may be popular or unpopular in the short term, the market does eventually get it right. Over time the price tends to converge with the true value of a company.
Those two facts means that you can take advantage of the market’s irrationality in the short term to be rewarded in the long term.
Buffett once said, predicting rain doesn’t count, building arks does. I am deliberately borrowing the phrase for a use for which it wasn’t intended, but it nevertheless fits. Predicting the share price is impossible, at least in the short term. Intrinsic value is the vessel that helps navigate the sometimes-tempestuous changes in share prices.
If you know the intrinsic value of a company, you can navigate clearly through the thunder and high seas, the gloom and the hype. Your share portfolio may still be buffeted around by the twin tides of fashion and sentiment, but with each rise and fall you are able to strengthen it, buying more below intrinsic value and perhaps selling when share prices are well above.
Suppose you have your eye on a company and its shares fall from $15 to $8. Should you buy now? What if you buy at $8 and the shares fall to $6? Suppose you decide to buy more. What if they then decline even further to $5 or even $3? When exactly do you buy?
Only if you are confident that the business is actually worth $8 per share, are you able to see a fall in the share price – from $15.00 to $8.00, for example – for what it is: a terrific opportunity. The right response is to buy more. If you’re like me and you like chocolate, then surely it is rational to order more when your favourite block is on ‘special’ at the supermarket? It’s the same with shares.
Treat buying shares the same way you buy groceries
You actually want the share price to go down so that you can buy more. Share price declines, particularly those that are produced when everyone around you sees only doom and gloom ahead, are precisely what you want.
The challenging part of investing isn’t identifying good businesses that you would like to own. The challenging part is knowing when to buy, while the prices of all these companies are gyrating amid noise and influences that may or may not ever impact their businesses.
Nobody should miss out on buying shares in great businesses because of the fear that the shares will go down even more. And there is no need to panic and sell at depressed prices either. But such rational behaviour requires you to have something other than the price to look at. You need to know the value of the business and its shares.
As Canva investors are now discovering, and as other Private Equity investors are hoping to avoid but cannot, what someone was willing to pay for a business last year may not have equated to what it was worth. And as the price investors are willing to pay today plummets, the difference between price and value is now plain to see.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Wesley Horn
:
Roger
I really would be interested in your take on Macquarie Telecom Group. This is a company, by almost any measure, with a set of very ordinary financials. And yet if you’d bought it 10 – 15 years ago, say, you’d be feeling pretty good. Why do you think a company like this has defied traditional analysis/valuation? It would seem it should be in the doldrums, but is holding up remarkably well. Thanks for any feedback.
Wes.
Roger Montgomery
:
Hey Wesley it has been a holding in the Montgomery Small Companies Fund since Day 1. We know it well and believe it is more valuable than the current price. You can read about it here at the blog. Use the search bar and type Macquarie Telecom and you will see why.
Wesley Horn
:
Hello Roger
I’m a believer in the price/value argument. Having said that, if you consult different sources they generally come up with different valuations. Of course, you have described your method of valuation. If we looked to five sources, say, and their valuations vary widely, how do we rationalise that?
As a long term investor another point I wrestle with is having identified what I believe is a quality company, at what point do I buy? If this company appears way overvalued because of a raging bull market, do we necessarily sit and tough it out, believing there will come a point at which it will fall and become undervalued – a process that might take years of patience to play out? CSL is a company that for many years always seemed to be overvalued. If you had sat on the sidelines (I missed it) waiting, you missed one of the best ever opportunities. Has it ever become undervalued? I think some fast-growing companies that become winners actually grow into their valuations eventually. More than anything the state of the market dictates under and overvaluation.
Patience is the hardest aspect of investing. The current market bears this out. With the benefit of hindsight, the market was getting very speculative before the recent fall. It was not the time to be putting more money into the market, but when the market is going up this is difficult to resist. Even if the market hasn’t bottomed, now is a far better time to be buying.
I’m looking for insight about timing buying into great opportunities. I suppose the best way to do it is to apply an accumulation process, rather than trying to time it perfectly, even if a company might appear a bit overvalued. Summing up, I don’t always believe you can wait for undervaluation to arrive, otherwise you miss opportunities, e.g. CSL. Your thoughts?
Wes.
Roger Montgomery
:
Regarding your question: “As a long term investor another point I wrestle with is having identified what I believe is a quality company, at what point do I buy? If this company appears way overvalued because of a raging bull market, do we necessarily sit and tough it out, believing there will come a point at which it will fall and become undervalued – a process that might take years of patience to play out?” Yes, I believe that is what the old version of Warren Buffett would do, and still appears to do from time to time. remenbre valuation is very much about the inputs you use. What makes a company’s intrinsic value grow is its earninsg growing faster than expected. Find a quality company doin that and you might not need to be too conservative with some of your inouts. Agree that patienceis the hardest part. Success requires intelligence and the right temperament. Patience comes under ‘temperament’. Dollar cost averaging can work a treat but if the value and quality are slapping you in the face, it might be worth swinging.