VALUE INVESTING
Break The Chains

By Stephen Bland (TMFPyad)
February 4, 2000

Some musings this week on the meaning of that highly loaded word that seems to mean different things to different people - value - and the association between cost and current price that haunts many investors.

When discussing definitions I like to start with the dictionary version. Mine defines value as "the worth, desirability or utility of a thing, or the qualities on which these depend."

But that is extremely general and does not help a lot with regard to shares or other things which are traded for financial reasons. For such things of monetary consideration I have my own definition:

"Value is represented by the price someone is prepared to pay in an open market at that moment."

You can sometimes hear people selling something, claiming that it is "worth twice as much" and similar comments. Complete nonsense naturally, if it was worth twice as much then why don't they sell it for twice as much? The truth is that the value of the thing is simply whatever the person can sell it for at that time. That does not mean that it will always be that figure, but it is at that juncture. Next week a different price, or "value" may well be placed upon the item. That is quite normal. Ever tried to buy a secondhand car? The seller will place a starting price on it by comparison with similar vehicles on the market, may well haggle and settle for a lower one, depending how many other people are waiting to buy it and how desperate he is to sell. That lower price, at that second, is the car's value.

Same with shares. The value of them at that moment, and only at that moment, is therefore equivalent to the then price. It is that simple, that is all that value means in the monetary sense. You may well sell at a later date and the process will be repeated, establishing a new price, and hence a new value placed on them by the market. With value shares, I will believe they are worth more than the current value attributed by the market but that won't do me any good until the market agrees with me, if it does.

Note the critical feature of these two trades, the purchase and the sale, which I don't think is always fully understood by people who wish to trade shares in the market. If you sell your shares a year later, the price you get, that is their new instantaneous true value, is completely unrelated to what you paid a year earlier. You are entering the market with a new deal, nobody is the least bit interested in how much you paid, and the price at which you can sell will be governed entirely by the new prevailing level of supply and demand in the market for those shares and not at all by what they cost you. Worrying about how much you are going to win or lose will not change the market price – the value at that moment – but it may well prevent you from selling through fear.

The shares have acquired an entirely different value. The "moment" part of my definition of value has moved on and with it the price.

Novices must grasp this point; it is extremely important for a value investor. You must free yourself from the chains of associated value. The value of a share, any share, one second after you bought it, using my definition above, will have changed. You will have arrived at a new moment and a new value will be established. This is a really vital concept to trading shares successfully. Put simply:

There is no connection between the price value at different dates except in your own mind.

You can read often on the boards messages from readers seeking advice on when to sell or what to do when they have an investment which has risen, or perhaps fallen, substantially. Not on the value board, necessarily, but all over the Fool. If I deal with these queries my answer will usually be along the same lines. "Why did you buy it? Do the reasons still hold? If no sell, if yes hang on." An absolute judgement because whether the share is showing a profit or loss in my view is not relevant to the sell decision, and that is perhaps especially true for a dedicated value player. Well, it is for me anyway.

The problem is that these readers are comparing the purchase price with the current price. But the two are not connected except by the person in their own mind. The market, in setting the new price value, is making an absolute judgement about that share; it does not care what the investor paid for it earlier. At the point of sale, you are offered the price equivalent to the contemporary opinion of the share's value. Take it or leave it. A marvellously impersonal and totally unemotional situation which does not relate in any way whatsoever the offered selling price to the investor's original buying price. At that point, that is the share's value in the market.

Think about this with regard to the stock market, which is a pretty open place really. It swirls with rumour and gossip, but the dissemination of pure information is quite accurate, rapid and widely available, especially of course since the advent of electronic media. So we have a good open market, plenty of action, many buyers and sellers, to ensure that the price mechanism at any moment gives us the "value" by my above definition.

So how can "value" shares, my style where I believe the fundamentals are too cheap, exist? I don't have any inside information, I trade purely on what is published plus my own views: "smell", if you like. But those views are my own, I don't have any ways of obtaining information above that available to everyone else.

What I am hoping for is that the value placed upon my shares by the market when I buy, which is the value at that point, whatever I believe, will be higher later, because I anticipate that the market will decide to award those shares a higher price. But at purchase, I cannot immediately make any money, even if I think the market has got it wrong. All I could sell the shares for at that point is roughly what I paid and it is no good my shouting that they are worth twice as much. I have to wait for sufficient people to agree with me to buy the shares and thus create a higher price, a new true value. At which point I will probably decide that the new true value is too high for me and dump out quick in the contrarian style.

Say the price value, using my definition, of a share today in the market is 100. I look at it, decide it is a value share and I go in. Some time later it is 150 and I've struck lucky. Nothing has changed in the company, merely the market perception of its shares. And yet the value was 100 and now it is 150. Those figures, at the split seconds when they were quoted, were the actual values, the absolute figures, the truth. But the truths were absolute for only those moments in time.

I have little interest in the fact that the price used to be 100. I long ago learned to break free from that prison. My only question, renewed almost daily, is whether I consider the share to be still a value share to my required extent, compared with the price value put upon it by the market. I would think exactly the same way if the market decided it was worth only 50 instead of 150. Obviously I don't want to make losses, but it happens.

Understand that the price of a share, at that moment, is in fact the market's opinion of its value, not yours. It is the real value. In that sense you cannot beat it. You cannot sell for more or buy for less than the market is offering, whatever you think. Following from that, understand that the market cannot know or care what profit or loss you are showing.

Then, break the chain in your mind between cost price and current price that the market happened to award your shares at those times. It causes fear. Fear of selling too early on a rising share. Fear of taking a hit on a falling one. Exorcise the demon of associated price and let your spirit soar unchained from this. Judge only on the continuing existence or otherwise of the story that sold you the shares in the first place. Get the story right and you will win.

Comments on the value board please.