Wise words from wise men are easy to find. Especially in the age we live in, when advice can be found at the click of a button. But what’s interesting is that a lot of investors choose to ignore or simply pass over advice from great investors. Warren Buffett is one such great investor. Known as the “oracle of Omaha” due to his powers of prediction when it comes to stock performance, he’s been an incredible investor for many decades. Along the way, he has shared various great pieces of advice. One of these quotes is what’s helped me during the year so far.
Know the difference between price and value
The above is the gist of the expression. The exact advice from Warren Buffett is “price is what you pay. Value is what you get”. What he’s referring to is that often there’s a difference between the two things. The price of a stock is dictated by market forces. If there are more buyers than sellers, the share price will rise. This doesn’t actually change the intrinsic value of the company. For example, a business may register a net asset value of £1bn. Yet the market capitalisation of the company (the number of shares x the share price) might be £1.5bn. The value is currently less than the price you paid for it.
Now, buying a stock that could be seen as overvalued isn’t always a bad thing. Technology companies are a classic example of a sector that has little intrinsic value to begin with (and might make losses for several years). Yet the future potential for large profits makes investors place a high value on the share price.
During the stock market crash of 2020, some stocks weren’t overvalued but undervalued! CEOs saw share prices drop 50% as investors sold out, fearing the worst. This provided long-term disconnects between the price and the value of some FTSE 100 and FTSE 250 businesses. Knowing this difference has helped me, and other investors, to gain by taking Warren Buffett’s advice.
Taking Buffett’s advice has helped me buy into oversold firms and put them into my Stocks and Shares ISA. The ISA is a great tool for private investors like me. It allows me to invest up to £20,000 this year without incurring capital gains tax on the profits. This is great at any time, but especially now, when I’m trying to buy up cheap firms with large potential share price gains.
As an investor, if I can buy a stock that has a low price but a high value during the stock market crash, I’m outperforming. In the long term, the price and value should return to a more balanced level. This should see the share price rally. But by taking Buffett’s advice and seeing the difference between price and value, I can also steer clear of some stocks. Not all stocks are good buys at the moment! Some good examples our team likes at the moment can be found here.
So by doing your homework, and heeding Warren Buffett’s advice, you can hopefully outperform benchmarks too during the current stock market crash.
Jonathan Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.