Warren Buffett, also known as the ‘Oracle of Omaha’ is a popular name in the investing world.
He is an American business magnate, investor, speaker and philanthropist who serves as the chairman and CEO of Berkshire Hathaway. Warren Buffett is considered the greatest investor of all time. As of June 2018, he is the third richest person on the world with a net worth of over $88.5 billion.
Warren Buffett was born on 30th August 1920, in Omaha, Nebraska. He made his first stock investment as an age of eleven. Later, he attended Columbia Business School as a graduate where he learned the philosophies of Value Investing through his mentor- Benjamin Graham, the father of value investing. In 1959, Warren Buffett created his Buffett Partnership after meeting Charlie Munger.
In 1962, Warren Buffett started buying stocks in a textile manufacturing firm called Berkshire Hathaway On May 10, 1965 Warren Buffett, through his investment partnership, took over the management and control of Berkshire Hathaway. Buffett’s partnership firm had accumulated about 49% of the shares of Berkshire.
As of today, Berkshire Hathaway is the third largest public company in the world, the ninth largest conglomerate by revenue and the largest financial services company by revenue in the world.
Becoming Warren Buffett – 2017 HBO Documentary
In 2017, HBO released a documentary on Becoming Warren Buffett, a co-production of HBO and Kunhardt Films; directed by Peter Kunhardt; produced by Teddy Kunhardt and George Kunhardt.
Here’s the video on how Warren Buffett became the greatest investor in the world –>
Why Warren Buffet Suggests- ‘Price is what you pay, value is what you get’?
In the 2008 letter to the Berkshire Hathaway’s shareholders, Warren Buffett wrote:
“Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” — Warren Buffett (Source)
In this post, we are going to discuss what Warren Buffett really mean by highlighting- “Price is what you pay, value is what you get” in his letter to the shareholders.
Price And Value:
Both price and value are the two sides of the same coin. Understanding the difference between price and value is the core principle of value investing.
Let’s explore the difference between price and value with the help of a simple example.
Suppose you are planning to buy a new phone and hence checking the prices of few phones on Amazon. There’s one phone that you really like- OnePlus 5T (Midnight Black 6GB RAM + 64GB memory).
Yesterday, the price of this phone on Amazon was Rs 30,599. However, today when you checked, the price has increased to Rs 32,999.
What really happened here?
With the change in the price, what can you say about the quality of the phone? Did it change overnight too? Is the phone still 6GB RAM + 64GB memory or did it increased just because the price increased from yesterday?
The quality is same. The only thing that changed is the amount of money you need to pay for it. Same value at a higher price.
Now, similar things happen in the stock price of companies. Although the quality does not change every second, however, the price does. That’s why, whenever you are purchasing any stock, you should remember that-
“Price is what you pay, and value is what you get!!”
Three types of value that you should know:
Whether you are purchasing a phone or stocks, there are three types of valuing things that you should know:
Relative value
Absolute value
Perceived value
Let’s discuss each value type one-by-one.
1. Relative value:
Relative value is the valuing how much the product is worth by comparing it with its competitors.
Here, the product or company’s worth is compared to its competitors or the other companies in the same industry.
For example, while renting flats- the landlords generally use relative valuation concept to fix the price for the flat. It’s not easy to correctly evaluate the price of rent. However, using relative value, the rent can be decided by considering what similar houses are asking for rent in the same area.
Similarly, coming back to the original example of purchasing a phone, you might use the same relative valuation approach here. You can look at the prices of different phones with the same configuration and then decide which one is selling at the best price.
The same logic applies to the share market. The valuation of the companies in the same industries can be compared. For example, the price to earnings (PE) ratio of Tata Motors can be compared to that of Ashok Leyland to find out which one is undervalued. Both of these companies are in the same automobile sector.
Nevertheless, an important point to notice here is that you should not compare just ‘two’ companies while finding an undervalued stock, instead, compare it with the industry average.
This is because while evaluating just two products, one expensive product can still be cheaper than other expensive product.
For example, iPhone 8 will definitely be cheaper than iPhone X. Does it mean that iPhone 8 is undervalued? No. If you compare it with the industry average, you can find that the iPhone is too expensive compared to similar phones with same configuration and quality.
Quick Note: I’m not criticising apple phones here. I’m a die-hard fan of Steve jobs and appreciate Apple products. Nonetheless, I accept that iPhones are expensive. Moreover, this is the best example that I come up to explain this concept 😉
Similarly, while performing a relative valuation of stocks, do not compare just two stocks, but consider the industry average.
2. Absolute value:
This is a pretty straightforward method of valuation. Absolute value aims to find how much the company is truly worth by considering its intrinsic features.
For example, in order to find the absolute value of a company, you can evaluate how many assets it own like machines, pieces of equipment, cash, buildings etc and how much liabilities (like debt) the company has. However, absolute value may be a little difficult to find as it also considers intangible assets and future cash-flows.
Anyways, once the absolute value of a company is known, you can easily find out whether is under or overvalued. If the company is trading at a market value below its intrinsic value, then it is undervalued or cheap. On the other hand, if the market value is above its intrinsic value, then the company is over-valued or expensive.
This is the third valuation method and can be considered a little dangerous. Here, the value of the object depends on what the people assign to it in mind.
The perceived value is completely unrelated to the absolute value.
For example, the value an art or painting totally depends on how much you will perceive it in your mind.
Here, it might have cost a total of just Rs 500 (absolute value) for the Artist to make it. However, some people may be ready to pay Rs 1,00,000 to buy that painting and the others might pay Rs 50,00,000. It totally depends on the perception of the buyer.
The most common example of perceived value:
Let me give you a more clear example of the perceived value that you can see in the day to day life. Let’s say you want to sell your old bike on OLX.
Now, although you can quote a price for your bike, however, the selling price will totally depend on the perception of the buyer. You might convince people to pay high, however, the bargain depends on how much the buyer wants to pay. Despite having the same quality, different people will quote a different price for your price.
Overall, the perceived value of the bike will be the price that the person will be willing to pay.
Stock price reflects perception.
The stock market also works on the perceived value. Here’s an amazing quote by Seth Klarman regarding the stock prices:
“… security prices reflect investor’s perception of reality and not necessarily reality itself.” — Seth Klarman
The Perceived value is used a lot in growth stocks, where the company is growing at a fast pace compared to its competitors and industry. That’s why investors are ready to pay a high price for those stocks.
Moreover, many a time, these perceived values of the company are influenced a lot by the analyst’s recommendations, market news or catalyst. As the underlying company remains the same, it doesn’t make much sense to overpay. Whether you pay high or low for the company, the value won’t change.
There are three types of value that every stock investor should know:
Relative value: It is the valuing how much the product is worth by comparing it with its competitors.
Absolute Value: Here the object is value based on its intrinsic features.
Perceived Value: It depends on the value assigned by the buyer in his mind.
Moreover, the stock price of a company reflects perception. Here, the price and value are different and most of the time unrelated to the share market.
Anyways, this is true only for the short run. Over the long period of time, the price will approach the value. That’s why if you have a stock when it was undervalued and have the patience to hold it for a long duration, then it certainly will reach its true value in future and give you good returns.
Final tip, do not overpay if you can get the same value at a cheaper price.
That’s all. I hope this post is useful to you. Happy Investing.
New to stocks? Want to learn how to select good stocks for long-term investment? Check out my amazing online course: HOW TO PICK WINNING PICKS? The course is currently available at a discount.
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
The Intelligent Investor by Benjamin Graham, also referred as the bible of the stock market, was originally written in 1949 by Benjamin Graham, a legendary investor and also known as the father of value investing. Ben Graham was also the mentor and professor of well-known billionaire investor, Warren Buffett.
The 2006 revised edition of the book ‘The Intelligent Investor’ has added commentary by Jason Zweig, a famous wall-street investor, and editor. These added commentaries are used to relate Graham’s idea to the present world. It highlights that the book has time-tested techniques. The book has over 600 pages (although originally around 450-500 page but the added commentaries in revised edition increased the width of the book). Overall, it’s a classic book with added quick notes.
Why You Should Read This Book:
Warren Buffett (worth over 73.1 billion dollars) says- ‘This book is by far the best book on investing ever written’. Needless to mention that this book is Warren Buffett’s all-time favorite. He also admitted that the book helped him in developing a conceptual framework for his future investments and capital allocations. Further, he made the following remarks about the book in its preface:
Investing doesn’t require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework.
Pay special attention to chapters 8 & 20.
Outstanding results are based on three things – Effort, Research, amplitudes of the market (This book will allow you to profit from them, not participate)
NOTE: If you want to buy this book, I highly recommend you to buy through Amazon at this link. It’s currently on sale here- THE INTELLIGENT INVESTOR by Benjamin Graham
The Intelligent Investor by Benjamin Graham book has many valuable concepts and a must read for all the stock market investors. The first few chapters of the book are dedicated to the general concepts of the market. As the book was originally written in 1949, the book also consists of lots of details about the bonds, preferred stocks & inflation.
The next few chapters describe the methods to analyze stocks using ratios, balance sheet, cash flow etc. The second half of the book is of more importance for the stock investors as it explains the different strategies of the defensive & enterprising investors, along with chapters on management, dividend policy, and case studies.
Although there are lots of proven concepts covered in the book, however, the key three points in the book- the intelligent investor by Benjamin Graham is summarized here:
1. Investing vs. Speculating:
“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” – Benjamin Graham
Let’s understand this concept with the help of an example. Imagine you are planning to buy a printing press. Now, to buy this company you can use two approaches.
First, you visited the company, calculated the asset value of the printing shops, checked the total income and cash flow of the company, verified the effectiveness of the managers, calculated the total assets & liabilities and then lastly come up with a final price for the printing company.
The second approach is that you met with the owner and decided to pay the price whatever he is asking for.
From the example, we can establish the difference between an investor and a speculator. The Investor follows the first approach while the speculator follows the other. Here is the key difference between these two:
Investor
Speculator
Goes through proper analysis
Does not meet these standards.
Considers the safety of principle
——–
Gets adequate returns
——–
Here is the quote about Speculators by Benjamin Graham:
2. The margin of Safety:
This is another one of the pronounced concept introduced by Benjamin Franklin. He says that one should always invest with a margin of safety. Let us understand this by an example.
Imagine you are in a construction business. You took an order to make a bridge, which can hold up to 8 tons. Now, as a constructor, you might consider making the bridge with an additional 2 tons of holding capacity so that it will not collapse in some extraordinary situation. Overall, you will make the bridge with a total of 10 tons of holding capacity.
Here, your additional 2 tons is the margin of safety.
In the same way, while investing we should consider this margin of safety. It is the central concept of value investing. If you think a stock is valued at Rs 100 per share (fairly), there is no harm in giving yourself some benefit of the doubt that you may be wrong with this calculation. And hence, you should buy at Rs 70, Rs 80 or Rs 90 instead of Rs 100. Here, the difference in the calculated amount and your final price is your margin of safety.
Here is the quote about the importance of margin of safety by Benjamin Graham:
3. Mr. Market
In the book ‘The Intelligent Investor’, Graham tells a story about a man he calls Mr. Market. In the story, Mr. Market is a business partner of yours (Investors). Every day Mr. Market comes to your door and offers to either buy your stake of the partnership or sell you his stake to you.
But here’s the catch: Mr. Market is an emotional man who lets his enthusiasm and despair affect the price he is willing to buy/sell shares on any given day. Because of this, on some days he’ll come to the door feeling jubilant and will offer you a high price for your share of the business and demand a similarly high price if you want to buy his. On other days, Mr. Market will be inconsolably depressed and will be willing to sell you his stake for a very low price, but will also only give you the same lowball offer if you want to sell your stake.
On any given day, you can obviously buy or sell to Mr. Market. But, you also have the option of completely ignoring him i.e. you don’t need to trade at all with Mr. Market. If you do ignore him, he never holds it against you and always comes back the following day.
The intelligent investor will attempt to take advantage of Mr. Market by buying low and selling high. There is no need to feel guilty for ripping off Mr. Market; after all, he is setting the price. As an intelligent investor, you are doing business with him only when it’s to your advantage. That’s all.
The key point to note here is that though Mr. Market offers some great deals from time to time. Investors just have to remain alert and ready when the offers come up.
Now, like Mr. Market, the stock market also behaves in the same manner. The market swings give an intelligent investor the opportunities to buy low and sell high. Every day we can pull up quotes for various stocks or for the entire market as a whole. If you think the prices are low in relation to value, you can buy. If you think prices are high in relation to value, you can sell. Lastly, if prices fall somewhere in the grey area in between, you’re never forced to do either.Mr. Market and Stock Market:
So, this is a value-oriented disciplined investing. Don’t fall victim to irrational exuberance if the underlying fundamentals of the company are strong. In short, do not react to the hyperboles of the market’s daily fluctuations. Don’t panic, don’t sell.
Other key points from the book The Intelligent Investor by Benjamin Graham on the Investor and market fluctuations:
A common stock portfolio is certain to fluctuate over any period of time. The investor should be prepared financially and psychologically for this fluctuation. Investors might want to make a profit from market level changes. But this can lead to speculative attitudes and activities which can be dangerous. Anyways, if you want to speculate do so with eyes open, and knowledge that you will probably lose money in the end.
Graham’s Opinion on aggressive investing: The low probability of aggressive picks will out-weigh the gains collected over a long period of time. ‘The aggressive investor will expect to fare better than his passive equivalent, but his results may well be worse.’
That’s all. I hope this post about the ‘The Intelligent Investor Summary & Book Review’ is helpful to you. I will highly recommend you to get a copy of this book and start reading. There are many valuable concepts by Benjamin Graham that new and old stock investors should learn.
If you need any further help with the book or have any doubts- feel free to comment below. I will be happy to help you. Happy Investing!
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
