Here is a taste of what I will be discussing. I have selected one of my favorite quotes by Warren Buffett regarding price and value. The following is how I interpret his quote. Note that purchasing individual stocks without tens of hours of research and a solid understanding of accounting and finance is difficult to say the least. I do not recommend that beginning or intermediate level investors purchase individual securities. Hope you enjoy my comments:
Intrinsic value and margin of safety are the cornerstones and/or hallmark of Warren Buffett. As Buffett has mentioned, three of his favorite and most influential works are as follows: John Burr Williams’ doctoral dissertation on the calculation of the present value of any financial instrument, Ben Graham’s margin of safety concept and relating stock price to the actual value of a company in Security Analysis, and Philip Fisher’s concept of long-term/sustainable/reliable profits in Common Stocks and Uncommon Profits. Those works provided the foundation and key underpinnings for his view on the importance on price.
I guess I would argue that any individual that purchases stocks realizes that price is important. Buy low/sell high (sell high/buy low when shorting a stock). I do not think I have ever heard a commentator or guest on CNBC, Bloomberg, or read an article in the Wall Street Journal, Barron’s, the Economist, or the Financial Times where someone would say that price is not important. Some may believe that during Bubbles people tend to just buy stocks if they are going up in price and pile in blindly. However, Buffett’s comment that price is important actually is the first part of his statement. Buffett says that “price is what you pay and value is what you get”.
What does Buffett mean by this? Again, I am just going off what he has said at annual meetings and written in annual letters to shareholders. Buffett tells everyone that the stock market is there to serve you and not instruct you. The stock market provides a quote every day for company shares by the famous Mr. Market who is willing to allow you to buy/sell shares. Buffett only buys shares when he believe that he gets more value, and the disconnect between the stock price and value is quite significant when compared to the probability in the likely rise of the stock over time (i.e. lower price). Thus, Buffett does not view shares in stocks as pieces of paper; rather, he views them as ownership interests in a company. That company has value……otherwise known as intrinsic value.
Ben Graham, Buffett’s mentor at Columbia and in his first analyst position, defined the difference between investors and speculators. Investors are buying shares because of their belief regarding the value of the underlying company (now that can be a value, growth, relative value, GARP, or other strategy). A speculator buys pieces of paper because the price pattern of a stock provides guidance on purchasing. The value of the company really has nothing to do with it. Earnings, revenues, gross margins, operating margins, market share and other factors do not matter. That is the heart of technical analysis. Now the natural argument would be that no one uses technical analysis alone. However, trying to blend technical and fundamental analysis, really is an exercise in understanding market psychology and being able to make short term purchases (note I did not use the term investments). There are very few individuals that I have known that use technical analysis as a guide to buying stocks for the long-run as Buffett’s holding period would be.
Reference article for more information and tie to Buffett’s usage of the quote: