The Difference Between Price & Value For Investors
By Jerry Fetta
As I write this article we are currently experiencing the biggest price bubble in United States history. What is a bubble? Well it’s simple really. A bubble is when prices are “inflated” beyond a capacity that can be supported by the underlying assets and at a point of critical inflation will “pop” and correct down to or below a price that is actually supported.
To understand a bubble we have to understand a trading concept called “Intrinsic Value” and “Extrinsic Value”.
Intrinsic Value is like a threshold of price level that is supported either by earnings or underlying, natural value. It is very objective because it can be easily measured and calculated.
Extrinsic value is an amount of price beyond that threshold. This is called extrinsic because the “value” is not substantiated and is rather created by market hype, demand, and trading volume. It’s much like a shadow. It isn’t the actual object, but a shadow casting off the actual object. And it’s important to know the difference between the object and it’s shadow because they aren’t the same thing at all.
Well right now, almost every asset out there is trading at a price based on its shadow. Not on the asset itself. This means that the more money that goes into investing into the shadow of the asset, it either provide no actual value for the shadow investors because they are technically paying for nothing or it provides value to the shadow investor by diluting the value of the owners of the actual asset.
Lets take a house for example. A house has a definite and finite value. A pool of investors could combine their money and buy that house and be able to take advantage of the value it has to offer. Shelter, rent, aesthetics, comfort, etc. These can all be reasonably shared by a small pool of people sharing ownership of the house.
But let’s say Wall Street gets ahold of the house and begins to promote it as an investment and they get dozens of people to invest in it. Well first, at a certain point more money will be invested in the house than it’s actually worth. This is price and value. The predictable byproduct of this is that it will drive the “cost” (not value) of the house up and the cost of the houses surrounding it in the neighborhood.
But is the house actually more valuable?
Let’s take a look.
For starters, we have to realize that either the original investors own the property and the new investors don’t actually get anything for their money other than the right to say they invested in the house. Or the alternative being that the ownership of the original investors is diluted by the new investors and now everyone including the new investors own a very small part of the house. This is less valuable to everyone. Imagine dozens of people trying to share a 4 bedroom house and each of those people owning a few square feet. Not a single person would actually get full use of the house and this would make the house less useful and less enjoyable.
Secondly, the factors that create underlying value haven’t increase along with the price. The price rising on this house didn’t suddenly cause it to provide more shelter, rent, aesthetics, comfort, etc. than it did before. So the new price isn’t supported by what the house provides or by what the owners get.
You wouldn’t buy a 4 bedroom house with several dozen investors at a price that is higher than is supported and I wouldn’t either because we know it’s a bad deal.
But then why do we do it with stocks? Why do we do it with crypto tokens (yes I refuse to call it “currency” because it has no use case as one)? Why do we do it with houses we own for ourselves by ourselves?
I’ve spent years trying to figure this out and I think on the surface it is impulse and fear of missing out. Everyone’s doing it. So and so made money off it. Take a risk. Bet on yourself (well really you’re betting on an overpriced, undervalued asset but we’ll leave that alone for now).
But what underlies the impulsive decision to invest in a bubble? I think that most people truly don’t understand the difference between price and value. I believe the financial system has tried to remove this from our minds so that we cannot differentiate between the two and begin to think that price is value. It’s an interesting thing because when someone does this, they then have to logically justify their emotional decision to buy this overpriced thing and they will do so by incessantly and often unsolicited-ly telling themselves others around them why it’s so valuable, why everyone else should be doing it too, and why you’re dumb if you don’t. This is the creation of the social media comment cowboy investment and crypto experts. They must defend their decision or they lose and they can’t lose because they don’t know how to reproduce they money they’ve placed into these overpriced assets.
So let me simplify this. Price is what you pay.
Value is what you get.
We have actually had this discussion in previous articles but I want to come back to it.
If I sell you a car for $20,000 and you get it home and find out it doesn’t work, you’d be angry with me. Why? Because you overpaid and I overcharged. What you paid was a lot more than what you got. Price exceeded value. Now if I did that enough times with crappy cars I would actually cause the market price of crappy cars to increase as a whole even though the cars weren’t worth anything.
But let’s say I sell you the same car for $20,000 and you get it home and find out it had a GPS I didn’t know about, a turbo booster, and after market custom rims and that the car was actually worth closer to $30,000. You’d be happy and I’d be upset because you paid less than the car was worth and I sold it for less than I could have.
These are examples of the difference between price and value and it exists with all objects and assets.
Now in the first example, the only reason a person would pay $20,000 for a car that was worth substantially less is because they were dumb enough to be taken advantage of by a car salesman.
In the second example, the only reason a person would pay $20,000 for a car that was worth $30,000 is because the buyer is actually smarter than the seller and knows exactly what he’s looking at.
In this facet, we can also draw comparison to investing. Someone who overpays for undervalued assets is dumber than the seller. Period.
Someone who underpays for high value assets is smarter than the seller. Period.
Well in this case of digital tokens, stocks, and other bubble category assets the sellers are Wall Street, investment banks, billionaires, and others in the same group. These people are smarter than Joe Sixpack on Facebook who is dabbling because he thinks he might strike it rich. Well we have to follow logic here and logic says Wall Street and investment banks are smarter than Joe. So in this case the seller is smarter, which means Joe is overpaying.
My point? Always be smarter than the seller and if you’re not, don’t buy. And if you don’t know who the dominant sellers are, don’t buy because you can’t tell if you’re smarter than them. Because if they’re smarter than you, you will be the one over paying.
The tragedy tied to this can be summed up by one of my favorite quotes by Warren Buffett.
“It’s only when the tide goes out that you learn who’s been swimming naked.”
And until then, the naked folks are going to keep acting like they aren’t naked simply because they water covers them enough to lie to us and themselves.
Remember, you’re only as financially right as you are financially free.
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To Purpose, Wealth, and Freedom.
Jerry Fetta is the CEO and Founder of Wealth DynamX. He is a nationally recognized financial expert featured in Forbes, Yahoo Finance, Fox, Chicago Weekly News, New York Finance and other publications with dozens of features on popular podcasts, earning endorsements and affiliations throughout his career with names like Grant Cardone, Dave Ramsey, and Pamela Yellen. Jerry’s mission in life is to help create millions of financially educated and solvent families achieving greater financial freedom and sharing the truth about money with their communities around them. Learn more at www.WealthDynamX.com