In his Q2 2022 letter to shareholders, Bruce Flatt explains why Price and Value are rarely the same, and why this often creates opportunity. Here’s an excerpt from the letter:
At junctures where stock markets trade off significantly, it is worth repeating why value investing is a proven way to achieve long-term success. Buying, building, and holding great businesses, with great people, in great places, for long periods of time, is the source of long-term investment success.
Value investing is, in essence, the arbitrage between “Price” and “Value”. The goal of the value investor is to arbitrage price differentials between the Price for assets, whether that be in the public or private markets, and the true intrinsic Value of those assets. And while it’s simple to understand in concept, it takes years to develop the discipline, patience and judgment required to successfully implement a value investing strategy.
We are great believers that over the longer term, the Price of a security will gravitate toward its Value. However, in the short term, for many reasons, Price often does not equal Value. Investors in the stock market, of course, have a daily mechanism allowing them to know the quoted Price of each asset. Price is more difficult to ascertain in the private markets—particularly during periods of market volatility—and it can be well above or well below the long-term Value.
Assets prices are usually dependent on the supply of and demand for capital, which in turn is heavily influenced by investor sentiment. In robust markets, there is generally more capital than there are assets. This forces Price higher, even to the point where it far exceeds Value. There is no doubt that, in hindsight, this described many technology and “growth” stocks in 2020/2021. On the other hand, in stressed markets, if a sale has to be made, the Price received for an asset can be far below its Value. We are starting to see some of these situations emerge.
In summary, Price is often influenced by the news of the day, market sentiment, the availability of capital, and other factors that may or may not have any relevance to the Value of a specific security.
Value, on the other hand, is the net present value of the future cash flows of a business or asset, based on assumptions for future growth and discounted at the appropriate rate for that particular investment strategy. The difficulty in ascertaining Value is that there is no absolute value for anything, so there will always be a wide range of views over an asset’s growth profile, profitability, and the appropriate discount rate. The experience and discipline we have in determining these Value factors for assets and businesses are key attributes of our franchise.
You can read the entire letter here:
Bruce Flatt Q2 2022 Letter to Shareholders
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