Mike:
I don't understand the distinction you're making between pricing and valuation methods. Please clarify.
I will try. An analogy springs to mind that might help. Or it might confuse me. :-)
Imagine that I had a box, which we will assume to be itself totally worthless. Let's assume that in private, I emptied the contents of my wallet into the box and sealed the box. What is the box (with contents) now worth? I would say that its value is equal to the amount of cash I emptied into it.
How could you determine the value of the box? Here are a few ways that jump to mind. You could open it up and count the money. If you trusted me (and my memory), you could ask me how much money I dumped into it. If you were of a scientific bent, you might use some kind of imaging method to "see" inside the box. These would all be valuation methods.
But maybe, being a gambling man, you would try to sell the box without knowing or having a good guess how much money is in it. Knowing something of the dynamics of crowds, you decide to hold an auction. So people who know me gather round, people who know you gather round, and the GGers gather round to bid. Some people think "Pirah is cheap" or "he never carries cash!" and they don't bid much. Others think "Pirah is just crazy enough to throw in a pile" and they are willing to bid more. Finally you sell to the highest bidder for the price of $X, and the box is torn apart with great excitement to find $Y inside. What was the value of the box, $X or $Y?
Watching this, another GGer decides "hey, we could do this weekly, maybe charge people to participate in the auction." And so it is done. Weekly I empty my wallet into a worthless box, which is sealed and auctioned off. After a bit, some participants might notice trends or patterns of behavior in the other participants and/or trends or patterns in how much money I dump into the box. They start to try to use their knowledge of these trends or patterns in formulating their own bids. They are watching pricing behavior, and they are using pricing methods in formulating their own bids.
Valuation methods try to determine what something is worth; pricing methods try to determine what somebody will pay for that something. If you believe that something is worth whatever somebody will pay for it, then there is no difference. If you believe that one can overpay or get a bargain, then there is a difference.
P: users are making guesses about how other investors will behave, not just about how the company will do.
M: Please show me one valuation method that doesn't do the same.
Anytime we invest, even if we pay zero attention to value or price, we are making a guess about how other investors will behave. That guess is always there to some extent. But not to the same extent in all methods of investing. TA and momo are very disconnected from value, and are purely based upon the expected behavior of other market participants. At the other end you have estimates of intrinsic value or of book value, which have much weaker dependencies on the expected behavior of other market participants. In between you have PEG-based methods, which do explicitly incorporate specific assumptions on the behavior of other market participants.
There is no absolute fair value.
The way I would state it is that we have no way of definitely determining the value.
Fair value is nothing more than a perception of investors.
I disagree on a basic philosophical level. I might go along with this, at least as a premise for a discussion, if we were discussing collectables (even tulip bulbs) but we are discussing businesses. The function of a business is to generate true profits; the value of a business is the value of those profits.
- Pirah |
