What is valuable?
A company with no sales, a faked product demo that doesn’t demonstrate any of their claimed features (because they were missing), designs bought off a student for a few thousand dollars and lots of embarrassed GM execs… the perfect mix of nonsense for someone to think: ‘yes this company has potential, I’d support that’…
At one point so many people thought that, that it was briefly worth more then Ford at $30 Billion.
So how do you calculate value?
Value is what someone is willing to pay for it.
“Better a diamond with a flaw than a pebble without.”
Confucius
“A horse! a horse! my kingdom for a horse!”
- Shakespeare, KING RICHARD III: Act 5: Scene 5
Calculating the value of something depends on a number of things:
Urgency, how quickly do you need something? The more immediate the need, the more expensive the price.
Desperation, the last piece of a puzzle, the last minute gift for a forgotten birthday, that critical thing you just have to have or everything will fall apart (or so you think at the time).
Utilisation, how many different uses does the thing have? Gold for example performs a number of technical functions that might be useful, but also doesn’t corrode and many people think looks pretty.
Culture, over thousands of years certain cultures have valued some things more and some things less. Like European explorers murdering their way across North and South America desperate for gold, despite the locals giving it no value. Sometimes this recognition of something being valuable has become so ingrained in our education and culture that we don’t even question it.
Fashion, if everyone wants something its price will (unless otherwise controlled) go up until it hits a level where people start to reconsider if they want it now… Franklin’s Barbeque in Texas is so popular a queue starts forming in the early morning, many hours before he opens and he typically sells out before lunch service would start. Such a regular occurrence is this queue outside his place that a small industry of coffee shops and stalls has appeared to only supply the people queuing. Closing when he closes.
Scarcity, if there isn’t much of something around, then typically people will pay more for something because once it’s gone, it’s hard to replace. Doesn’t really matter that thing is, a rare mineral or a limited edition print. De Beers [a famous diamond miner and seller] has for 70 years horded its diamonds away in secret vaults, releasing only a small number to be sold. Thus controlling the price by keeping diamonds rare.
FOMO [Fear of missing out], you don’t know why you want something, but everyone seems excited about it… so there must be something there, you must just not be able to see it yet. No time to hang around and work it out, I better get it now before there’s no more or the price is too high!
Potential, could this be worth more in the future? The ultimate value of a startup business is not what they are doing now, that’s usually nothing impressive or even clearly terrible… the value is in what they might do in the future. At the time of writing [September 2020] Tesla is the most valuable car company in the world, but only recently has it made a profit, typically losing billions each year. Even with the profit it still sells a tiny number of vehicles compared to others. Investors however believe that these loses are small compared to the amount of money and number of cars it will make in the future!
“Priced In” refers to obvious potential. When a Waitrose supermarket opens in a neighbourhood, all the house prices rise by 20%. Why? Because the type of people who want to shop at and live near a Waitrose can afford it. Demand for property goes up and so do the prices.
Expectations, this product is “reassuringly expensive”… “you get what you pay for”. We all know that you have to pay for quality. So something expensive must be a higher quality right?
An advert from Stella Artois’ Reassuringly Expensive advert campaign. The beer must be a better quality than the others and by putting the price UP they dramatically increases sales.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down”
“Price is what you pay. Value is what you get”
Warren Buffet
Markets
A market, whether it’s selling traditional physical goods, services or stocks and shares in businesses or insurance and other financial products, they all share two common features:
People wanting to sell something & people wanting to buy something.
Depending on all the above factors described, there may be more sellers than buyers or more buyers than sellers. For something like a company share, bought at a stock exchange (a financial market), where the item is digital so there’s no physical limitation in how many you can buy (you don’t need a big truck and a yard to store them all in) the system is slightly freer than it might be compared to a Black Friday shopping panic.
So with no other limitations, if I have the money I can buy as many as I want. When lots of people want the shares in a electric truck startup that has no product yet (who knows why) then there is a bidding war for them.
If 10 people want to buy my house, the highest price will get it. There’s only one house after all. But what if the price was so high that my neighbour saw that and decided that she’d now sell hers which was identical to mine?
The more people there are wanting to buy something like company shares, pushes the price up until a point where people want to sell them. If too many people then want to sell, there might be more for sale than there are buyers to buy them and the price starts to drop. The price of the item changes depending on how many people want to buy and how many people want to sell at any given time.
(Nothing featured on this website should be considered investment advice!)
Stock Market Value Misconceptions
It’s a common held misconception among market traders that if someone is winning someone else must be losing. But that’s not possible, it’s possible for everyone to lose. How? Because the values of companies in the stock market are not real. They are the value someone was last willing to pay for a share of it, not an actual objective amount.
For example, if I buy an orange for £1 and then sell it to you for £5 because you really like oranges on that day, I’ve made £4 profit on the trade. But your orange is not worth £5 unless someone else pays £5 for it. If the only person wanting oranges other than you is me, and I’m only willing to pay £1 for it, then that orange (if you ever wanted to sell it) would only be worth £1. I’ve created value out of nothing by finding someone who thought something I had was worth more than I bought it for. Since you were the last person to buy an orange, and you paid £5, all oranges are in theory now worth £5. But what if we both have lots of oranges, and the only person willing to buy oranges comes along and says they’ll only pay 20p for an orange? This is only a problem if we need money, and thus have to sell our oranges. I can’t buy apples with oranges, I have to sell my oranges to then buy the apples. So if we both decide to sell, we both lose £4.80 in value per sale (not so depressing for me, because I only paid £1 for them, but you paid £5 so the drop is dramatic for you). £9.60 of value has simply vanished in an instant. Not into anyone’s pocket, it’s just ceased to exist.
This is why stock market crashes are so damaging. There’s no big winner raking in everyone else’s loses behind the scenes. The system doesn’t need to stay in balance. Everyone can lose if the “market sentiment” is that everything is worth less than we thought it was.
Why is this a harmful misconception? It’s damaging because it’s used in stock market cons and get rich quick schemes as background context for why you’re missing out on easy millions and thus should trust the con-artists elaborate scheme. The scam is based on FOMO and goes something like this…. “there are millions of dumb investors out there, the unsophisticated investors, the people not like you, who lose money everyday… and those loses, they don’t just disappear (they do actually), the money doesn’t just vanish (yes it does because it was never real)… someone is cleaning up, someone is collecting all those loses. Every trade has a winner and a loser, and by following this simple guide / giving me money to unlock some super power / using this automated trading bot / buying my crypto (whatever)… you can be one of the winners.”
Don’t be fooled. In the words of Warren Buffet, possibly the greatest investor of all time, cons like this exist because “no one likes getting rich slowly”.
“A great business at a fair price is superior to a fair business at a great price.”
Charlie Munger
Never forget that markets are not entirely rational built purely on logic and rules, they are based on humans and humans are irrational beings.
Given all of the above factors that can influence the price and value of something it’s no wonder that prices can change wildly. Company stocks can climber higher and higher, only to crash the next day like the hangover after a fun night out.
In the words of the great economist John Maynard Keynes: