As we have discussed regarding value in the previous article of a Bibliophile. Now, I am going to talk about the 4th Chapter of The Most Important Thing – The relationship between price and value.

There is not an availability of any asset class which having a birthright for providing a higher return. If we bought a particular asset class at an appropriate price, then that provides us a higher return to safety.

An example of one the biggest wealth creator company of the Indian stock market—

If someone has bought this company during the March-2000, At the high price of around Rs.431 then after the 16 years of the period, he gets returned at 7% CAGR. And if enter to the similar company at the low price of around Rs.275 during the March-2000 then after the 16 years of the period, he gets a returned of 10% CAGR (*Considering all time high price for calculating returns). Though revenue grew at 30% CAGR, Operating profit grown at 27% CAGR and Net profit also grown at 27% CAGR during the same period with supported by the good management team.

If we buy such a good thing at a too high price, then we have to wait for the very long time for getting fair returns rather getting superior returns. But if we have bought junk asset class or good asset class at an appropriate value, then we can able to create a superior return.

We should focus on correctly buying an asset at a cheaper price so that we need not keep focusing on the selling decisions. Because our buying decision provides us a huge safety. Whenever we buy any stock at a cheaper price and all our calculations of intrinsic value are correct, then over a period of time, the stock price should reach its intrinsic value.

So, that One of a good idea of making an investment is to buy whenever the pessimistic situations around us which provide us a good return with proper safety. But such scenario not always comes. This means we construct our portfolio at the time of crisis, but every time, we cannot stay only dependent on the crisis for making our buying decisions.

Thus, most important are to understand the relationship of price & value. By knowing the relationship between price and value, we can able to take an advantage of mispriced valued stock and consistently create a wealth for the longer period of time. We also need to understand the Psychology of investors along with the understanding the price – value relationship because the psychology of investors can drive stock prices in the short run. But at a longer period, the price should reach its intrinsic value. So, that it is an essential for us to buy an asset at a discount from its intrinsic value.

Investors Psychology is also one of the important factors along with the Fundamental value of the security which can drive stock prices to an extreme side and that provide us an opportunity for our entry/exit. We should avoid falling into the trap with short term price fluctuation due to the psychology of investors but should take an advantage from it.

People never focus on the price at clever people make an investment. But they start herding towards the news of such deals. So, that more and more people start buying the same stock and due to the flow of buying, the stock starts rising and again more investor start buying into it and stock start rising again. Thus, psychology drives a price much more rather than its fundamental in the shorter period of time. Everyone starts creating stories after the clever people make an investment, those stories drive the price of the asset class at extreme direction.

As per the Howard Marks, there are few ways by which we can earn a profit on the investment:

• Benefiting from rising in the asset’s intrinsic value.

In this method, an investor has to predict accurately to the improvement in the intrinsic value of the assets in the future. But this task is not as easy as it seems. We even don’t know our future and we are going to predict the future of the intrinsic value which is very uncertain in nature.

• Applying leverage

Leverage means investing using borrowed money. Leverage always works as a double edged sword. It can either make you or will break you. It magnifies both gains as well as losses. So, leverage might provide us a higher return, but it can also create a threat to our own capital. Selling for more than your asset’s worth

• Selling for more than your asset’s worth

Here, we need to hope for the buyer who is ready to buy an asset at a higher price. If we are holding an asset which is overpriced or fairly priced than we need a greater fool to buy an asset from us at a higher price.

• Buying something for less than its value

In this option, we are buying an asset at the discount, from its intrinsic value. It’s just required for the proper functioning of the market and that brings an asset to its intrinsic value. This can be one of the most useful ways to make a consistent return with a safety of our capital.

Click for Video — Sultan Mirza

As we have seen in the video that Ajay Devgan has bought Guava at a very high price compared to the real value of the Guava. We have many a time experienced such kind of the irrationality among the investors who focus on story prevailing at market space rather than focus on the real value of the particular stock. We will not always able to meet Sultan Mirza (Ajay Devgan) / Irrational investor who buy an asset from us at a very irrational price. So, that we always need to focus on the buying an asset at a discount from the real value for getting a consistent return to safety.

Read for more detail: The Most Important Thing Illuminated by Howard Marks