Price vs Value

In the left corner we have price, the crowd favourite. With his coach’s supply and demand by his side, he’s ready to go. In the right corner we have value, the enigma, the myth. Backed by his team ‘research’ and ‘analysis’, he looks ready to take the title. Who will you back?

Identifying the value of an asset is no easy feat, particularly for  an emotion driven investment class like property. Investor Phillip Fisher  summed it up pretty well  when  he  said: ‘The market is filled with individuals who know the price of everything, but the value of nothing.’ The key to successful investing is to avoid the situation illustrated below:

The pitfalls of conflating the two can  be costly. As an example, last week I spoke with a client who independently purchased a one bedroom apartment in South Melbourne for $450,000. Here are the facts:

  • Price: $450,000
  • Size internal: 42 square metres
  • Size external: 2 square metres
  • Square metre rate for a comparable property:
  • $9000
  • Value = 44*$9,000 = $396,000
  • Price – Value = $54,000 (price is 13.6 per cent greater than value)

As Warren Buffett famously proclaimed; ‘price is what you pay, value is what you get.’  Now, just because an asset seems ‘cheap’ doesn’t mean it represents good value. Conversely, a highly priced asset doesn’t necessarily lack value.

So, why would someone pay more for an asset than what it’s worth? I’m going to borrow a phrase from former US Federal Reserve Chairman Alan Greenspan when he pointed at ‘irrational exuberance’ as the driver of the inflated internet technology sector during the 1990s.  Greenspan eloquently described the effect where strong sentiment leads to the irrational behaviour capable of leading the herd to inflate prices beyond their fundamental value.

The latter portion of the growth phase of a property cycle is often characterised by irrational exuberance. The phenomenon is responsible for the corrections (periods of low or negative growth where prices adjust to fundamental values) that follow a market’s cyclical peak. We need look no further than the performance of the Sydney property market during the last growth and correction phase of the cycle (1999-2008). The table below shows the annual growth of the Sydney property market over these years:

A slow transition into correction it was not. As irrational exuberance rears its head, value diminishes, the probability of a correction increases and investing becomes inherently riskier. Disentangling value from price is one of the fundamental philosophies of the Blue Wealth research process. Indeed, there are many who know the price of everything, but the value of nothing. In the battle of price and value,  be one of the few who back value: invest with Blue wealth


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