Friday, February 5, 2010

What Is Intrinsic Value? - Low Price?

“Price is what you pay; value is what you get.”
Benjamin Graham

As with most things, the momentary price of a stock is easy to determine. Today, delayed stock quotes are available from many on-line services and real time quotes can be had through most on-line brokerage houses including mine, USAA Investment Management Company.

As with most things, the value, or “intrinsic value”, of what you are about to buy is much harder to discern. John Templeton, one of history’s greatest investors seems to have equated value with low price. Or rather, he was certain that a basket of low priced stocks purchased during periods of market pessimism would perform well; with the good performers dominating the poor performers. He bet his life on this strategy at the beginning of his career as illustrated by the following quote from the web site

“While standard stock-buying advice is “buy low, sell high,” Templeton took the strategy to an extreme, picking nations, industries, and companies hitting rock-bottom, what he called “points of maximum pessimism.” When war began in Europe in 1939, he borrowed money to buy 100 shares each in 104 companies selling at one dollar per share or less, including 34 companies that were in bankruptcy. Only four turned out to be worthless, and he turned large profits on the others after holding each for an average of four years.”

At least in this case, John Templeton didn’t try to determine the intrinsic value of the 104 companies in his 1939 portfolio. He assumed that most of them were worth more than the price he paid. If 52 of the companies failed and the other 52 doubled he would have broken even.

In hindsight, his risk seems small and apparently it seemed so to him at the time. However, because he borrowed the money used to buy the 104 companies, at lot depends on the terms and conditions of his loan and the speed in which his portfolio would grow. We don’t know the terms of his loan, but obviously the deal seemed favorable.

Recently, this was a viable strategy again. Last spring one could have bought a basket of seriously depressed financial companies for under $10 per share. Those who pulled the trigger have done very well to date. I wasn’t one of them. And, despite the current much higher prices of financials, I have no desire to own any. My perception of their value is much lower than their current price.

The question is why do I think that? What does intrinsic value mean to me? I’m going to think this through over the next few posts.

I think more clearly when I write. And there is nothing like a posting deadline to force me to write.

Link to Other Topics in the Special Report: What Is Intrinsic Value?

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