Price vs. Value#

"Price is what you pay. Value is what you get." – Warren Buffett

This famous quote encapsulates the heart of investing. In the stock market, you see a price every second. But that price changes constantly based on news, sentiment, and liquidity. Does the value of the business change every second? Of course not.

The Core Distinction#

Example: The House in a Storm#

Imagine you buy a rental property for $500,000. It generates $30,000 a year in rent.

• Scenario: A massive thunderstorm hits the town. Panic ensues. Nobody wants to buy real estate today. The highest offer you get is $400,000.
• The Price: Has dropped 20% to $400,000 because of fear/sentiment.
• The Value: Did the storm destroy the house? No. Did tenants stop paying rent? No. The house still generates $30,000/year. The intrinsic value remains $500,000.

As an investor, your goal is to buy the house when the storm hits (Price < Value).

The Three Truths of Valuation#

Professor Aswath Damodaran, often called the "Dean of Valuation," emphasizes three critical truths that every investor must accept:

1. All Valuations are Biased#

You cannot value a company in a vacuum. If you like the CEO, use their products, or read positive news, you subconsciously adjust your inputs (like growth rates) to get a higher value.

• The solution: Be honest about your bias. Ask yourself, "Why do I want to value this company?" and "What if I'm wrong?"

2. Most Valuations are Wrong#

The future is uncertain. You are forecasting cash flows for 5 or 10 years into the future. You will be wrong.

• The solution: Don't aim for a precise number (e.g., "$124.32"). Aim for a range (e.g., "$110 to $140"). Valuation provides an estimate, not a fact.

3. Simpler is Often Better#

Complex models with thousands of inputs create a false sense of precision. If you have to estimate 100 variables, you have 100 chances to make a mistake.

• The solution: Focus on the big drivers: Revenue growth, margins, and risk.

Numbers vs. Narrative#

A spreadsheet is just a tool. A good valuation connects numbers to a story.

• All Story, No Numbers: "This company will change the world!" (But how will they make money? When?)
• All Numbers, No Story: "They will grow 20% forever." (Why? What competitive advantage allows that?)

Example: Valuing a Ride-Sharing Company#

• Bad Valuation: Plugging random growth rates into Excel until the price looks right.
• Good Valuation (Narrative + Numbers):
  1. Narrative: "Ride-sharing will replace 2nd car ownership for urban millennials because it is cheaper and more convenient."
  2. Numbers: "Total Addressable Market is $X billion. The company can capture 20% market share. Operating margins will improve to 15% as they stop subsidizing rides."