Philosophical Basis for Value Investing

Value investing is based on that every asset has a value. A good investment occurs when we pay less than the real value of the asset or equity for it. In words of Warren Buffett, “Price is what "Price is what you pay. Value is what you get."

Value Investing vs. Market Efficiency Theory

Market Efficiency Theory says that stock prices fully reflect all available information on a particular stock; hence, it’s impossible to predict a return on a stock price because nobody has access to information not already available to everyone else.

However, this theory is not completely true. I was demonstrated that they are some clear signal which mean than market is inefficient. For example, the fact that many Value Investors, such as Warren Buffett, John Templeton or Joel Greenblatt, could beat the market repeatedly is a good evidence of market inefficiency. I will study this topic more in depth in an upcoming article.

Value Investing vs. “Bigger Fool” Theory

This theory argues that the value of an asset is not important as long as there is a “bigger fool” around willing to buy the asset from them. I know that people can make good profits using this method, but the problem is that is dangerous because there is no guarantee that there will be a “bigger fool” when you want to sell.

A good example of that you can earn a lot of money and that you can lose it with the same ease is the case of Infospace.com. During the dot-com bubble, people could make a lot of money investing on this company with the “Biggest Fool”. The company went public in December 1998 closing at $20. It reached a peak of $1,305 in March 2000. Its share price is currently below $11. Here you can see the graph of its share price.

The company was the same, its fundamentals were the same, but the price fluctuated move by the greedy of big fools who wanted easy money. People lost millions because of using this bubble. However, real intelligent investors did not.

Can we value a company objectively?

Some people might say that value is in the eye of the beholder, but companies are not pieces of art. Value comes from the present value of the future cash flows that the company will generate, so the value of the company is completely objective.

The problem is that we might not know surely the future cash flows that a company will generate. Can we value objectively them? The answer is yes. There are some methods to objectively value companies with this problem, but I tell you more about this topic in forthcoming articles.

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