When it comes to price and value, most people think that they are one and the same.
This could not be further from the truth.
In this blog post, we will discuss why there is always a difference between price and value, and why this is so important in the world of business. We will also cover how different markets work, and how you can become a better investor by understanding this concept.
A fool knows the price of everything and the value of nothing. Click To TweetTwo Sides of a Coin
Did you ever wonder why people transact and exchange goods, services, and work at a certain price? Who gets to decide how much something is worth? Why do we even have price tags in the first place? If price and value were the same, then it would be easy to know what something was worth.
Price is just one of the factors to consider when evaluating value.
For a better understanding of how people determine price and value, we got to look at some examples that show why price and value are not always the same thing. This will lead us to the concept of supply and demand.
Trust me, understanding these concepts will help you make better decisions in your life as an investor, an employee, or a business person.
Price is what you pay, value is what you get. Click To TweetWe know that markets exist because there are always buyers and sellers ready to transact if the price is acceptable to both sides. This creates supply-and-demand dynamics where prices fluctuate based on factors such as scarcity or desirability. Prices always aim to find an equilibrium where the quantity demanded by buyers is equal to the quantity supplied by sellers.
This is the so-called macro perspective. However, on a 1:1 basis, it gets more complicated than that. It gets very subjective.
Each and every one of us does have a different view about how much something should be worth.
The intelligent investor is a realist who sells to optimists and buys from pessimists. Click To TweetIn most markets, price and value are not always in line with each other. The price of a good or service is usually based on what the buyer is willing to pay. The value is then determined by what the seller thinks it’s worth. In some cases, like when there is a lot of competition for a product or service, prices may be lower than the perceived value. In other cases (like rare collectibles), prices may be higher than the perceived value.
This creates tons of opportunities for merchants, business people, and investors.
The Invisible Hand
Adam Smith coined the term “the invisible hand of the market”, describing how a free market eventually always regulates itself. He believed that the price of a good or service is determined by the aggregated total sum of all individual decisions made by buyers and sellers in the market.
While Adam Smith’s idea works for the macro picture of a free market, opportunities arise because the price is always based on what someone is willing to pay. Value is very subjective.
What one person may see as valuable (such as an antique or an old mansion), another person may not find worth anything. This is why it’s so important for investors to do their own research before investing in something!
Different Markets, Different Rules
Now that we have a basic understanding of price and value, let’s take a look at how different markets work differently.
Here are four examples:
Public Stock Markets
In public stock markets, such as the New York Stock Exchange (NYSE) or NASDAQ, price and value are not always in sync. On the one hand, there are so many ways to evaluate the value of a stock. On the other hand, once markets are open, stocks trade non-stop and oftentimes “at market”. This means: When someone buys a stock, they don’t know what price they’ll pay until a counterparty agreed to sell.
Because there are so many buyers and sellers in these markets, prices can fluctuate wildly from one minute to another. The price finding process depends on supply-and-demand dynamics, emotions, different views, fear and greed, and so forth.
Value is not determined by those who set the price.
Value is determined by those who choose to pay it.
The stock market is like a huge voting machine with constant updates.
Read more here to become a better investor.
Bond Markets
In bond markets, price and value do tend to be more aligned.
Bonds also tend towards higher price stability over time. Price and value can still be different due to supply-and-demand dynamics or other factors. Especially interest rates, duration, inflation, and perceived issuer risk factors.
Also, bonds are mostly traded “over the counter”, meaning a buyer needs to agree with a seller to transact first. If you dump a bond “at market” into the abyss, you run the risk traders pick you up on the offer. On the other side, if you place a limited purchasing order, you might get filled if someone sells under pressure or without a clear strategy.
Real Estate Markets
In real estate markets such as single-family homes, you can find great deals for sure. First, every home is a different object altogether.
The price is usually a function of:
- what the seller believes his property is worth and
- the buyer is willing to pay for it.
For a transaction to happen, both sides have to be happy with the agreed price and terms. If not, they wouldn’t transact.
There might be many reasons why someone wants to sell a house. Most often it has something to do with needing cash fast (divorce) or simply wanting more space (growing family).
Buyers look at selling offers based on how much they’re willing to pay. They are directed by their expected outlook on the relevant property as well as current conditions like interest rates which impact affordability levels across all income brackets.
The interesting part of the real estate market is:
You can get great bargains if you look around and understand the sellers’ motivation.
This is something you can’t do at all in a stock market.
Labor Markets
This is probably the most important market for anyone reading this blog to understand. On the first appearance, price and value in labor markets are usually more in sync because of the high level of competition for jobs. When someone is looking for a job, they typically have to consider what their skills are worth to companies that may be hiring. But this is mostly true for minimum pay jobs or very standardized roles.
Similar to the real estate market, the more specialized you become as an employee, you got to “know your worth”. Employees need to know what their skills are worth on the open market so they can negotiate good or at least fair salaries with potential employers.
Don’t sell yourself below value!
Never lower your price, add value! Click To Tweet
Conclusion
As you can see, price and value vary greatly from market to market!
Understanding how these concept works is the most valuable skill there is. Investors can make better decisions about where to put their money. Homebuyers can get a better deal when buying their home. Employees can avoid selling themselves below value when looking for a job.
Any economic transaction on this planet is based on price and value. From fleamarket selling to the most sophisticated merger and acquisition.
Just remember: Price does not equal value!
Price can be made up out of thin air, but it cannot exist on its own forever. Value does always exist but sometimes stays hidden for too long.
Price and value are two different things. However, they do need to match so a transaction can happen or the price will go down closer
Appreciate your blessings.
Understand your worth.
Value your life.
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Stay tuned for future posts that will dive deeper into each of these markets!
Know your worth!
Matt