What is Value?

Reading Buffett ‘s latest letter, I liked this little passage on value (from his 2013 shareholder letter, page 18):

• Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.

A lot of really important ideas in that comment. Worth digging into them out a bit:

1. Buy things that make money. If you can’t figure out how much money you can make with it, pass. Valuation is done always with reference to other valuations. If you’re trying to value something the best way is to think of it as a collection of things that you really understand. (What’s a convenience store worth? Well, let’s start by adding up the cost of all the chips and chocolate bars and cigarettes.)
2. No one has the ability to evaluate every investment possibility. You know enough to make money.
3. But omniscience isn’t necessary; you only need to understand the actions you undertake. Others are going to make money and you may not understand why or how they do it. That’s ok! Stick to your knitting.

Buffett goes on to make a few points about how he doesn’t care about price data, which he likes to do (I don’t care if the stock market closes!). Then…

• If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.

Again, focus on your independent, unique view of something’s value. Buying something because some day someone else will buy it back is a vastly more complicated kind of bet (who can predict what others will feel in the future?).

• Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: “You don’t know how easy this game is until you get into that broadcasting booth.”)

And the only thing more complicated than predicting the actions of individual people is predicting the actions of millions of people.