Price vs. ValueGuest Post
Our job at Burgundy is to understand the true value of the quality companies that comprise our portfolios and Dream Team1 lists. That’s the reason we focus so heavily on fundamental research. Stock prices are subject to many factors, often beyond our ability to predict or influence, but knowing the value of a firm is something we can control.
The recent volatility in global markets provides an important reminder: the price investors are willing to pay for a piece of a company can fluctuate significantly over a short period, despite few operational changes in the business. These highly emotional periods when prices tend to get far out of line with value can be a gift for a long-term investor.
The concept of purchasing assets when they are available at a discount to their true worth is simple, but execution is fraught with challenges. Not only is attempting to discern intrinsic value difficult, but there are also a myriad of apparent mispricing opportunities. When price is well below a company’s perceived value, the investor may fail to profit because the gap between price paid and intrinsic value is never closed.
One effective strategy to mitigate this risk is to invest alongside shareholder-minded management teams who are good capital allocators, understand the concept of value investing and act to unlock value for shareholders. We believe that such a team can be found at Brookfield Asset Management.
In his last letter to shareholders (of which Burgundy is one), Bruce Flatt, CEO, did a superb job describing the concept of value investing and how Brookfield takes advantage of perceived mispricing in its real estate assets by buying its own stock when it is believed to be undervalued:
“It is often difficult to describe the concept of value investing, and specifically the difference between Price versus Value. We have a very simple example of this within our portfolio, where the markets are, for various reasons, pricing a security at nowhere near Value. More importantly, we view the aberration as an opportunity to be capitalized on—to your benefit.
Price is a function of supply and demand characteristics, which are often influenced by the news of the day and short-term results. This has always been true, but is even more so today with social media, the 24 hour news cycle and all the information available to investors. Value, on the other hand, is the net present value of future cash flows based on assumptions for growth, discounted at an appropriate interest rate. The Price of a publicly traded security is often not the Value of it. The trading Price is known daily. Value takes knowledge and experience to fully define, and is more often an art than an exact science. …
It is clear that Price can be different for many reasons. Our job, however, is to know Value. We have transacted on more [real estate] properties than anyone globally—for over 25 years. This gives us comfort in our ability to understand Value. Furthermore, we have control over the assets we own, and in virtually all cases can realize the Value as we so choose. A stock market participant likely does not have this benefit, even though he/she may believe in the Value. The issue for the stock market investor is knowing “when” the Value may be reflected in Price. We can only assume that the people [who] sold us their shares at the prevailing Price last quarter do not believe that the Value will be recognized in the market any time soon, have a different view of Value than us, or just decided to do other things with their money. Regardless, to us, this is a stark example of the difference between Value and Price.”2
Burgundy has adhered to one investment philosophy to appraise companies for about as long as Brookfield has been valuing real estate. This history provides us with comfort in our ability to recognize value. As long-term equity investors, we too do not have to transact unless we believe value can be realized.
In recent weeks, we have seen many quality companies priced below our estimate of their intrinsic value, and we have put cash to work to take advantage of the opportunities the market has provided. These are the moments that define the quality-value investment style, and we expect they will serve our clients well over time.
- A Dream Team company is a list of companies that embody the business, financial & management characteristics that Burgundy deems high quality, but their current market price does not offer enough of a margin of safety to warrant investing at this time. Burgundy monitors these companies, waiting for the right purchase price.
- Reproduced with permission from Brookfield Asset Management.
Article By Mathew Harrison, Burgundy Asset Management