Stephen Mauzy, in a post The Chimera of Intrinsic Value, writes:
When the term “intrinsic value” is conjured, it is conjured to support an analyst’s target investment price, which more often than not differs from the market price.Somehow the aggregated opinions of buyers and sellers got it wrong, but the analyst gets it right. The market-formed opinion overlooks the investment’s intrinsic value. But it won’t indefinitely; eventually the market coalesces and intrinsic value and market value meld into one.
Actually, nothing is overlooked.The analyst offers only a subjective opinion of expected future value, not an irrefutable calculation of an intrinsic value. He or she can’t, because there is no such thing. Value -- all value -- is subjective. If I were to give 10 analysts the same data, the same time, and have them independently calculate investment value, I assure you that I will get 10 different calculations.
While I don’t differ substantively with what Mauzy has to say, the notion there his statement that “all value is subjective” is potentially misleading because it obscures an important distinction.
When Austrians say that “value is subjective” this applies to the individual’s ranking of consumption opportunities. If you prefer a new pair of shoes over a nice dinner and I prefer the opposite, neither of us is right or wrong from an economic standpoint. The value that the individual places on a good comes from the potential for the good to meet human needs. but those needs are inherently known only to the individual. The individual’s preference for A or B or B over A is taken as a starting point for economic analysis.
The Austrian view on the subjective nature of preference is in contrast to a view which might say the following: that there is a property of the good itself, which could be quantified as a cardinal number like height, weight, or temperature; and that number is a direct cause of the good’s price. There is no such number, nor is there even a unit in which such a number could be measured. Austrian marginal price theory demonstrates how money prices emerge out of the preference rankings of individuals to buy or sell the good, against their preference ranking to buy, sell, or hold units of money.
Subjective valuation does not apply to investment goods in this way. Investors do not -- for the most part -- buy investment goods based on the basis of subjective valuation because they do not directly satisfy human needs. (An example of an asset serving as a consumption good would be if the buyer of a stock derived satisfaction from telling people that he owned those shares ). Investment goods are valued indirectly, their value is derived. The valuation of investment goods is estimated by entrepreneurs, analysts and investors, based on their their marginal contribution to the production of consumption goods. Because this contribution will occur in the future, and the sale prices of the final consumption goods is not known, this component of valuation is inherently an estimate.
This estimation process depend’s on the buyer’s beliefs about the future: the analyst’s view of the future prices of the consumption goods yielded from those investment goods, of the prices of goods from higher stages of production that are required as inputs for the company or firm being evaluated, and the future supply and demand conditions for alternatives at all stages. This process is “subjective” in the general sense of the word in the English language, meaning, their beliefs about the future, even when grounded in facts about the past and present, still involves a lot of guesswork. But valuation of securities is not “subjective” in the sense in which Austrians use this term to talk about consumption goods. It is a mix of data about the goods, for example, copper is used to make pipes, current prices, and beliefs about the future.
The term “intrinsic value” is oneof the sources of confusion in talking about this point. If an economist were to use this term in the context of consumption value, then Mauzy’s critique would apply. There is no such thing as intrinsic value when it comes to consumption goods. However, “intrinsic value” is a term of art within investing. When using this term, it is important to keep in mind that the same term can mean different things in different domains. In the investing domain, it means an estimate of the value of particular assets based on their use within the structure of production. For Austrians if we replaced this term with “the entrepreneur’s appraised price, based on assumptions about the future”, then it might be easier to have a conversation about it.
While many financial thinkers totally dismissing the idea that the aggregated opinion of buyers and sellers got the price wrong, I don’t think that Mauzy is doing so, he is only pointing out that analysts frequently estimate a value for an asset different than its current price. (There is probably a survivor bias here because if the analyst came to the conclusion that the asset was accurately priced, there would be no profit opportunity in owning or short selling it). The view that the individual entrepreneur will always lose when speculating against market prices is known as the Efficient Markets Hypothesis, which is generally rejected by Austrians because it denies the existence of entrepreneurial opportunity. Austrians see the market as consisting of a diversity of opinions about the highest and best value of resources. The price does represent a sort of aggregated view, but that view can be wrong because no entrepreneur has seen a better use for those assets.
My final point for Mauzy is that it is not only value investors who think that the market “got it wrong”. All entrepreneurship implies that the market previously “got it wrong” when pricing factors. The individual entrepreneur who forms a new business must hire away labor and capital from other businesses. In order to do so, he must outbid those firms for these resources. By outbidding other firms, the entrepreneur is saying that he believes he can employ those resources at a higher price than they were, or could have been employed by other participants on the market, and still make a profit. In other words, the market “got it wrong” in employing those factors at the prices they were (formerly) employed at. When Steve Jobs spent over $100 million of Apple’s money to develop the iPhone, he was showing by his actions he believed that the market “got it wrong” by not having previously combined the available productive factors into a touch sceen phone, and that the mobile carriers “got it wrong” by mainly offering services as a combination of call minutes.
