The differences between value and price has drawn a lot of debate and opinion from different scholars for a long time. Some scholars ascertain that there is a significant difference between the two while others refute that there is no any significant difference. It is an issue that in most cases confound investors in getting the difference between value and price. In finance, the satisfaction obtained from the use of a good or a service is termed as value. It typically describes the accrued benefit obtained from ownership of a product (Greenwald 2011). The benefit could be the satisfaction or pleasure obtained or utility gained from the consumption of the product as well as the power or the capability of the product to be exchanged for other products for money. If the commodity can extinguish a need or want, then it has a positive value. Therefore, the value can simply be defined as what consumers believe the service or the good is worth to them.
On the other hand, price in finance is the amount of compensation or payment made to another party in exchange for a product or a service. There are different forms of price in finance, the asking price, which is the price quantity of compensation asked by a seller of the product. Also there is the transaction price that is the actual compensation or payment made for a product. Then there is the buying price that denotes the quantity of compensation made by a customer or buyer of a product (Escarraz 2006). It can also be defined as the ratio of the number or quantity of products that are exchanged for another product (Greenwald 2011). Price plays an essential role in a free market economy as it dictates the interaction between demand and supply. It is set to equate the extent and quantity of goods to supply the market and those that are required, however, the price may be distorted by government regulations through taxes. This paper seeks to enunciate the distinction between fundamental price and value. Furthermore, it will address how investors can manipulate the distinction gain abnormal returns.
Distinction between fundamental value and price
Despite some scholars refuting a significant difference between value and price, many researches have ascertained that there is a clear distinction between value and price. First, through definition, price is considered the quantity of compensation or payment made for a given service or product whereas value, on the other hand, is what is what is obtained from the consumption of the good or service. For example purchasing a pen that costs $5, the price is simply $5. When the purchased pen can be used to write an article or make a product that can be sold for $10, then its value is $10 multiplied by the number goods able to produce. Secondly, the price is more of objective while the value is more of subjective. Further, the value is often incommensurable while price can be benchmarked based on other factors or prevailing market prices.
Furthermore, value is always mitigating risks while the price is an evident deliverable or completion. Moreover, price is considered regarding CFO, audit and procurement while value is based on the consumers or professional judgment. Also, value emphasizes or favors alternative fees whereas price simply denotes hourly-based bills. Price is real while value can be perceived as to co-opt a quip and a hope over anticipated experience. Also price only favors cost-plus margins, negotiation, and competitive bids while value favors the effectiveness of the fees paid and data analytics (Escarraz 2006).
Value can be expressed or measured regarding financial gain, physical gains or an emotional gain (Greenwald 2011). For example purchasing a meal in a hotel satisfies the want of food and the satisfaction or fulfillment obtained makes the payment or expense worth. Value cannot be quantifiably expressed due to a nominal value, inflation or any other economic factor. On the hand, the price is quantifiable and can be adjusted based on the inflation rates or other economic factors. Price is mainly dictated by the prevailing market demand and supply. For instance when the demand is relatively high the prices are most likely to go up when the demand is low the price subsequently goes down when there is increased supply for a commodity the prevailing prices will be reduced on the same note when the supply is low the prices goes up. Value is the worth of the product excluding the demand and supply (Koller et al. 2011).
How investors can exploit the distinction between value and price to gain abnormal returns
Investors primary aim when making any form of investment is to maximize their returns. Investors tend to make a lot of considerations while making an investment. They aim at obtaining maximum by using the least possible price. For instance, they would purchase stock in the stock exchange market when the prices are lowest and sell the stocks in the future when the prices are highest.
Price action strategy: Investors can influence the distinction between value and price through the pricing strategy to obtain abnormal returns. For them to gain profit on an investment, they can use the momentum trading strategy or the value investing strategy. For the value investing strategy, stocks or investment opportunities just like any other good, are sold from time to time and investors who focus on value often wait for the sale prize. At this time, the stocks are often undervalued, and there are vast opportunities or room for the stock to grow in the future (Escarraz 2006). They can as well influence pricing to gain maximum returns through the momentum trading where they can invest or buy stocks when the stock goes higher. They peg their decision on the fact that anything in motion will tend to stay or increase in motion. Despite this being a good pricing strategy, it is preferable for short term investment.
Investors can invest in assets that focus on maximizing value. Investors can create value for their investment investing in products that maximize value; this can be attained through continuous monitoring of consumers if they are willing and able to pay a significant amount over the displayed or estimated cash flow value to the investment for its investment units. For instance investing in business units with reputable brands or in detachable assets is considered valuable. Furthermore, investors can opt to reduce or limit the investment capital and instead increase value by emphasizing on high valued activities for example research, marketing or design as this will result in a relatively added advantage over other investors (Koller et al. 2011). They can also reduce capital employed and focus on outsourcing activities that are considered the low value added activities such as production when they can be effectively and efficiently done by others at a cheaper cost. Such investment ideas on influencing value and price have been successfully implemented by the Apple Inc. which designs some of their products in California and produces or manufactures then in Taiwan or even the Starbucks restaurant that manages several restaurants without owning them.
Increase prizes. Logically consumers attribute high prices to high-quality products. Therefore, an investor can intentionally opt to influence their prices to increase the perception of increased quality or value and gain more consumers, in the long run, the investor gains abnormal returns from the manipulation. Furthermore, investors can also opt to get rid of prices on their tables. They argue that it is better to direct a customers attention away from prices because prices are icky and in most situations the mention of money makes people withdraw physically. However, when the prices are already higher, there is no need of increasing the price since it will not be effective rather it will keep off other potential customers. Moreover, investors can improve the value of the investment by enhancing the brands image may be through the use of celebrities to improve their products image (Escarraz 2006).
Investors can also take advantage of an inflammatory economy. Typically, inflation deteriorates the value of a countrys currency. When prizes hike, investors main aim remains to make profits, they can, therefore, stick to investment that improves or increases in value at a higher rate than the rate of inflation (Koller et al. 2011). For example, investors can opt to invest in investment opportunities such as oil, real estate or gold are considered hedges against inflation.
Convey urgency or scarcity. Typically the preference of consumers is independent of the prevailing market forces such as price, demand, and supply. Consumers perceive the rarer a product is, the more valuable it is. Investors, therefore, can decide to create a microeconomic environment by supplying fewer products to increase the perceived value of the product and in the long run increase prices and gain more sales. Scarcity can be used to increase price and demand for a product (Koller et al. 2011).
From the above discussion, there is a clear distinction between value and price. In my view, investors should focus on the value of their products than the prices they set for their commodities. Typically, most products if not all have various alternatives with pricing and value. Consumers who make purchases based prices are often disappointed. Prize constantly changes depending on many variables, for example, seasonality of the necessity of products or service. Investors should, therefore, refrain from focusing on pricing but rather on the value that their consumers obtain from the consumption of their products. Despite peoples perception of value greatly differ there are some aspects of a product that can be enhanced to enhance the perception of a product other than pricing. It can be concluded that increasing the value of an investors product will enhance the products brand image and in return will encourage or attract more consumers to the product. It is clear that most consumers are drawn attracted by best value for their price. Shifting to value-oriented investment is, therefore, more preferable than price based investment.
Escarraz, D. R. (2006). The price theory of value in public finance. Gainesville: University of Florida Press.
Greenwald, B. C. (2001). Value Investing: From Graham to Buffet and Beyond. New York: Wiley.
Koller, T., Dobbs, R., Huyett, B., & McKinsey and Company. (2011). Value: The four cornerstones of corporate finance. Hoboken, N.J: John Wiley & Sons.
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