Understanding Value

There are two types of investors in the stock market. Speculators (or "emotional investors") and value (or "unemotional") investors.

Now speculative investors are not necessarily bad, and a lot of traders make a lot of money in the speculation market. When you are speculative investor, you are investing based on what you think the crowd is going to do. If you see a stock going up and you think it's hype will last for a while, then a speculative investor sees that as a good time to buy. He doesn't care what he's actually buying, whether its an oil company, a dot-com or a company that sends people out to pick up your dog poo.

The key ability of a speculative investor is his ability to read a market. He must be deep enough within the market (or close enough to the market-movers) to get clear indicators of the immediate future. If he misjudges or mistimes a market swing, his entire strategy can fall apart. His goal is to create a series of short-term successes.

Value investors are of a different breed, of which Warren Buffet is probably the most famous. Value investors do not care about the timing or the swings of the market. Instead their investment method is based on calculating the underlying value of a company. This is done by a variety of methods, including figuring out the value of the equipment and property owned by the company, the company's revenues, and the growth potential.

The key ability of a value investor is figuring out the worth of the underlying asset. When he buys stock, he compares the worth of the company to the worth of the stock. If it's a good match, he buys. He doesn't care if the stock is rising or falling, but simply whether or not it's a good buy right now. He may get hammered in the short term, but does not worry about it because if his calculations are correct then the company will rebound.

How does this work in real estate? Obviously the speculators are easy to spot. These people bought because real estate was climbing, and some have cashed out and some are losing their shorts.

But value is a more difficult proposition. Most of the time when I hear people talk about a properties value, they refer to either assessments or comps (which are comparisons of a property to other similar properties that have sold recently). The problem is that assessments are notoriously all over the chart and have no real meaning. And comps are more of a study of the "price" and not "the value of the underlying asset".

Comps are valuable tools to the speculative investors. But the question is how to figure out the real value of real estate. Something that I will go into more depth on next time.

But before you get your hopes up, remember that every investment strategy is based on predicting the future. Everyone looks at their own indicators and makes their own models. Some are more successful than others, but no one is 100% correct. The goal in investing is finding strategies that you are comfortable with, and that are designed to allow a certain level of failure.

That said, next post I want to go a little into the indicators that I use to try to better determine the value of real estate. It's by no means a comprehensive formula, but helps me loosely figure out what I believe that value of a piece of property is.