How Warren Buffett Thinks About Price vs. Value

Warren Buffett's entire career rests on one distinction: price is what you pay, and value is what you get. The line comes from his teacher Benjamin Graham, and Buffett has repeated it for decades. Most investors nod at it and then spend their days watching prices.

Price is an opinion, value is an estimate

A share price is simply the last figure at which two strangers agreed to trade. It changes every second and reflects mood as much as fact. Value is the cash a business will hand its owners over its remaining life, discounted back to today.

Buffett never pretends that value can be calculated to the decimal. He wants a range, and he wants the price to sit well below the bottom of it. If he needs a spreadsheet to prove a stock is cheap, it is not cheap enough.

From cheap companies to good companies

Early Buffett bought "cigar butts": poor businesses priced so low that one last puff of profit remained. Berkshire Hathaway itself, a dying textile mill, was one of them, and he later called buying it a mistake.

See's Candies changed his thinking. Berkshire paid about $25 million for it in 1972, a price that looked rich against its assets. But See's could raise prices every year without losing customers, and it needed very little capital to grow. The lesson, pressed on him by Charlie Munger, was that a wonderful business at a fair price beats a fair business at a wonderful price.

What makes value durable

Buffett looks for a moat, meaning something that stops competitors from eroding profits. Brand, cost advantage, switching costs and scale all qualify. Coca-Cola, which he bought heavily after the 1987 crash, had all the brand it needed.

He also watches what management does with the cash. A great business run by people who waste its earnings on poor acquisitions destroys the value the moat creates.

How he uses a falling price

For most investors a falling price is a warning. For Buffett it is a discount, provided the value has not changed. He has said he would rather see the stock market close for years than be forced to sell a good business.

This is why he keeps large cash reserves. Cash lets him act when prices detach from value, as they did in 1987 and 2008.

What to take from it

• Estimate what a business is worth before you look at the quote.
• Demand a gap between that estimate and the price.
• Prefer businesses whose value grows on its own.
• Treat volatility as an offer you may accept or ignore.

Part 1 of 15 in the series Lessons From the Masters. Next: George Soros and the Art of Being Wrong Quickly.

Independent educational commentary, not investment advice. References to people and firms do not imply affiliation or endorsement. The picture is an illustration, not a photograph. Past results say nothing about future ones. Trading leveraged products carries a high risk of loss.