It is a known fact that price doesn't necessarily reflect true value. With the stock market being swamped by companies overvalued due to little more than trend, the divide between price and value has declined progressively. This got me thinking about how tricky it can be to find a bargain. Then, while shopping on Amazon, I found the perfect analogy between the overvalued stock market and headphone deals.
What I was looking for
I was looking at buying good quality, wireless headphones with a slick and stylish design. They had to suit my budget of US$200. With my preferred specifications in mind, I set about searching for my ideal set.
What I found
While scrolling through the multitude of options, I came across the perfect pair of Jabra Revo headphones. They matched all my preconceived requirements. I was ready to add them to my cart and so selected my chosen colour - white - and suddenly, the price leapt up. This did not make any sense and called for further investigation.
The headphones had individual price tags depending on their colour. Even though all of them had exactly the same specifications, providing the same results, there was a price difference of $34 between the most expensive and the cheapest set: the grey headphones retailed at $172.99, the black pair $194.54 and the white pair at $207.21. How could this be possible?
The value of headphones should surely be based on components, functionality, durability etc. According to these fundamental specifics, a particular model is given an intrinsic value. Yet this was not the case. The colour alone dictated value as this was the only variable. I had just committed a value investing cardinal sin: I had chosen the colour of my headphones based on nothing more than fashion. Once I stopped laughing at myself, this is what I realised.
For the purpose of this example, the grey headphones represent an undervalued share, the black pair represent a share at fair value and the white pair represent an overvalued share. Bear in mind that the headphones have exactly the same specifications and functionality.
An undervalued share trades at a price significantly less than its intrinsic value. In our example, the grey headphones are a great investment. They have awesome components and satisfy my every expectation. Priced at lower than intrinsic value, this pair is a definite buy. If I buy the grey headphones it's a win-win for me. I'll be the proud owner of good quality headphones, bought at a steal.
The black headphones are trading at fair value, which is good, but still not a bargain. It means that the price I'd be paying fairly justifies the value of the product's intrinsic components. Buying the black pair won't save me money but won't lose me money either.
The white headphones are overvalued. If I buy the white ones I'll be paying way too much for what I receive. In effect, as soon as I hit, 'Buy now', I'm losing money. Why would I pay $207.21 for exactly the same product that I could buy for $194.54 or $172.99? Personally, I'd rather save my $34 for the sake of a colour that I'll rarely see - as the headphones should spend most of their time on my head and therefore out of sight - and know that I've bought a great deal.
Why the price difference?
The answer is simple. It all comes down to trend, popularity and image. The white headphones are popular and a best-seller at the moment for no other reason than 'white is in'. Those who buy white are willing to do so at a premium because they want others to know they are up with the latest trend.
Fashion is cyclical. The chances are, in a few months’ time, grey headphones may be the most popular, causing a steep increase in their price which surpasses intrinsic value. If I really want white headphones, the smart thing to do would be to buy the greys right now, wait until they overtake the whites in popularity making the whites cheap and the greys expensive. Then I can sell the greys on eBay for a profit and buy the whites at their new, undervalued price.
Overvaluation occurs in the stock market every day. An IPO is identified as a popular investing opportunity and millions of investors jump on the bandwagon. This causes the shares to skyrocket, over-valuing them even further. Many investors will still buy these shares even though they are now trading far beyond intrinsic value. Doing so is very risky, because the chances of the share price dropping from a high to a damaging low becomes increasingly likely with every point it climbs. Once the trend for that particular stock is over, its price comes tumbling down. At that time you might panic-sell the stock you bought (for far too much) at its new low price and lose a great sum of money. Always remember even though stocks grow fast at times, they can even fall faster.
As 3D value investors we never react to trends or herd mentality. We believe that you should only buy into a strong company's shares when it trades under fair value. This ensures your investment stands the best chance of growing and at the same time withstand market fluctuation. We enjoy low-risk investments. Don't be sucked into buying something that you know is expensive for no solid reason. Keep in mind: If you buy at the top price, the only way for it to go is down.
What I bought
Who would have thought that shopping for headphones would be an educational experience? Being a 3D value investor, I always look for great products being sold at an undervalued price. So it’s safe to assume that I bought the grey set of headphones. Now I’m listening to great-sounding music with a smile on my face, because I have an extra $34 in my pocket that I’ll be using to buy myself some energy drinks and snacks for my next Battlefield tournament.
Which pair of headphones would you have bought? Tell us your choice and why in the comment section below.