For anyone reading this that’s not an accountant, I should tell you that one of the big debates rocking the financial-reporting world is the concept of “fair value”.
Because that’s what every investor wants to know: “yes, I know that’s the price you bought it for – but what’s it worth, man?”
The answer is “fair value” and that’s as far as we get. Because defining that trite little phrase is about as successful as asking a group of clerics to decide which religion is “the one”.
“Fair value” means different things to different people at different points in time. For example, let’s talk about my iPad. Some scenarios:
- I live alone on an island with no electricity (fair value of my iPad = nil);
- I am dying of thirst in a desert (fair value of my iPad = number of bottles of water I can trade it for);
- I’m blind (fair value of my iPad = negative a million because I have no idea what it is and that’s frustrating);
- I’m about to board a long-distance flight (fair value of my iPad = priceless).
It’s not easy to define. But it does force one to think outside the paradigm when you’re sitting as the judge on Dragon’s Den and trying to decide if the waterless shampoo that Carlo from Wessex invented is really going to change life as we know it. And what we should conclude is that value is not really related to cost.
Which brings me back to share prices. Because what lots of accountants (and their bankers) do seem to agree on is that the “fair value” of your investment is best represented by the number of shares you own multiplied by the price that the share last traded at.
Doesn’t that sound reasonable?
It shouldn’t.
Let’s say that I have an apple and I can sell it for $1. There are lots of people that would buy just one apple. It’s a pretty fair value, I’d say. What if I had a million apples to sell. Does $1 per apple still sound reasonable? Not really. Now there is bargaining and risk and time-constraint. You’re almost certainly not going to get $1 million for a million apples.
Unless, of course, you live in Greece, and you’ve got the only licence to sell apples, and your brother in parliament called in favours and got a law passed saying that the guild of shopkeepers is legislatively obliged to buy all your apples at your price whenever you want it*.
But that aside, calling the last traded price the fair value of your shares seems like an exaggeration.
If the last trade on Friday was just 100 shares sold by a rookie investment banker who actually just wanted some cash to score a gram of coke…. Then that’s not reflective of the price that you would have to settle for to sell your million shares when the market opens on Monday.
At best, it’s an estimate.
*Life is good when you’re a “special interest” group.
