Value Investing – Principle #2: Intrinsic Value (Lesson 7)

Intrinsic Value

It’s a bubble. It has to have intrinsic value. You have to really stretch your imagination to infer what the intrinsic value of Bitcoin is. I haven’t been able to do it. Maybe somebody else can. Alan Greenspan

In the mid 1630’s, men would gather at their local tavern in the Netherlands and would barter a new product – tulip bulbs. They were imported a few years earlier and it was the latest craze in the country. As demand for the bulbs rose, the price followed suite. As the market price for these bulbs rose, other forms of financial instruments were introduced including granting rights to a bulb’s future regeneration; something we commonly refer to today as an option. Towards the end of this market frenzy, some buyers were willing to pay an entire year’s worth of wages to own a bulb. Their goal, resell the bulb for more money within a few days. In February of 1637, investors that had been in this buying/selling frenzy for many months recognized this crazy uncontrollable market craze because more and more novices entered the exchange as all of them sought a good return on their investment. These smarter individuals, what we referred to today as institutional investors, sold the balance of their inventory and ceased buying bulbs. With their exit, and no new entrances into the buying exchange, there was a sudden loss of interest in buying a tulip bulb. The price crashed. This is historically referred to as the ‘Great Dutch Tulip Craze‘ or ‘Tulipmania’ for short.

This is considered the first market crash. Notice the key similar elements of a modern crash. First, lots of buyers, specifically inexperienced traders, enter the market. Secondly, the smarter and bigger players exit the market (they stop buying), effectively taking their gains. And third, and most importantly, buyers recognize that the price for the particular stock (in this case, flower bulbs) doesn’t match the real value of a flower bulb.

The lesson here is straight forward, intrinsic value is merely the real value of the respective asset you are buying. With tulip bulbs,

© 2020 – 2022, David J Hoare MSA. All rights reserved.

error: Content is protected !!