Counterparty risk assumptions

how do you determine the objectively correct intrinsic value? everyones guessing man, one persons concept of mispricef could equal anothers perception of fair value

The enforcement mechanism is the motivation of each investor to maximize value. This is like an auction.

This isn't counterparty risk, but the major mechanism is that all shareholders want a return on their investment. The big players who want returns on their investment and have enough shares to possibly get their favored directors on will either want the company to pay dividends or buy back shares to raise the price, and they can't do it without the small investors also getting their piece of the pie.

This assumes that the company is generating cash flow to do these things. It's not a perfect mechanism and the company might remain undervalued, but if they're hoarding cash rather than investing it internally, eventually enough shareholders are going to want that cash to force their hand.

this boils down to "how to corps return value to shareholders", and the answer is simply buybacks and dividends

I feel like you are being dense on purpose here.

I think we're confusing ownership of a business with owning a portion of a pizza. When you own a portion of a business, you can't just walk away with the cash, its not a pizza that you just take your slice and leave. Someone MUST buy your share of the company to pay you anything. If everyone just walked away with their portion of the cash the business would cease to be. Owning a part of a company is never owning a portion of a stockpile of money and its not owning 1% of an office chair. You can't sell 1% of an office chair and you can't just sell 1% of a company. Your ownership is simply voting rights in the future of the company. Those voting rights have value to other people but you can only sell them if someone else wants to buy them. It's not about the pile of cash, its about the power of ownership.

When it comes to dividend stocks the company specifically does take a portion of the cash and divides it up by those people who hold the voting power, but its because they are the ones that "risked" their capital. Someone at the beginning IPO risked their capital to buy into this company. Every person after that is buying that persons "stake" in the fate of the company, whatever it may be and the company in its by laws and structures have determined a process by which they share some of those profits with those rights holders. This is the only time stock ownership works anywhere close to what you're describing.

Once a company goes public there is no one person that can just swoop in and "chop of the pile of cash and hand it out". That's why to incorporate and to go public there are so many bylaws, structures, and legal documents you have to draft.

You are asking the question like we're splitting a pizza, but that's not what is happening.

There is no mechanism that keeps it proportional to value of the assets. That is the entire concept of Price to earnings -> The price of all those ownership stakes \* the current price being traded vs the actual earnings of the company. These range from 0 to over 100 in extreme cases. You migth be buying it because its cheap, or you might be buying it because you think it will go somewhere big in the next year. On this premise alone there is not a mechanism to control proportion because to me its worth a lot more because I expect it to go up, vs someone else might expect it to stay the same and so they don't want to pay the price.

I think price to earnings is what you are driving at, but you are making a false assumption about a mechanism existing. There is none. I currently own shares of 2 biopharma companies that have "no value". The companies are not bankrupt and have still been listed for 3 years. I cannot realize those losses because literally no one wants to buy it and until, as a corporation, by the by-laws all parties agree to fully dissolve it (and even then laws govern the selling of the assets and how peopel get paid out). If there IS money left over when it gets all the way down to shareholdes, I would then be compensated, but any company in these situations has more debt than even the chairs in the office can be sold for so I won't see a dime when they do. So I own a stake in something that has cash flow, but because its a dying company and no one wants to buy my stake, its mostly worthless.

I don't just get "1% of what's left" because you aren't buying a pile of cash or even a cash flow - you are buying a stake in the fate of the company whatever it is, and the stock market is simply trading the perceived value of that stake in the company. Almost the entire market is speculative perceived values.

I hope this helps put it in perspective?

Great discussion. I do not believe in valuation based investing. But, assuming that the company has a pile of cash and other liquid assets, a corporate raider (or a private equity firm) can arbitrage the difference between price and value. Other People’s Money (1991) starring Danny DeVito provides a good case. This video clip is central to the movie’s premise:

https://youtu.be/gtvTY3hYYQ4?si=gYn\_k-5ajQSbG1Ca

You can ask the same about the value of a dollar. It's a piece of paper or an electronic token. Who is going to agree to exchange goods or services for it? How can you force someone to do it?

Your share represents a share of assets and future revenues. We all agree that it does and act accordingly.

Earnings are money. We value money because other investors value money. The entire stock market is about making money.

you’re making an unrealistic assumption that you somehow are able to determine the legitimacy of a companys books and that theres also been a marketwide gentlemans agreement to never buy the stock and keep the share price undervalued forever

if you found this obviously hidden gem, you’re going to buy as much as you can and the price will rise accordingly. others will catch on and the price rises more. the incentive for this happening is basic supply and demand

Earnings determine how profitable a company is, and by extension, how valuable the stock is.

A pile of cash can't be undervalued or underpriced so I really don't know what we're talking about at this point.

I do at this point feel like you're arguing for the sake of argument and have lost the plot of your own original question as you weren't ever originally talking about a pile of cash and now you are talking about a pile of cash but trying to attribute market attributes on an asset to a literal pile of cash which does not have market attributes - a pile of cash cannot be undervalued. So here is your original question broken down with specific responses:

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"I'm a big believer in value investing and Warren Buffett's ideas of buying companies for less than what they're worth.

But here's the part that I could never wrap my head around... Let's say a company's "intrinsic value" is $200 per share, but the stock price is $100/share. Ok, so that's a good buy then, you're buying "a dollar for fifty cents", as Buffett puts it."

"But, in order to make money, the PRICE needs to go up, because you need to sell it. You only own a tiny fraction of the company, so you don't actually receive the cash flows yourself. So if the market stays irrational and the price never catches up to the intrinsic value, you could still lose money." (This is where price is important, price is the perception of value someone is willing to pay for. Prices can be irrational and they can stay irrational indefinitely. Just look at the prices of the mag7 - they are pricing in for an expected future valuation that is massively variable because it is different in everyone's head what they could be worth in 3 to 7 years.)

"Now if you had a controlling share of the company, or wholly owned the company, those cash flows would be yours and the intrinsic value is all you care about. Warren said he doesn't really care about the stock price, he just wants to own good businesses... That's great if you can buy the whole company outright, but let's say his KO shares went down fifty percent and stayed there for decades, not keeping up with its intrinsic value... wouldn't that impact him as much as any other investor??" (yes it would impact him as much as any other investor. If you wholly owned the company it wouldn't be on the stock market, it would be a private company. If you wholly own all shares - you do not care about the intrinsic value because you must sell those shares and as you sell them price discovery will happen and the price will fall. You still care about the perceived value of the shares and if its a publically traded company. If Elon Musk tried to sell large portions of his shares it would literally tank the price of his companies and their current price based market cap, because the price would fall as everyone is not willing to buy at the same price.

I feel like something's missing here, what force is there in the market to keep the price and the intrinsic value close to each other? Is there some arbitrage I don't know about? Can't a stock just be mispriced forever? Or are value investors relying on faith that price eventually catches up to intrinsic value? (yes a stock can be mispriced forever. Value investors are relying on faith that price eventually catches up because they believe in certain theories about that market that the price will eventually come to fruition but that is a theory. That's why its the value investor thesis. Warren buffet bought good businesses because he assumed that good business with good operations will grow or continue to generate revenue. He was not a speculative investor. He did not win on every trade he made, sometimes a company will change management or pivot its goals / operations before the price catches up. Value companies are not doing as great now because so much capital is being poured into a yield hungry market - value companies tend to do better when growth slows down or turns down and people start looking to other parts of hte market for returns.)

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I hope this clarifies all that the comments have been trying to describe.

The risk you re concerned with is not counterparty risk, but poor governance risk. Poor management risk.

Particularly for small companies there is not a lot that can be done to force management to do better.

If you look at the cases where the company has a market value less than cash, or at least less then net assets, you will often find it to be a microcap company domiciled/incorporated in a very management friendly state like Nevada, and with a large percentage of the company held by insiders. The other red flag to look for are related party transactions. Those are the conditions where the management may run the company in such a way that over time the cash gets transferred the managers via salary, bonuses, stock option grants and other incentive grants, and sometimes via related party transactions such an oil company hiring the well drilling company owned by the CEO.

In some cases there isn't an effective way to improve management. In that case the low market valuation of the company is very reasonable and will not change.