Price and Value: From Ibn Khaldun to Benjamin Graham
Price and Value: From Ibn Khaldun to Benjamin Graham
PT Usaha Tumbuh Orientasi Hidayah, a fictitious issuer with the ticker code UTOH, has recently announced a 100% increase in net profit compared to the previous year. At first glance, such an achievement should be good news for investors. However, after the financial report was released, UTOH’s share price rose by only 3.2%.
Why did the company’s profit double, yet its share price only increased slightly? Did the market fail to appreciate the company’s performance, or had investors already priced in that growth long before the financial report was published?
This phenomenon demonstrates that share prices are influenced not only by current business conditions but also by expectations, risk perception, and investors’ assessments of a company’s prospects. Even investors analysing the same company may not agree on a fair price to pay.
The issue of how prices are formed has been a focus in economic thought long before modern capital markets developed. In Al-Muqaddimah, Ibn Khaldun discussed the relationship between prices, societal needs, commodity availability, and economic conditions.
Centuries later, Benjamin Graham developed a different perspective in the world of investing by emphasising the importance of distinguishing market price from a company’s intrinsic value.
Both lived in different historical contexts and did not address exactly the same issues. However, bringing their thoughts together can help us pose a more fundamental question: understanding how prices are formed is important, but is that enough to determine the value of a business?
Ibn Khaldun and the Mechanism of Price Formation
Ibn Khaldun was a 14th-century Muslim thinker known through his work, Al-Muqaddimah. In this work, he discussed the formation of commodity prices by considering economic conditions and societal life.
He observed the price differences between essential goods and luxury items, as well as how population size, prosperity levels, demand, and commodity availability relate to prices in various cities.
This thinking is significant because it invites us to view price not as a standalone figure, but as the result of interacting economic conditions. To understand price changes, we need to look at the factors influencing them, rather than merely observing the final result.
However, the relevance of Ibn Khaldun’s thought must be placed appropriately. He discussed the price of goods within the context of the society and trade of his era, not stocks or corporate valuation. Therefore, his ideas cannot be directly regarded as a theory to explain modern capital markets.
Nevertheless, the underlying question remains relevant: how do economic conditions and the decisions of market participants affect prices? In the stock market, this question becomes more complex because investors do not only assess current company conditions but also estimate the business’s ability to generate profits in the future.
Stocks and Expectations
Stocks represent ownership in a company. When buying shares, investors are essentially buying a portion of a business whose economic prospects depend on various factors, including revenue growth, profitability, competition, and business risk.
Consequently, share prices reflect not only known information but also investor expectations for the company’s future. Two investors may analyse the same issuer but produce different valuations because they use different assumptions regarding growth and risk.
Returning to the issuer UTOH, a 100% increase in profit does not mean its share price should rise by the same percentage. If investors previously anticipated an even larger profit increase, the result might actually be considered disappointing. Conversely, if profit growth exceeds market expectations, the share price may rise more sharply.
Thus, share prices are influenced not only by the actual condition of the company but also by how information regarding those conditions is interpreted by investors. Differences in expectations then influence buying and selling decisions and are reflected in the interaction of supply and demand.
This is where a significant limit exists in using Ibn Khaldun’s thought. The discussion of conditions affecting price formation helps us understand market mechanisms, but it does not yet answer whether the formed price is commensurate with the company’s economic value. To answer that question, we require a different analytical framework.
Benjamin Graham: Price is Not Value
Benjamin Graham, one of the key figures of value investing, emphasised the importance of distinguishing market price from a company’s intrinsic value. Market price indicates how much must be paid to acquire a share at a given time, whereas intrinsic value is an estimate of the business’s economic value based on financial conditions, profitability, business prospects, and the risks faced.
Through the ‘Mr. Market’ analogy, Graham described the market as a partner who offers a different price every day. The price offered by the market could be too high or too low compared to the estimated business value.
Therefore, Graham emphasised the importance of a ‘margin of safety’—buying shares with an adequate difference below their estimated intrinsic value. This gap provides a safety buffer in case the investor’s assumptions are too optimistic or business conditions develop worse than anticipated.
This approach demonstrates that understanding price formation is not enough to make investment decisions.