This is a companion piece to our recent essay Rational Price.
Fellow Partners,
Nowadays people know the price of everything and the value of nothing.
Oscar Wilde
Imagine you were going to purchase 100% of an asset you admire — say, all the shares of a wonderful business, all the homes in your favorite seaside town, or all the gold in the world. How much would you have to pay? The answer would be much more than was implied by the most recent market price.
In calm markets most transactions take place near the middle of a range of potential prices for the given asset. The price boundaries are not tested.
Euphoric markets test upside price bounds.
Pessimistic markets test downside price bounds.
But rarely do markets reveal absolute price — the price one would have to pay to own 100% of a given asset.
This is irrelevant for traders. Their focus is on price.
This is essential for owners. Their focus is on value.
The Anatomy of Value
Consider a pursuit to buy 100% of a desirable asset.
Phase 1: buy before the market finds out.
When one starts buying an asset, they encounter sellers willing to part with their position at recent market prices. Some will sell at a slight discount. A few may sell at a substantial discount. Collectively these sellers allow current market prices to determine the value they ascribe to their positions.
This is the easiest buying phase.
Phase 2: the market knows…now up your offer.
One’s buying difficulties increase with one’s ownership stake. Sellers will begin to exploit the presence of a large buyer, requiring the buyer to increase their offers. Some will accept offers slightly above recent prices. Some will want larger premiums.
This buying phase requires more haggling. But it is still anchored to recent market prices.
Phase 3: the wall.1
Our most profitable insights have come from recognizing the deep reality of some businesses.
Nick Sleep
Eventually one will encounter sellers who believe their positions are worth far more than recent market prices. Some will be delusionary. Some will be emotionally attached. But if it is a high-quality asset, some will simply be better attuned to the long-term value of the asset than the market writ large.2 Markets rarely surface these values. When they do, they can become key pivot points.
Conflation
As recently discussed, Rational Price can vary substantially depending on one’s time horizon.
The last and most reluctant sellers — typically hidden because they rarely transact — are a critical group.
The total value of an asset is typically estimated by multiplying the asset’s last traded price by its total quantity, giving us market capitalization. It’s a reasonable calculation, but conflates the price of a recent transaction with the potential price of all transactions.
Conflating “any” and “all” with respect to price is a recipe for poor thinking.
For example, the current market cap of all above-ground (mined) platinum is about $225 billion. Now imagine buying all of it — including all those wedding rings — with a $225 billion budget. You wouldn’t even come close. Belief in what the asset is, or could become, gets in the way. Even without the additional value applied to the raw material (e.g., raw platinum smithed into jewelry), there is a wide range of opinions on the value of the asset.
The same is true of many businesses whose publicly traded shares are a fraction of total outstanding shares (ask Jeff Bezos for the price at which he would sell all of his Amazon shares), or any asset held for properties beyond their current market prices (gold for gold bugs, bitcoin for bitcoiners, founder’s shares for founders, hedging instruments for hedge funds, etc.)
Options
This creates two basic options.
Option 1: Focus on price. Buy and sell assets frequently. This is a zero-sum game — the best win at the expense of the rest — that incurs relatively higher fees and taxes.
Option 2: Focus on value. Buy and sell assets rarely. This is a positive-sum game that focuses on allocating capital to quality.
Good investment analysis helps companies raise the world’s standard of living. Enterprises work best when they have access to capital priced to reflect the value they can create. Index funds, by the way, do not price capital; they only mimic the actions of those who do.
Abdiel Capital
Option 2 is the most rational for this partnership’s disposition and capital duration. We believe in keeping our focus on the business, knowing why, and building better businesses.
We are watching our businesses’ progress, confident that their long-term rational value will eventually be reflected in their prices.
All the best,
John
Founder and Managing Partner
There are nuances to this anatomy across different types of assets — e.g., Boards are generally required to consider all purchase offers. But the basic principles are the same.
This is where insider buying and selling can provide some wonderful tells. Large inside owners selling substantial portions of their position do not inspire confidence; conversely insiders aggressively buying common stock in their company can be a great signal.