Intrinsic Value

The concept of intrinsic value is generally frowned upon by economics. Value is entirely subjective, they will say, or they will say that value is whatever the going price is.

However, there is something about the concept of value that tells us that it cannot be price, nor entirely subjective. It must be something more. Furthermore, there must be some way to determine the fair value of things.

How are we to make investment decisions if fair value is whatever is currently paid, or merely what we happen to feel? Such metrics are completely useless to us as investors.

Luckily, there are good reasons to resurrect the concept of intrinsic value, and hence our ability to determine what something is worth based solely on objective qualities.

Warren Buffett summarized it as follows:

Price is what you pay. Value is what you get.

In this little quote, there is a lot of wisdom. First of all, price and value are separate things. The market does not determine value. It determines price.

Secondly, value is what you get. It has to do with utility. Also, it is related to scarcity.

If something is both useful and scarce, it is valuable. If something is either useless or widely available, it is not valuable.

To illustrate, we can take the following examples:

Imagine a store selling three products. These are bottles of fresh air, fresh four-leaf clovers, and gold rings.

It is immediately clear to us that the gold rings are the most valuable, despite being less vital to life than air, and more common than fresh four-leaf clovers.

The fact that air is widely available makes a bottle of fresh air worthless, and the fact that fresh four-leaf clovers have limited durability and utility make them too worthless, at least form an investment perspective.

Gold rings, on the other hand, have durability, utility as jewelry, and they are scarce. The fact that jewelry is universally appreciated by everybody in the world, no matter how rich or poor, adds to the value of gold.

Furthermore, there are several other features of gold that make it particularly valuable.

Gold is not only scarce, but its above ground quantity is very predictable. It takes enormous resources to mine gold. The above ground quantity of it goes up by predictable amount every year. There will not suddenly be a glut of gold in the world.

The fact that gold is never truly consumed, but always recycled, makes gold possession eternal. Gold does not wither or tarnish. It stays as fresh as the day it was mined for all eternity.

Some would say that the fact that gold never is consumed is a bad thing for its value. But all it takes to dismiss this is to ask someone what they would rather own. Something that withers and tarnishes over time, or something that lasts for ever. Let's say that silver came in two flavors, one eternal and one that tarnished, which would most people want to own if all other qualities are identical?

Even if non-tarnishing silver was vastly more common than tarnishing silver, the non-tarnishing type would be most coveted.

This helps to explains why gold is more valuable than silver, despite the relative abundance of above ground gold to silver.

All together, we can compile a long list of valuable qualities attributed to gold. These qualities can be expressed entirely in terms of utility. We do not have to put a price on any of them to realize that gold is valuable.

This is the intrinsic value of gold. We can all agree on their existence. We may not agree on the proper price for gold, but its intrinsic value cannot be denied.

From this, we can compare gold to other products and services. We can thereby determine a relative hierarchy of value. No two persons will come up with identical lists, so subjectivity is definitely a part of the valuation process. However, we cannot deny that certain things have more utility, and are scarcer than other things.

Very few people will value a bottle of air or a four-leaf clover above a gold ring.

The reason for this is that all things have intrinsic value that we can all agree on, at least in general terms.