Review: Austrian School for Investors
I recently read Austrian School for Investors, because I have been a student of investing for many years, and I know a group that has read the book for discussion.
Although I began the book with the anticipation of a clear explanation of the application of Austrian methodology to investing, I finished the book with a sense of disappointment. I would not recommend this book for anyone sincerely desiring to apply Austrian theory to investing.
Before I point out specific problems with this book, I want to revisit— subjective value theory, which sets the Austrian school apart from all other schools of economics. Although many know and advocate the subjective value theory, I believe that many don’t fully understand it. Its simplicity seems to disguise its fundamental nature and importance. After reading this book, I would put the authors in the group of people who know subjective value theory but don’t fully understand the theory and its application.
Here’s a simple explanation of the application of subjective value:
All exchanges occur because both parties value what they receive more than what they give up.
That’s it. No exceptions. Regardless of the purpose of the exchange.
People buy what they value more than what they give up. People sell what they value less than what they receive. This principle applies to all purchases/sales, whether the items consist of turkeys, iPhones, cars, houses, stocks, bonds, paintings, etc. No exceptions.
When people buy investments, they have a single objective, no matter what the investment vehicle: buy something for which someone else will, in the future, offer them in exchange something they value more than the investment. Regardless of their stated justification, they can have no other reason.
If the investor understands that simple objective, they only have the difficult task of making a reasoned guess about what others will want in the future.
If, in the process of making that guess, they expect the market to bid up the price of companies that show an accounting profit, investors should keep in mind the importance of consumers. The authors alluded to the importance of good company management, but they made no mention that good managers cannot record profits when consumers don’t purchase a sufficient quantity of their products.
For the sake of clarification, money does not represent an exception to subjective value. People pay an amount of money for a stock because, at that moment, they value the stock more than the money. Their rationalization for that value does not matter. Likewise, when they sell the stock for an amount of money, they value the money more than the stock. Money consists of just another commodity in investment transactions.
In addition, market prices — stated in a quantity of money — do not provide a measure of value. They only record the amount of one commodity (money) some people have decided they value more than the investment they gave up. Market prices only indicate what other people might give for a similar quantity of the same investment. They do not, to repeat, indicate value.
Because value, and its measure, always originates with individuals, another person cannot create nor store value. The answer to the question, “What’s it worth?” must always be, “I don’t know.” To cite a recent market price as a measure of worth or value consists of a logical fallacy.
The concepts I have described above amount to a recitation of ideas fundamental to Austrian methodology that the authors have ignored or contradicted in their description of “Austrian investing.” Yes, they do mention subjective value frequently, but, then, they proceed to make statements that conflict with subjective value.
I will give only a couple of examples of how the authors fail to apply subjective value rigorously.
“From the perspective of the Austrian School, the only way to sustainable capital accumulation and thus wealth accumulation, is thrift, value preservation, and responsible risk taking by employing liquid funds in roundabout ways on assets offering higher value creation potential.”
(Page 220) (Emphasis mine.)
First, the authors need to define wealth, a term which they frequently use in this book. Wealth becomes very difficult to define in terms of ordinal valuations determined by individuals.
Second, because of its subjective nature, value cannot be either created or preserved.
“At the core of value investing is the determination of a company’s fundamental (or ‘intrinsic’) value, which is examined independent of the stock price.”
(Page 281) (Emphasis mine.)
“The concept of intrinsic value implies a strict separation of ‘price’ and ‘value’. It should be noted here that the term ‘intrinsic value’ in this context is not meant to deny the fundamental subjectivity of value judgments. Rather, it is in the words of Robert Blumen, ‘the entrepreneur’s appraised price, based on assumptions about the future’.”
(Page 282) (Emphasis mine.)
In the two paragraphs cited above, the authors make the type of statement which makes this book, from a truly Austrian perspective, both frustrating and confusing. They first referred to intrinsic value, which they claim can be examined independent of stock price. They then state that their use of the term “intrinsic value” does not deny the fundamental subjectivity of value judgments. How can this be?
By using the term intrinsic value, the authors do deny subjective value judgments. One cannot reconcile their self-contradictory statement.
Also, the idea of separating price and value makes no sense. Prices result from the actions of buyers and sellers acting based on the structure of their separate value preferences. Without individually determined value, no transactions would occur, and thereby no prices registered. Prices, it should be noted again, do not represent a measure of value. They simply indicate a point in the relative range between what buyers and sellers value as individuals.
If you choose to read this book, keep in mind at all times that the purchase or sale of any asset occurs only because both parties value what they get more than what they give up. Understanding this one concept does not change the game; it will give you a clearer understanding of how to play the game.
- Austrian School for Investors: Austrian Investing between Inflation and Deflation by Rahim Taghizadegan, Ronald Stöferle, Mark Valek ↑