The most dangerous idea in finance.

T here is an idea in finance so simple, so intuitive, that its destructive power is not immediately obvious and often goes unnoticed - it may be the most dangerous concept in finance for investors.

The idea is this: that there is a single rational price for a given asset at any point.

Valuation is inherently controversial.  This is because someone has to own every asset at every point in time.  That means the concepts of bubbles, overpaying, miss-pricing, are often obfuscated.  No-one wants to own - or pay for - an overvalued asset.

This contributes to investors often taking cues from other investors. Herd mentality. Safety in numbers.  Greater fool mentality.  But the danger is when those investors are playing different investing games.  In particular, when they have different time horizons.  Different holding periods.

For example: how much should you pay for Amazon today - what in-fact is 'fair value'?  

If your holding period is forever: you will want to understand intrinsic value.  Return on equity.  Return on capital invested.  Free cash flow.  Moats.  Margins. Management - to name a few.

Investing for a decade: similar, but maybe the sector dynamics are now more import.  Are we entering a golden decade of sector growth for instance.

Holding for a year: product cycles, business cycles, new tax laws, possible anti-trust intervention.

And for the day-traders: does value even matter?  Does any of the above matter in the same way?  If you buy at breakfast and sell at lunchtime, how useful is a discounted cash-flow analysis?  Value is arbitrary - change in value is what matters.

For every asset class there are investors of every time horizon.  Expensive to one investor can be value to another - in-fact most of the time this is a prerequisite for a trade to take place at all (not always, but often).  

One investor's meat is another investor's poison.

This dynamic can underpin financial bubbles - the danger.  Money chases returns in an ever increasing way.  As prices continue to increase, as they gain momentum, as greater and greater numbers of investors flock to a given asset, and those investors have increasingly shorter time horizons, bubbles build.  

Rather than the value of a company actually increasing, a financial bubble is a symptom of time horizons compressing as increasing number of short-term 'investors' (read traders; speculators) gravitate to a rising investment or sector as a whole.   

As human beings it is more comfortable to assume we are each making rational decisions, that markets are generally efficient, that information is mostly symmetric.  But every investor is playing their own game, with their own time horizon, their own view on value, their on view on risk, and their own internal conflict and rational - price is personal.  Price can be arbitrary.