MEET BENJAMIN GRAHAM'S MR. MARKET
May I introduce you to Mr. Market. But NOW (here) with his full name: Mr. BULL Market :-)
Mr. Market is a parable that Ben Graham used in his teachings and that's found it's way into the heart of value investing. Mr. Market helps us remember...
... the difference between market price and intrinsic value / so the story goes something like this:
Imagine that in some private business you own a small share that cost you USD 1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a USD 1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form you own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination... Basically, price fluctuations have only one significant meaning for the true investor. They provided him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention... to the operating results of his companies.
Warren Buffet (the student OF Ben Graham ;-) on Mr. Market
Warren Buffett has also talked about Mr. Market. As always, Buffett shows his ability to clearly explain any topic in this following passage from the 1987 Berkshire Hathaway Shareholder Letter:
"Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his."
So he goes on >>
Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.
Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.
But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game. As they say in poker, "If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy."
...[A]n investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben's Mr. Market concept firmly in mind.
Here is what Ben Graham had to say
...about Mr. Market in his book "Intelligent Investor"
Benjamin Graham wrote in Chapter 7 of "The Investor and Marketing Fluctuations of The Intelligent Investor":
[N]ote this important fact: The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgment.
Jason Zweig notes that "this may well be the single most important paragraph in Benjamin Graham's entire book. In these 113 words Graham sums up his lifetime of experience. You cannot read these words too often; they are like Kryptonite for bear markets. If you keep them close at hand and let them guide you throughout your investing life, you will survive whatever the markets throw at you."
It's foolish to think that all stock price declines are merely the result of the market being fearful. Often, a decline in share price can be warranted. But remember, in the short-run the stock market is a a voting machine; in the long-run the stock market is a weighing machine.
Stock prices will fluctuate day-to-day. But over many years, stock prices should and will reflect the true intrinsic value of the underlying business.
Remember, Mr. Market has incurable emotional problems (recheck the Driving license above; Being a Bull stuck in a suit can lead to strange outcomes...). Sometimes he's happy, sometimes he's depressed. But he doesn't mind being ignored, and he'll always be back tomorrow to quote you a new price. So let Mr. Market serve you and not guide you. Take advantage when he quotes you an attractive price and ignore him the rest of the time. Keep this in mind, and you will survive whatever the markets throw at you!