I’ve said numerous times, the most important lesson in The Intelligent Investor is Ben Graham’s Parable of Mr. Market. It’s a simple story for how the market works, how some investors view price movement, and how you should really view price movement.
But it’s also one of those stories that are easy to understand but harder to actually put into practice when market prices move wildly.
That said, I think it helps to see the market through the lens of (childish) behavior – temper tantrums, throwing fits, impulsiveness, hysteria…it’s all possible and more. You can take advantage of opportunities Mr. Market offers or you can do nothing but whatever you do, don’t let Mr. Market’s mood drive your own.
So whenever I come across a good version, told by someone other than Graham, I save it or post it here, as a reminder that the stock market is an exchange for pieces of businesses, not paper. The prices reflect Mr. Market’s mood toward the paper, not necessarily the value of the business.
Seth Klarman tells a great version in his book worth sharing:
An ever helpful fellow, Mr. Market stands ready every business day to buy or sell a vast array of securities in virtually limitless quantities at prices that he sets. He provides this valuable service free of charge. Sometimes Mr. Market sets prices at levels where you would neither want to buy nor sell. Frequently, however, he becomes irrational. Sometimes he is optimistic and will pay far more than securities are worth. Other times he is pessimistic, offering to sell securities for considerably less than underlying value. Value investors – who buy at a discount from underlying value – are in a position to take advantage of Mr. Market’s irrationality.
Some investors – really speculators – mistakenly look to Mr. Market for investment guidance. They observe him setting a lower price for a security and, unmindful of his irrationality, rush to sell their holdings, ignoring their own assessment of underlying value. Other times they see him raising prices and, trusting his lead, buy in at the higher figure as if he knew more than they. The reality is that Mr. Market knows nothing, being the product of the collective action of thousands of buyers and sellers who themselves are not always motivated by investment fundamentals. Emotional investors and speculators inevitably lose money; investors who take advantage of Mr. Market’s periodic irrationality, by contrast, have a good chance of enjoying long-term success.
Mr. Market’s daily fluctuations may seem to provide feedback for investors’ recent decisions. For a recent purchase decision rising prices provide positive reinforcement; falling prices, negative reinforcement. If you buy a stock that subsequently rises in price, it is easy to allow the positive feedback provided by Mr. Market to influence your judgment. You may start to believe that the security is worth more than you previously thought and refrain from selling, effectively placing the judgment of Mr. Market above your own. You may even decide to buy more shares of this stock, anticipating Mr. Market’s future movements. As long as the price appears to be rising, you may choose to hold, perhaps even ignoring deteriorating business fundamentals or a diminution in underlying value.
Similarly, when the price of a stock declines after its initial purchase, most investors, somewhat naturally, become concerned. They start to worry that Mr. Market may know more than they do or that their original assessment was in error. It is easy to panic and sell at just the wrong time. Yet if the security were truly a bargain when it was purchased, the rational course of action would be to take advantage of this even better bargain and buy more.
The fact that a stock price rises does not ensure that the underlying business is doing well or that the price increase is justified by a corresponding increase in underlying value. Likewise, a price fall in and of itself does not necessarily reflect adverse business developments or value deterioration.
It is vitally important for investors to distinguish stock price fluctuations from underlying business reality. If the general tendency is for buying to beget more buying and selling to precipitate more selling, investors must fight the tendency to capitulate to market forces. You cannot ignore the market – ignoring a source of investment opportunities would obviously be a mistake – but you must think for yourself and not allow the market to direct you. Value in relation to price, not price alone, must determine your investment decisions.
Margin of Safety
- Warren Buffett Explains the 2008 Financial Crisis (video) – WSJ
- Lehman’s Lessons, 10 Years Later – WSJ
- Concealed Emotions – M. Housel
- The Decision Matrix: How to Prioritize What Matters – Farnam Street
- How to Make a Big Decision – NY Times
- Things Fall Apart (Part 2) – Epsilon Theory
- A Market Shakeup Is Pushing Alphabet and Facebook Out of the Tech Sector – Barron’s
- Bezons Unbound: Exclusive Interview with the Amazon Founder on What He Plans to Conquer Next – Forbes
- Interview: Tom Murphy, Chairman & CEO of Capital Cities/ABC (podcast) – oGoLead Podcast
- How a Growing Market for Citrus Fruit Spawned the Mafia – Aeon