Mr.Market

(Continuation of the wonderful compilation of Warren Buffett's sayings done by Bud Labitan called "The Warren Buffett Business Factors" but unfortunately the link I had recorded is broken.)


Ben Graham and Mr.Market

Ben Graham taught me that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values. The true investor welcomes volatility. Ben Graham explained this in Chapter 8 of The Intelligent Investor. There he introduced "Mr. Market," an obliging fellow who shows up every day to either buy from you or sell to you, whichever you wish. The more manic-depressive this chap is, the greater the opportunities available to the investor. That's true because a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to either ignore the market or exploit its folly.

Ben Graham told a story 40 years ago that illustrates why investment professionals behave as they do: An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. “You’re qualified for residence”, said St. Peter, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, “Oil discovered in hell.” Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. “No,” he said, “I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all.”

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:D

This classical tale of Dr. Jekyll and Mr.Market was told mentioned in Ben Graham's investment classic book The Intelligent Investor. (Chapter 8).

But the one version that I liked is retold by Mary Buffett in her book The New Buffettology.

Benjamin Graham introduced Mr.Market to Warren. (see page 34)

Mr.Market had an interesting personality trait that some days allowed him to see only the wonderful things about the business. This, of course, made him wildly enthusiastic about the world and the business's prospects. On other days, he couldn't see past the negative aspects of the business, which, of course, made him overly pessimistic about the world and the immediate future of the businesses.

Mr.Market also had another quirk. Every morning he tried to sell you his interest in the business. On days he was wildly enthusiastic about the immediate future of the business, he asked for a high selling price. On doom-and-gloom days, when he was overly pessimistic about the immediate future of the business, he quoted you a low selling price hoping that you will be foolish enough to take the troubled business of his hands.

One other thing, Mr.Market doesn't mind if you don't pay any attention to him. He shows up to work every day - rain, sheet, or snow - ready and willing to sell you his half of the business, the price depending entirely on his mood. You are free to ignore him or take up on his offer. Regardless of what you do, he will be back tomorrow with a new quote.

If you think that the long-term prospects for the business are good and would like to own the entire business, when do you take Mr.Market on his offer?

When he is wildly enthusiastic and quoting you a really high price?

Or when he feels pessimistic and quotes you a very low price?

Obviously you buy when Mr.Market is feeling pessimistic about the immediate future of the business, because that's when you get the best price.

Graham added one more twist. He thought Warren that Mr.Market was there to benefit him, not to guide him.

You should be interested only in the price that Mr.Market is quoting you, not his thoughts on what the business is worth.

In fact, listening to his erratic thinking could be financially disastrous to you. Either you will become overly enthusiastic about the business and pay too much for it, or you become overly pessimistic and miss taking advantage of Mr.Market's insanely low selling price.

Warren says that, to this day, he still likes to imagine himself being in business with Mr.Market. To his delight he has found that Mr.Market still has his eye on the short term and is still manic-depressive about what businesses are worth.

Warren has discovered that to take advantage of the market's pessimistic shortsightedness, he must invest in companies whose economics will allow them to survive and prosper beyond the negative news that creates a great buying opportunity.

To do this Warren has to make sure that the company in which he is investing is not only intrinsically sound enterprise, but also has the economic ability to excel and earn fantastic profits. Warren isn't interested in the traditional contrarian investor approach of bottom picking.

Only by selectively picking the cream of the crop is he able to recover, but continue upward.

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Mr. Market is there to benefit and not to guide!!

:D

Ever think of the share market in this perspective?

These investment gurus are teaching us that that our investment decision should never be influenced by the current share market price (what Mr. Market is quoting you) and definately not his thoughts on what the business is worth. Do not let your investment decisions be influenced by the drops in share prices and conversely do not be influenced by rises in share prices.

And this is where it does get complicated. No joke!

In Warren Buffett's Berkshire Hathaway's 1997 Annual Report * , Buffett remarked the following:

We ordinarily make no attempt to buy equities favourable short-term price behavior. In fact, if the business experience continues to satisfy us, we welcome lower prices as an opportunity to acquire even more of a good thing.

The very last part of what he said, "we welcome lower prices as an opportunity..".

And in my opinion, this is something, like the buy-hold thingy, which is usually badly misconstrued by the investing public. For they abused this simple teaching and erronously incorporate lower prices as the main reason to buy a stock. But if one takes the effort to re-read what Buffett is saying here, the lower prices is an opportunity to acquire even more of a good thing, if and only if the business experience continues to satisfy us. Meaning to say, the underlying business economics of the stock must still be good.

Imagine what could go wrong if one uses falling prices as a buying opportunity.

Well... think about why stock prices fall drastically first. Isn't there something wrong in the business that caused investors of the stock to dump the stock and head for the exit? Take the recent dramatic drop of Talam as an example. For sure, the share price has dropped so drastically. But is it really a buying opportunity because of this huge drop in share price? Now if the business does not improve and gets worse, and in Talam's case, what if the losses contninue for x number of quarters? Isn't it logical to say that there is a good possibility that the share price could even go down lower? Would one dare to discount such a risk?

Which is why investing is so complicated and so risky! And it is really difficult for the average investor to distinguish between a temporary setback in a company's business with a real deterioration of a business.

The winners are those that managed to pick out stocks with GOOD underlying business econimics but due to some unforseen circumstances faced temporary setbacks in their share price (like due to drepressed market sentiments) will be rewarded with fame and glory.

The losers? The losers are those who purchased a stock soley because they ass-u-med that the stock is cheap due to their low share prices. They failed to realise that the stock is cheap because the business is simply failing! And with the market being very unforgiving to such stocks, their stock investment would be punished severely. Things like falling profit margins, diminishing market share of a company product, company burning up cash faster than it generates, rising loans, rising inventories, rising receivable issues are clear distinctive signs that there is something drastically wrong with the business. And if such a stock experiences a huge drastic drop in their share price, like they say, why be a hero in a hard place? Why ask for trouble? Isn't avoiding the share a smarter and more logical reasoning?

Here's a perfect old example of what I have written before in a forum. ( Just Walk This Way ). That was way back in 2003. Bintai then was trading around 3.30. Bintai WAS really a good decent stock before it shares plummeted from 6.00+.

So same question, did this falling, lower price represent an investment opportunity or was it a dead trap?

Now because Bintai's underlying business economics has yet to recover, Bintai last traded at 1.00.

See how unforgiving the market is?

See how complicated and dangerous investing is?

Forget this not... NOT all lower prices equates to buying opportunities!

Yeah.. some would argue... no risk no gain dude... but do consider this... risking a lot to gain a little pales in comparison to risking a little to gain a lot!