In 1949, Benjamin Graham published The Intelligent Investor, which became one of the most widely acclaimed books ever written on the topic of investing. Mr. Graham was a professor at Columbia Business School at the time and he also ran a very successful investment partnership. One of Professor Graham’s students, Warren Buffett, would later go on to say that The Intelligent Investor was the greatest book ever written on the subject of investing. Given the recent volatility in the stock market, we thought it would be helpful to review the chapter in The Intelligent Investor which deals with the investor’s attitude towards market fluctuations. In chapter eight of the book, Graham provided an extremely useful framework to help investors deal with the short-term ups and downs in the stock market. Graham wrote that investors should consider stock prices to come from a business partner named Mr. Market who shows up every day and quotes a price at which he is willing to purchase your interest in the business or sell you his. Unfortunately for Mr. Market, he suffers from emotional troubles and exhibits wild mood swings on a regular basis. In his 1987 Berkshire Hathaway Shareholder Letter, Warren Buffet provided this characterization of Mr. Market:
“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.”
During stressful periods in the market, we believe using the Mr. Market framework is very helpful. For example, the stock market has been incredibly volatile so far in 2016. In just the first 26 trading days of the year, the S&P 500 has moved by 1% or more 16 times, which is nearly twice the rate of last year. In the face of such volatility, it can be easy to lose sight of the fact that often times market prices are much more volatile than the underlying changes in business value that stock prices are supposed to represent. It is not uncommon at all for a stock price to move by 30% or more (from high to low or vice versa) within a twelve month period, yet it is highly unlikely that the underlying value of the business has really changed to such a great extent.
It is important to keep in mind that often times Mr. Market prices stocks based on emotion rather than fundamentals, and as a result, his price quotes should in no way guide investors. He should either be ignored or taken advantage of; however, he certainly shouldn’t be seen as possessing some type of special insight. Falling under the spell of Mr. Market can be a particularly dangerous mistake. One of the biggest errors investors can make is succumbing to fear and selling a stock for no other reason than it is declining. How does it make sense that an investor would be more tempted to sell the lower the price offered by Mr. Market? The value of a business is determined by the results of its operations over the long run and this is what investors should be focused on. We don’t look to Mr. Market for validation of our investments over the short-term, rather we look to the performance of the businesses themselves because we know that, despite Mr. Market’s wild short-term mood swings, ultimately the market will recognize value.