Hello Mr. Market
In my previous articles (Part I, Part II), I have described some of our thought processes and mind sets when we are buying or selling a stock. We discussed our fear of losing, our cravings to be liked, and our need to act now. We also discussed how overconfidence and commitments to previous decisions or information can impact our investment decision process.
My intention in this article is to introduce you to Mr. Market, the manic-depressive figure that was created in the mind of the brilliant professor Benjamin Graham. I will also provide a different point of view for investing in the stock market.
Before we start talking about Mr. Market, let me ask a very simple question:
What is a stock?
Easy question isn’t it? Before continuing reading, give yourself 30 seconds to answer this question. Well, here are some answers that I got when I asked other people, “A stock is a sure way to make (lose) money”, “A stock is a company”, “A stock is the price of a company”, “A stock is this really annoying 3 letter words that run on the bottom of my CNBC screen and makes me dizzy”
A stock represents a partial ownership of a business/company. For example, think of a media company, let’s call the company MyMediaCompany. The company has 1 million shares (stocks) outstanding, which means that by buying one share of MyMediaCompany you really own one millionth of MyMediaCompany. This is a very important concept. A stock is not just a ticker or a 3 letter word, a stock represent a partial ownership in a business, which means that as a partial owner of MyMediaCompany you partially own its web site, movie studios, TV channels, book publishing, theme parks cruise lines, hotels, media stores etc’. You get my point; by owning a stock of MyMediaCompany you are a partial owner of all that MyMediaCompany owns.
Why is this so important to understand this concept?
Let’s explore some of the answers that I received about why a person bought a stock of a company (or shares of a company):
- I bought the stock at $5 because $5 is a cheap price
- I bought the stock because my friends owns it
- I bought the stock because it use to be $50 and now it is $20 so it must be cheap
- I bought the stock because it has to go up
- I bought the stock because the yelling news anchor said the price graph is in an head and shoulders formation and it is reaching the price breaking point. Yes, someone really told me that!
All of these answers focus on the one piece of information that is the easiest to get – the stock price and ignore the most important question that we should ask ourselves – What is the value of the business behind the ticker, the business that this stock represent?
Just by understanding the value of the company you can tell if the price of the stock is cheap or expansive.
Valuing a company is not an easy task, but it is the first and most important step that needs to happen before you purchase a stock, Peter Lynch once said “Spend at least as much time researching a stock as you would choosing a refrigerator”. I will write more about why companies issue stocks, ways of valuing stocks, research and refrigerators in my next article.
Now that we know that a stock represents a partial ownership of a company, and that the most important activity is first to value the company and only then to look at its price, it is easy to conclude that only once you know the value of the company and the offering price you will be able to make a prudent investment decision. Mr. Buffet tells us “Price is what you pay, Value is what you get”. Always demand more value for your purchase price.
So, who decides the price of the companies?
Again, I went out and asked a few people. Here are some of the more interesting answers that I have received:
- The market decides the price
- The government decides the price
- The companies decide the price
- It is all one big gambling machine
- The ticker decides the price (yes, I have heard that as well)
There is probably some truth in every answer. The real answer is that in the short term we, the investors (and all sort of other automatic software programs), decide the market price of the companies. In the long run, the company’s results impact its market price.
Where is this price being decided? Ok, that’s an easy question; it is decided in the stock exchange. But what is the stock exchange? For the sake of simplicity, let’s think about the stock exchange as a big market in which people decide how much they are willing to pay in order to buy a share of a company and at what price they are willing to sell a stock.
At last, here comes Mr. Market.
Prof. Benjamin Graham, which is known as the dean of value investing, and has written two fabulous books that are a must for any serious investor (“Security Analysis” and “The Intelligent Investor”) have used a character which he called Mr. Market to explain the above concepts.
You can think of Mr. Market as a character that has one unique characteristic; he will come every day and offer to buy or sell a fractional share in a company at a price that he sees fit. The most useful characteristic of Mr. Market is that he will not take any offence if you ignore him, he will still come the next day with another price offer.
If you are investing from a business prospective you will ignore Mr. Market until your facts (obtained by your research) will indicate that Mr. Market’s quoted price has a wide discount from the true value of the business that he tries to sell or buy from you. You can ignore him in all other cases; remember Mr. Market will always show up the next day with another offer. The important question that you should ask yourself is:
Will you let Mr. Market daily quotation determine the true value of the business, or will it be you who determine the true business value and use Mr. Market manic-depressive behavior for your advantage, buy from him when he offer you the business at a foolishly low price and sell to him when he offer to buy at an equally foolish high price.
It is you who decides if you want to let Mr. Market influence your investment decisions or if your research, facts and reasoning prevail. As Benjamin Graham said “Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom that you will find useful”.
And what should you do in all the other times?
You do nothing. Yes, remember a decision not to buy and not to sell is one of the most important decisions that an investor can make. All you need to do is to deepen your knowledge and wait for the next time in which you will be able to take advantage of dear Mr. Market.
Mr. Charlie Munger (Berkshire Hathaway Vice Chairman) likes to say that “you don’t make money when you buy stocks. And you don’t make money when you sell stocks. You make money by waiting”
What to do when you wait? Why can’t we wait? Is waiting really that simple? I will answer these questions and many more in the next article.
Avitzur Asset Management, LLC
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