Friday, April 2, 2010

The Intelligent Investor (Part 3): Mr. Market

As noted in the previous post, the Intelligent Investors have these traits:

- They see stocks as businesses - when you buy a stock you become an owner of that company
- They recognize two basic patterns the market has in unsustainable optimism and unjustified pessimism - both extremes are wrong so maintain a level head during bubbles and crashes
- They understand future value is a function of present price - the higher price you pay, the lower the return you will be
- They maximize margin of safety - never overpaying for a stock and reducing risks
- They develop discipline and courage - recognizing that your biggest enemy is yourself and not to be swayed by the market or other people's moods. You decide your fate.

Graham describes a character named Mr. Market throughout the book. See if you recognize him in yourself (p.204-205):

Imagine that in some private business you own a small share that cost you $1000. 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 $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 your 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. He must take cognizance of important price movements, for otherwise his judgment will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed-- this in plain English means that he is to sell his shares because the price has gone down foreboding worse things to come. In our view such signals are misleading at least as often as they are helpful. Basically, price fluctuations have only one significant meaning for the true investor. They provide 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 his dividend returns and to the operating results of his companies.

I fall into this trap a lot when the market crashes, I sell and when it goes high, I buy. Graham says our mentality should be the very opposite. When a good company goes out of favor with the market, it is time to purchase more when it is at a DISCOUNT and a BARGAIN. So next time you see the stock market crash. The Intelligent Investor's FIRST response would be: Great! Everything is on clearance!

Buy quality and buy value.

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