The father of value investing, Benjamin Graham, used a parable with an imaginary investor named Mr. Market to illustrate how an intelligent investor should take advantage of market volatility. This is a parable about greed and fear, price and value, and how the intelligent investor will react.
If every investor did their research and only bought stocks with a margin of safety below the intrinsic value of the company, the market would be efficient and fairly stable. But we know that this isn’t true. The market swings wildly from day to day and takes large swings in valuation over periods of euphoria and pessimism.
The Parable of Mr. Market
Graham illustrated his lesson by asking us to imagine we own a share of a company. We have an imaginary partner in the business named Mr. Market who offers us a price every day at which we can buy from or sell to him our share of the company.
Mr. Market is an emotional man who lets his enthusiasm and despair affect the price he is willing to buy/sell shares on any given day. The fortunate aspect of this parable is that Mr. Market does not care if you take advantage of him. He shows up everyday with a price he is willing to buy or sell shares.
Sometimes he is exuberant and sets the price above the fundamental value of the business. Some days he is pessimistic and fearful, so he sets the price below the fundamental price of the business. On occasion, at emotional extremes, the difference between the price and the value can be extreme.
What Does the Intelligent Investor do?
The intelligent investor has done his homework. He knows the fundamental value of his interest. When Mr. Market wants to sell at prices far below intrinsic value the intelligent investor will buy from him. When Mr. Market is willing to purchase an interest for more than its fundamental value the intelligent investor will wisely sell to him.
I love this story because it is simple and yet profound in its real life application. It’s a mindset of looking for opportunities based on value and price, not on emotion. It’s the discipline of avoiding owning assets that are priced above their real value.
The intelligent investor will attempt to take advantage of Mr. Market by buying low and selling high. There is no need to feel guilty for ripping off Mr. Market, after all he is setting the price. As an intelligent investor you are doing business with him only when it’s to your advantage; that’s all.
Happy Value Investing!
Related Reading: Perceived Risk vs. Real Risk: A Key to Successful Value Investing