This is Part 4 of our book review of The Intelligent Investor, Revised Edition, Updated with New Commentary by Jason Zweig (affiliate link). Part 4 covers Chapter 8, The Investor and Market Fluctuations.
I am posting the series in reverse order so that they appear in sequential order on the blog. You may find the Introduction and relevant links at: Benjamin Graham – The Intelligent Investor Book Review – Introduction
The Investor and Market Fluctuations – Chapter 8
The stock market is prone to wild fluctuations. Investor do not always focus on the value of a stock like a business owner, but instead allow their emotions to affect buy and sell decisions.
Many investors focus on timing the market. In other words, they try to predict the market through direction, momentum, or various other indicators they believe predict the future. Mr. Graham contends “it is absurd to think that the general public can ever make money out of market forecasts”.
Through out The Intelligent Investor, Graham demonstrates that the investor should use pricing to make buy and sell decisions. We want to buy stocks when they are priced below their fair value and sell stocks when they advance above fair value.
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.
Graham used a parable with an imaginary investor named Mr. Market to illustrate how an intelligent investor should take advantage of market fluctuations. This is a parable about greed and fear, price and value, and how the intelligent investor will react.
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.
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 may choose to buy from him. When Mr. Market is willing to purchase an interest for more than its fundamental value the intelligent investor may choose to 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 or timing. 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.
It is important to be prepared for the inevitable market fluctuations with your finances and your intellect. In other words, you should be prepared financially and emotionally to to benefit from prices that are disconnected from their real values.
As an investor you should stop comparing yourself to others. Intelligent investing is not whether you can beat the market or not. It’s about sticking with your discipline and meeting your own investing goals.
Avoid allowing Mr. Market to influence your behavior, but instead take advantage of his irrational behavior by buying when he is despondent and selling when he is euphoric. If you concentrate on owning sound businesses at reasonable prices the results will take care of themselves.