Why Investors Must Understand Value

Preamble – Parody never seems to work on the Internet. People do not want help in thinking. They want conclusions. They also do not have the patience to read to the end. Despite these facts, it is a powerful tool and I urge you to stick with me to the conclusion. Apologies to Mr. Graham and Mr. Buffett.

Introducing Mr. Market

Imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his. Even though you might think the business that the two of you own is stable, you are wrong. Mr. Market’s quotations vary widely and reflect ultimate truth. At times he feels euphoric because of his deep insight into the favorable factors affecting the business. In those times, 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 acutely aware of 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. On both cases, he sees the recent trend in prices as solid evidence about what will happen next.

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, but you are foolish to ignore his wisdom. He comes armed with charts and moving averages and golden crosses and omens. The “message of the market” is part of his message to you. Listen up!!

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to guide you. His wisdom is available to you, but not to others. It is not yet reflected in current prices. Only through his special interpretation of the message can you determine the true value of your business. Mr. Market helps you profit from reading the newspaper and stock quotes, even though it is the same information widely known to everyone, including professional investors. If it were a poker game, this information would be crucial in helping you beat the alleged experts at the table.

This is a world in which markets know more than you do, but are still not efficient. You just need to know how to jump in front of the news in your market timing.

The Real Mr. Market

And now, let us compare my version with the actual words of Warren Buffett from his investment letter of 1987 .

Imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his. Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. 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.

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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. Under these conditions, the more manic-depressive his behavior, the better for you.

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”

My take?

Misguided Market Timing

Following the emotional Mr. Market is the biggest reason that investors go wrong in their timing. The current market is a typical example. The big news is that markets have declined. Every journalist must produce a story explaining why. They all produce the laundry list of well-known worries. Investors see this as fresh information.

Mr. Buffett also explains why you get this information:

Ben’s Mr. Market allegory may seem out-of-date in today’s investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising “Take two aspirins”?

Investment Implications

There is no substitute for knowledge about your investments. If you think that loaning money to the US government for ten years at 2% is a great deal, then go for it! Make sure you have a concept of value.

If you think that Ebola represents a long-term threat to airline and recreation stocks, then the current prices might seem just right. If you see the chance of a reduction in panic, you might find an opportunity or two.

If you think that the large populations of China and India will be completely satisfied with current energy consumption, then you might agree with the stories about “glut” and the fire sale of energy stocks. If not, you might find some opportunity.

Written By: Jeff Miller