In this period of high uncertainty for investors, a winning investing mindset and a strong temperament are the things that can make all the difference.
In this article, we are going to look at Warren Buffett’s comment on taking advantage from Mr. Market from the letters to Berkshire Hathaway shareholders’ of 1987 and 2012.
This is an emotional period of time for investors it is easy to get stuck or act based upon fear that causes negative long-term consequences. The timeless wisdom by Ben Graham and Warren Buffett are still the foundation of investing success and often times it is a matter of framing the situation differently.
Today is very easy to find a lot of information about whatever company or market situation you want to analyze. When it comes to making a decision, the most challenging part is not to gather information but to manage the information overload.
In the midst of all that mess, most of which is simply noise, there is one thing that we can count on and is that the market has and will have price fluctuations.
Stock Market Fluctuations
Big or small, we as investors should embrace price fluctuation because they are what allow us to spot opportunities and take advantage of particular situations by having the right mindset.
That’s the key for successful investing. If all investors based their investment decisions on rational and conservative estimates of intrinsic value, it would be very difficult to make money in the stock market.
This doesn’t happen for a number of reasons: first because there is not really a single estimate of fair value true for everyone and second because market participants are human (or algorithms coded by humans) and subject to a wide range of emotions that often times take over as the driver of decision making.
The fact is that the large majority of investors don’t focus on the value of stocks like business owners would do, they try to time the market spotting short-term opportunities.
Therefore, investors frequently tend to show over-optimism and greed, causing stock prices to go up (sometimes resulting in a bubble), transforming them into excessive pessimism and fear when things start to change, driving stock prices substantially below intrinsic value.
The Parable of Mr. Market
The explanation of this behavior was presented very clearly by Ben Graham in the milestone book The Intelligent Investor through the parable of Mr. Market.
Mr. Market is a hypothetical investor who is driven by emotions and everyday offers a different price for the same business depending on how he feels, letting his enthusiasm and despair to determine the price.
His perception of the value of the business changes every day and he doesn’t really care whether you take advantage of him or not, after all, he is setting the price.
The Intelligent Investor, someone that is prudent and has made a good estimate of what the business is worth, can take advantage of that behavior. Graham wrote:
“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.”
He offered intelligent investors an alternative to the pendulum of greed and fear.
“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 sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market.”
Warren Buffett on Mr. Market
Buffett surely understood and applied what his mentor Ben Graham meant to say. Here is a very interesting point of view by Warren Buffett taken from the 2012 and 1987 Berkshire Hathaway shareholders’ letters.
In his 2012 shareholder’s meeting (video), here is how Warren Buffett described this idea of taking advantage of Mr. Market’s behavior:
…the beauty of stocks is they do sell at silly prices from time to time. That’s how Charlie and I have gotten rich. You know, Ben Graham writes about it in Chapter 8 of the Intelligent Investor.
You know, next to — well, Chapters 8 and Chapters 20 are really all you need to do to get rich in this world.
And Chapter 8 says that in the market you’re going to have a partner named “Mr. Market,” and the beauty of him as your partner is that he’s kind of a psychotic drunk and he will do very weird things over time and your job is to remember that he’s there to serve you and not to advise you.
And if you can keep that mental state, then all those thousands of prices that Mr. Market is offering you every day on every major business in the world, practically, that he is making lots of mistakes, and he makes them for all kinds of weird reasons.
And all you have to do is occasionally oblige him when he offers to either buy or sell from you at the same price on any given day, any given security.
The stock market is the most obliging, money-making place in the world because you don’t have to do anything.
You know, you sit there with thousands of businesses being priced at the same price for the buyer and the seller, and you don’t — and it changes every day, and you’ve got lots of information about most of those businesses, and you don’t have to do anything.
Compare that to any other investment alternative you’ve got. I mean, you can’t do that with farms.
If you own a farm and the guy has the farm next to you and you’d kind of like to buy him out or something, he’s not going to name a price every day at which he’ll buy your farm or sell you his farm, but you can do that with Berkshire Hathaway or IBM.
It’s a marvelous game. The rules are stacked in your favor, if you don’t turn those rules upside down and start behaving like the drunken psychotic instead of the guy that’s there to take advantage of it.
While this may sound really boring, and to some extent it probably is, it is still a great approach to the stock market especially for those that are in for the long run.
In his 1987 letter he stressed out how investors should not try to chase the ultimate investing strategy because business judgement and temperament are the most important factors for investing success:
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”? The value of market esoterica to the consumer of investment advice is a different story.
In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben’s Mr. Market concept firmly in mind.
There are all kinds of research that show that over periods of 30 years or longer there has never been a period in which stocks didn’t outperform cash, bonds and inflation, even if there were downturns along the way.
However, the long run is…long, and 30 years might be a long time to wait and it is easy to get bored. Yet, if you are below 50, chances are that you will live longer than 30 more years and if you are younger, your time horizon is even further.
If your investments are a long-term project, constantly following stock price changes is a very bad idea because it does not produce any additional result and makes you act emotionally because our psychological biases make us so sensitive and adverse to short-term losses.
If you focus on the stock market price changes, you are not taking any advantage from the market, is the market that is taking advantage of you. Take advantage of Mr. Market, determine the value of the businesses that you want to own, be patient, allow compound interest to work, decide in advance what to do and never act emotionally.
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