eBusiness Weekly
Kudzanai Sharara
In his book “The Intelligent Investor,” Benjamin Graham created an imaginary investor named Mr Market.
According to Graham, Mr Market is the man who pulls the strings on the stock market.
Depending on his mood, Mr Market determines the direction in which the market will take on a given day, week, month or year.
When in a bullish mood, Mr Market can pay anything to get his shares and as a result share prices will go up across the board.
But when Mr Market is in a bearish mood, he would be looking to sell off his shares at whatever price, even at a loss.
Mr Market can better be described as irrational, emotional and certainly moody. Investors are better advised to have their own strategy and not dance to the tune of Mr Market.
Just as Graham said, Mr Market is very emotional to a slightest bit of news.
When news seems positive, Mr Market displays his irrational exuberance, paying through the roof.
But when news seems negative, Mr Market is also quick to press the panic button.
The best way to react to Mr Market’s mood swings is to take advantage of them. When he is pessimistic buy from him and when he is euphoric sale to him.
Graham’s mentee, Warren Buffett once said that it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful.”
We can change that and say it is wise for investors to be “fearful when Mr Market is greedy, and greedy when Mr Market is fearful.”
This statement relates directly to the price of an asset: when others are greedy, prices typically boil over, and one should be cautious lest they overpay for an asset that subsequently leads to anaemic returns.
When others are fearful, it may present a good value buying opportunity.
That’s the basic rule of investing. Buy low, Sale high. Mr Market’s volatile swings allows you to do just that.
While Mr Market is just an imaginary investor created by Graham, he represents investors collectively or should we say he represents popular market sentiment.
On good news, popular market sentiment would send share prices through the roof, but on bad news, popular sentiment would send share prices tumbling.
Market sentiment is however seldom rational. Its driven by euphoria and pessimism.
Euphoria and pessimism is not the way of a rational investor. A rational investor is seldom swayed by mood swings.
Rational investors make decisions based on true intrinsic value of the businesses. Rational investors do not fall prey to emotional overreactions of Mr Market.
For rational investors daily price fluctuations do not affect long-term investing decisions. Long term investments are determined by intrinsic value and not Mr Market.
The intrinsic value of a stock is its true value. It refers to what a stock (or any asset, for that matter) is actually worth — even if some investors think it’s worth a lot more or less than that amount.
Investors who know the intrinsic value of a stock can use it to search for the best bargains in the market. Knowledge of the intrinsic value helps determine whether a share price is undervalued or overvalued.
The goal of value investing is to seek out stocks that are trading for less than their intrinsic value. There are several methods of evaluating a stock’s intrinsic value, and two investors can form two completely different (and equally valid) opinions on the intrinsic value of the same stock.
However, the general idea is to buy a stock for less than its worth, and evaluating intrinsic value can help you do just that.
