In his book “The Intelligent Investor” Benjamin Graham invents a character named Mr. Market and includes him in a parable to teach investors how they should think about the market. The story goes something like this:
Imagine you own a small share in a business that cost you $1,000. One of your partners is a kindly fellow named Mr. Market (I picture him looking like the Mr. Monopoly character). Every morning, like clockwork, Mr. Market comes to your office with an offer to either buy your interest in the business or to sell you another share of the business at a given price.
Often this price is pretty much what you think the business is worth, so you do nothing. It’s ok, he isn’t bothered by this, he’ll be back again tomorrow with a new offer.
However Mr. Market can be moody about the future prospects for the business. Sometimes he is quite giddy about the prospects for the business and offers to sell you another share of the business, or buy your share at a high price. Other times, he’s depressed about the future of the business and his offer is low.
The key, as Ben Graham explains, is that you should know your business well enough to have a good idea of its worth. The intelligent investor can then sell his interest to Mr. Market when he offers a price that is too high and buy Mr. Market’s interest when the price is too low. On most days, he can ignore Mr. Market.
This a neat little parable because it contains some important lessons. First, when you buy a stock you are buying an interest in a business. It’s not a blip on a computer screen. If you have already determined that your share of a business is worth $1,000, then you will not panic and sell if Mr. Market offers you only $750 for your share. Instead, you can ignore him or take him up on his offer and buy his share. On days when Mr. Market is giddy about the prospects of the business, don’t let the excitement get the better of you and buy another share at $1,500. Instead, take your profit by selling your share to him.
Too often today, in this age of real time quotes, it’s easy to see stocks as nothing more than red or green lights flashing across a computer screen. There are no shortage of web sites, blogs, and market commentators who will tell you a stock is a buy because it is moving up, or a sell because it is moving down. While there are some people who can make money doing this, for most it is a recipe for losing money. Know the value of the business you own and you’ll be better able to correctly decide when to buy or sell.
