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If you study securities analysis at an academic institution or on Wall Street, you will study Benjamin Graham. Ben Graham was an economist, a business professor, and an investor. He has been called the father of value investing.
His book, “Securities Analysis,” was published in 1934 and is required text for securities analysis students. And his 1949 book, “The Intelligent Investor,” has been described by Warren Buffett as the best investment book ever written.
In fact, most people today know Graham as Warren Buffett’s mentor. Buffett is the only student to ever earn an A+ from Graham at Columbia University. (As an interesting bit of trivia, Harvard Business School rejected Buffett’s admission application in one of the most boneheaded decisions since the Red Sox sold Babe Ruth to the Yankees.)
Graham used what has become a famous metaphor called “Mr. Market” to explain how the stock market works. It is probably still the best way to understand how stocks are priced and what it means to you as an investor.
Let’s say you own a business and you have a partner. His name is “Mr. Market.” Your business is a good one. It has given you a high return on what you have invested in the business. The only thing is your partner, Mr. Market, is kind of a strange dude. He’s very emotional. Some days he’s on a very euphoric high and other days he’s very depressed. I guess today we would describe his condition as manic-depressive.
Mr. Market has a curious habit. Every day he comes into the office and offers to sell you his share of the business or buy yours. However, because he is so moody, if he happens to be euphoric on a particular day he wants a very high price for his share. On the other hand, if he’s in one of his down moods he’s willing to sell out for a pittance.
The interesting thing about Mr. Market is that he doesn’t seem to care whether or not you choose to buy his interest or sell yours. He doesn’t get his feelings hurt. You can do whatever you want. It’s completely up to you. He just keeps coming in the office every day, offering to buy or sell at wildly different prices. It’s always the same good business it has always been. That doesn’t change. It’s just that, depending on his mood, some days Mr. Market is enthusiastic about the business and other days he’s very pessimistic.
Since you know what the business is worth, you can just listen to Mr. Market’s offer every day and decide if his offer is a good one or one you want to turn down. Even though Mr. Market’s moods might be difficult to get used to, he’s actually a great business partner to have.
That’s exactly the way you should view the stock market. Choose your favorite business that happens to be one of the 10,000 or so publicly traded stocks. Look at the stock tables in the paper and notice the yearly high and low price for that stock. You’ll find that there can be a dramatic difference between the high and the low during a single year. The business hasn’t changed. It’s just the mood of Mr. Market that changes.
So that’s how some great investors like the Ben Graham’s, Warren Buffett’s, and Joel Greenblatt’s of the world have made fortunes. They understand how the stock market works. They look to buy partial interest (shares) in good businesses (a business with a high return on capital) when Mr. Market is willing to sell his interest at a bargain price.
There is no reason why you can’t do the same thing.
(c) Larry Holmes
write by FREDERICK ELLIS
