In his classic treatise, The Intelligent Investor, Benjamin Graham, the father of value investing, created an allegory to help new investors understand how to think about stock prices and value investing in general.
By using it, you can help protect yourself from overpaying for a stock, panicking when the market crashes, or doing foolish things resulting from emotional reactions to the nightly news. Along with the margin of safety concept, Mr. Market is a cornerstone of the value investing strategy.
Your Business Partner, Mr. Market
Benjamin Graham recommended that someone who wanted to become a disciplined, successful investor imagine a scenario every time he or she wanted to buy or sell shares of stock, which, to Graham, represented ownership in a business, not just pieces of paper that moved around on the ticker tape. Picture yourself in a partnership with a man named Mr. Market. Now, Mr. Market is a manic depressive fellow and sometimes he is euphoric about the state of the economy and specific stocks, bonds, real estate, or other assets. Other times, Mr. Market believes the world is ending and doesn’t want to own anything for cash.
Every day, Mr. Market knocks on your office door and comes in offering to buy or sell his share of the company to you. He’s rather agnostic on which you choose because he has set the price based on his mood. Sometimes, Mr. Market is close to what you, a far more rational investor, believes is the true, or intrinsic value, of your company. Other times, he offers ridiculously low prices or unjustifiably high prices. What should you do as his business partner?
You have three choices, based upon how much cash you have available: