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
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:
- If Mr. Market offers a stupidly low price, you can buy more shares, increasing your ownership in the business.
- If Mr. Market offers a stupidly high price, you can sell him your shares and cash out.
- If Mr. Market offers a fair price or you simply don’t have a lot of extra cash, you can do nothing. Continue owning what you own, collecting dividend and interest income. Sooner or later, he’ll change his tune and you’ll be able to take advantage of the situation.
Mr. Market Provides an Intellectual Framework
Ordinarily, investors, even those practicing value investing, panic when stocks crash because they see the money they’ve lost on paper. Yet, if they were using the Mr. Market allegory, and actually sitting down, picturing their business partner coming into their office, they wouldn’t have this reaction. They would pull the financial statements, value the business, and decide whether he was having another one of his manic days.
Within only a few short months, GE skyrocketed back to $15 per share, where it sat for quite some time. That would have represented a 250% return for savvy value investors that continued to pick up shares as the market collapsed. Those who sold their shares at $6 each were doing so because of “other peoples’ mistakes in judgment” as Benjamin Graham explained.
Mr. Market Can Help You Buy or Sell Any Investment
The beauty of the Mr. Market allegory is that you can use it in any business field, whether buying equipment, building a law practice, buying or selling a hotel, building rental houses, trading art, launching a vineyard … the list is endless. By applying a value investing strategy, you can protect yourself from overpaying and making foolish emotional mistakes. It is another testament to the genius of Benjamin Graham and his value investing strategy.