Mr. Market – Benjamin Graham’s Famous Value Investing Allegory
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 against 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.
Benjamin Graham, the father of value investing, recommended that intelligent investors imagine they have a business partner named Mr. Market who is manic depressive and wants to either buy your interest or sell you his every day at wildly different prices. This is probably the single most famous allegory in the history of financeEvery 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.
Consider Graham’s most famous student, Warren Buffett. Buffett’s business partner, Charlie Munger, points out that in the decades it took to amass two of the greatest fortunes in history, both he and Warren have seen the quoted market value of their shares of Berkshire Hathaway, the holding company through which they hold their operating assets, by 50% or more on at least three separate occasions. Yet in each of these cases, the underlying businesses were fine. They were still churning out cash profits that could be redeployed into buying additional investments. They balance sheet was still rock solid. The undervaluation did not reflect the economic reality of the business and, thus, could be safely ignored or taken advantage of depending upon the investor’s unique circumstances.
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 help protect yourself from overpaying and making foolish emotional mistakes. It is another testament to the genius of Benjamin Graham and his value investing strategy.
Update: This post was lightly edited on 05/11/2019, nearly a decade after it was published, to keep it fresh and relevant. I stumbled across it when I was working on a related project that involved releasing certain old posts from the private archives. I was not comfortable with the discussion of a specific equity during the 2007-2009 collapse which was a great example at the time, and the trading of which was lucrative for us, but that is no longer relevant due to substantial changes in the enterprise over the past ten years, including a material sell-off of valuable units, a split-off of another unit, and a subsequent decline in market price after we had sold the position and many years after this post was originally authored. I removed that section and added a paragraph involving a broader historical example of the same concept using Berkshire Hathaway as an illustration. The alternative was to pull the post so it was no longer available, which I think would have been a shame given how important this concept is in understanding value investing and Benjamin Graham’s contribution to the world of finance. This is the trade-off I am willing to make now that Aaron and I are the founders and managing directors of a fiduciary global asset management firm, Kennon-Green & Co., through which we manage our own family’s wealth.