Tuesday, June 16, 2015

Mr. Market Revisited

From the 1987 Berkshire Hathaway (BRKashareholder letter:

"Ben Graham...said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but."

Mr. Market, as Warren Buffett explains in the same letter, is a "poor fellow" with "incurable emotional problems" who tends to swing from euphoria to depression and, best of all, allows his emotional state to influence the price he's willing to buy or sell at. Here's how he once explained it:*

"The market is a psychotic, drunk, manic-depressive selling 4,000 companies every day. In one year, the high will double the low. These businesses are no more volatile than a farm or an apartment block [whose values do not swing so wildly]." - Warren Buffett at Wharton

The second by second quotations offered by Mr. Market may, at times, be nonsensical in a way that can directly benefit those with a relatively more even temperament who know how to judge the economics of a business reasonably well.

"Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you." - From the 1987 Berkshire Letter

Thinking about the capital markets in this way remains as relevant today as ever though it's at odds with those who, instead, behave as if the equity markets are a casino or, on the other hand, maybe still believe prices are set more or less efficiently.

"Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game." - From the 1987 Berkshire Letter

If nothing else this should logically lead to a very different reaction to bear and bull market environments.

Bear markets are usually viewed as being an unfavorable environment while bull markets are supposed to be a favorable environment. That makes little sense for the long-term investor.

Obviously, sometimes a bull market offers the chance to sell something originally bought at attractive valuations at full price (or maybe even at a premium).

Yet, for those investing with the long haul in mind, it is a bear market that can reduce risk -- which is certainly not captured by something like beta -- by offering the chance to buy part of a business that's "no more volatile than a farm or an apartment block" at a big discount to value.

"You make most of your money in a bear market. You just don't realize it at the time." - Shelby Davis

There's no reason to dread a bear market when shares are bought that can be valued -- within a narrow enough range -- with justifiable confidence.

It simply means getting used to shares of something bought cheap to possibly temporarily get cheaper. Some won't be able to tolerate seeing the quoted values below what was paid.

Well, if what was paid truly is less than per share intrinsic value, and the time horizon is long enough, those quotations shouldn't really be a problem.

Those that can't stomach when quoted prices remain below what they paid (sometimes for an extended period) really shouldn't be buying common stocks.

Adam

Long position in BRKb established at much lower than recent market prices

Related post:

Mr. Market

* Based upon notes that were taken at a 2006 Wharton meeting.

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