Who is Mr Market and why do we care?

9 minutes

 

Mr. Market

The stock market goes up and down every day. If you watch one of your stocks on a daily basis you could see it rise and fall even on the same day. It can be kind of maddening and extremely frustrating.

One of the questions that investors ask is why does the market behave this way? Frankly, there is no easy answer and there are lots of speculations about the real reason.

Stock prices can change daily as a result of market forces. This means that the prices rises and falls due to supply and demand. If more people want to buy or demand than sell it or supply. Then the price goes up. On the flip side if more people want to sell the stock than buying, then there would be a great supply than demand and the price would fall.

Now if only it were that easy, let me assure you it is not.

Who is Mr. Market?

Mr. Market is a creation of Benjamin Graham that he used to explain the vagaries of the stock market.

Benjamin Graham is considered the father of value investing and was a huge influence on Warren Buffett. In 1949 Graham wrote a hugely influential book titled “The Intelligent Investor”. This book is considered by most to be the biggest influence on investing out there.

In this seminal work, he included his character, Mr. Market.

So what does Mr. Market do?

Every day he shows up at your door offering to buy and sell his shares at a different price. Sometimes, the price quoted by Mr. Market seems reasonable, but most times it is ridiculous. The investor is free to agree with the quoted price and do a trade with him. Or to ignore him completely. Mr. Market doesn’t mind either way and tomorrow he will be back to quote another price.

Sounds simple, huh.

Let’s look at an excerpt from The Intelligent Investor, Revised Edition 2005, pages 204-5.

“Imagine that in some private business you own a share that costs you $1,000. One of your partner’s, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or sell you an additional interest on that basis. Sometimes his idea of value seems plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.

“If you are a prudent investor or sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you would be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position. Continue reading “Who is Mr Market and why do we care?”

Value Investing: The Art of Buying Undervalued Companies

11 minutes

 

“Price is what you pay, value is what you get.”

Warren Buffett

In this simple saying, Warren Buffett, arguably the greatest investor of our generation has summed up what value investing is. It is the search for companies that are selling below their intrinsic value, with the hope that we can buy them at a discount and that their price will rise over time.

Value investing, unlike some other investing strategies is fairly simple. It doesn’t require that you have an extensive background in finance. Certainly, understanding the basics of finance will help, but you don’t need to go to Harvard to follow this strategy.

It also doesn’t require an expensive subscription to terminals to help you find companies or how to read very extensive charts. There is also little need for math, but some is required.

The main ingredients needed are patience, common sense, money to invest and the willingness to do some reading and accounting then you have what it takes to become a value investor.

Five Fundamental Concepts of Value Investing

Value Investing Fundamental No. 1 – All companies have intrinsic value. This is what gets most people about value investing. The basic concept is so simple that you probably do it on a daily basis already. The idea is that if you already know the true value of something then you will save a ton of money by buying it when it is on sale.

Let’s use an example to illustrate. Most people would agree that whether you buy a new cell phone when it’s on sale or when it’s at full price, you’re getting the same cell phone with the same screen size and same memory. The obvious assumption that we have to make is that the value of the cell phone will not depreciate with time as new technology becomes available.  

Stocks are the same way, the company’s stock price can change even though it’s intrinsic value has stayed the same. Stocks, like cell phones, go through periods of higher or lower demand. These fluctuations change the price but they don’t change what you are getting.

Most savvy shoppers would say that it is crazy to buy a cell phone at full price when you can buy them on sale many times throughout the year, particularly during the holidays. Stocks work the same way. The only difference is that unlike cell phones, there is no predictable time of the year that stocks will go on sale, such as a Black Friday event. Which is unfortunate. Also, their prices won’t be advertised in a daily mailing like Target. Also unfortunate.

If they did know about the sale price it would create more demand and drive up the price, which means they wouldn’t be a bargain for us to take advantage of.

The trick with value investing, if you are willing to do a little sleuthing work to find these secret sales, you can get stocks at a discount that other investors would be oblivious to.

Continue reading “Value Investing: The Art of Buying Undervalued Companies”

Superinvestors of Graham and Doddsville: What We Learned

13 minutes


picture courtesy of ruleoneinvesting.com

“While they differ greatly in style, these investors are, mentally, always buying the business, not the stock. A few of them sometimes buy whole businesses, far more often they simply buy small pieces of the business.”  

        Warren Buffett, Superinvestors of Graham and Doddsville

In May 1984, Buffett laid out his thoughts on everything you need to know about his investing philosophy.

In a speech at Columbia Business School, which was later adapted into an essay. Buffett introduced what he termed “The Superinvestors of Graham and Doddsville.”

The “Superinvestors of Graham and Doddsville” is a name that Buffett gave to Benjamin Graham and a group of his proteges. The group of money managers once studied under or worked for Graham, Buffett or Munger, Buffett’s partner at Berkshire Hathaway. We will talk about each of them more in depth coming up.

The speech was given in honor of the 50th anniversary of “Security Analysis” which was written by Benjamin Graham and David Dodd. The book was published in 1934 and was the seminal book on analysis business using financial fundamentals that were outlined by Graham and Dodd.

Warren Buffett is arguably the world’s great investor, there have been many books, essays, and papers written on his greatness. I am not smart enough or eloquent enough to improve on them but I will touch on his beginnings for a moment.

Although Buffett’s father was a stock broker he didn’t have his a-ha moment until he read another very famous Graham book “The Intelligent Investor”. It caused Buffett to apply to the Columbia School of Business to study with Graham. To this day, Buffett credits that book with changing his professional life and Warren believes that most of what everybody needs to know about investing come from two chapters in the book.

The chapter on Mr. Market, which outlines behavioral finance concepts before the term even existed. And the chapter on Margin of Safety.

Breakdown of the speech

At the start of the speech he asks the question “is the Graham and Dodd look for values with a significant margin of safety relative to prices approach to security analysis out of date?”

He then touches on the theory of Efficient Market Hypothesis, which states that the market is efficient in how it prices each and every stock in the market. Meaning that the market is taking into account everything that is known about the company’s prospects and the state of the economy in the price of each stock.

The hypothesis states there are no undervalued stocks because there are smart security analysts who utilize all available information to ensure unfailingly accurate pricing.  

He thinks that this is bunk!

Continue reading “Superinvestors of Graham and Doddsville: What We Learned”

Value Investing Advice from the Dhando Investor

12 minutes

51gn-ygw5ol-_sx330_bo1204203200_The Dhando Investor, the low-risk value method to high returns is a wonderful book written by hedge fund manager Monish Pabrai. In it, he gives a comprehensive value investing framework for the individual investor.

The book is written in a straightforward style that is easy to read and comprehend. The Dhando Investor lays out the amazingly powerful value investing framework. Written with the intelligent individual investor in mind.

The Dhando method expands on the value investing principles expounded by Benjamin Graham, Warren Buffett, and Charlie Munger. In this book, we will come across phrases like “Heads I Win! Tails, I don’t lose much”, “Few bets, Big bets, Infrequent bet.”

Other concepts discussed are Abhimanyu’s dilemma, a detailed breakdown of the Kelly formula to invest in undervalued stocks.

So who is Monish Pabrai? I can hear you asking who is this guy and why are we talking about his book?

Let’s dig in a little and learn more about Monish.

Monish was born in 1964 in Mumbai, India and he moved to the US in 1983 to study at Clemson University. After graduation, he worked in the tech world until branching out on his own.

He started his own tech company with $30,000 from his 401k and $70,000 in credit card debt. In 2000 he sold the company for $20 million.

In 1999 he started Pabrai Investment Funds, that he still runs today. Since the fund’s inception, he has generated net returns of 517% versus the 43% return of the S&P 500 for the same time period. We are talking 16 years that he has made these returns.

His focus is long-only equities that are deeply distressed. He looks for two to three ideas a year, which he feels is enough. His portfolio is highly concentrated in that he generally only holds 10-20 stocks at one time. Currently, he has seven positions.

Buying and holding are only part of his strategy, he also looks very closely at his mistakes as well. Investing is a field where mistakes can be very costly and they must be looked into. He is unusual in that he doesn’t gloss over mistakes but rather spends time breaking down what happened so he can learn from the mistake. So he doesn’t repeat it in the future.

He uses a checklist of what not to do in the markets. Pabrai built this list by analyzing investors that he admires and deconstructing their mistakes. As a result, he ended up with hundreds of checkboxes on his investing checklist. This is not his exact checklist but rather an outline of his checklist and how he things about constructing his. He feels that each individual investor should come up with their own checklist as they learn more about investing.

Monish Pabrai’s primary source of investment ideas come from the 13F SEC filings from other value investment managers that he admires. 13F SEC filings are a quarterly filing required of all institutional investment managers with over $100 million in assets. In this filing, they will list all the current holdings for each fund. It will also list the prices purchased or sold as well.

This is a great source of investing ideas and is a whole investment strategy in and of itself. We will dig into this topic in a future post.

Continue reading “Value Investing Advice from the Dhando Investor”