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.

“The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination. He must take cognizance of important price movements, for otherwise, his judgment will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed–this in plain English means that he is to sell his shares because the price has gone down, foreboding worse things to come. In our view, such signals are misleading at least as often as they are helpful.

“Basically, price fluctuations have only one significant meaning for the true investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”

Warren Buffett

Warren Buffett on Mr. Market

Of course, Buffett has some thoughts on our friend Mr. Market. He wrote about him in his annual shareholder letter for Berkshire Hathaway in 1987.

In his own words, he describes Mr. Market as only Buffett can do with wit and charm.

Ben Graham, my friend, and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He 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. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions, he will name a very low price, since he is terrified that you will unload your interest on him.

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.

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: 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 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. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.

…[A]n investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben’s Mr. Market concept firmly in mind.”

How Mr. Market affects us

As you may or may not have noticed but as of January 2017, the market has been flirting with the 20,000 plateau for the last three weeks. As you watch the talking heads predict when it will cross the mark you realize that they don’t have a clue and they are just talking to hear themselves talk. Prediction in the stock market is about as valuable as a share of stock in Enron, aka nothing.

So how does all this pertain to Mr. Market? If you watch the business news you will see the examples of this on an almost minute by minute basis. As the newscasters talk about the stocks and the news regarding each stock you can see the prices fluctuate.

Good news drives the prices up and bad news drives it down. What does this actually have to do with the value of the company being talked about?

Almost nothing.

I will give you an example. As the price of oil tanked recently the stock market dropped as well. Why is this? Are they related? Not really. See the economy has been pretty stable for the last few years and prices have stabilized and jobs have come back and wages are rising.

But. The bottom falls out in the oil market and this starts everyone running for the door.

Why is this silly or over reactionary? The energy sector is only 7% of the stock market and is only 6% of the US GDP. So why the stampede from the market?

Mr. Market is the answer. He is there to feed our fear by offering lower prices so we don’t lose all of our money. If we ignore him today he will be back with lower prices tomorrow.

Now obviously if you are invested in the energy sector then you need to do your due diligence and check your financials on the companies you do own to see if things have changed such that you need to alter your allocation for that company or companies.

If you own a tech company that has nothing to do with oil then maybe this will present a buying opportunity as the prices drop and the fundamentals of your business are still valid.

To quote Benjamin Graham again from the Intelligent Investor, Chapter 7.

“ [N]ote this important fact: The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.”

Truer words have never been spoken. These words need to be burned into our brains to help us remember when Mr. Market is at our door.

As Jason Zweig stated.

“This may well be the single most important paragraph in Graham’s entire book. In these 113 words, Graham sums up his lifetime of experience. You cannot read these words too often; they are like Kryptonite for bear markets. If you keep them close at hand and let them guide you throughout your investing life, you will survive whatever the markets throw at you.”

We have to always remember in the short-run a market is a voting machine and in the long-run, the stock market is a weighing machine.

The key to mastering your relationship with Mr. Market is controlling your emotions. This is often the biggest challenge we face as investors are maintaining a grip on how we feel about our companies.

Let’s face it. The stock market is going to rise and fall and our job is to stay focused and not let those emotions get the best of us and give into Mr. Market’s ploys of buying on the way up and selling on the way down.

Final Thoughts

It’s hazardous to our investing health to think that all stock market declines are the result of markets being fearful. Remember that a decline could be an indication that something is wrong with the company you have invested in. Caution is always the best answer for these situations.

Before reacting it is best to investigate to discover for yourself what is going on before making a decision. Haste can lead to waste, in this circumstance.

Mr. Market will always be there to offer us the best prices as he sees them at that time. It is one of the ways that I can help rationalize how the price of a company can go up or down just because it’s Tuesday.

A few years ago I was talking to a financial advisor that I worked with and asked his opinion of why the market seemed to fluctuate so much. He said it was because people sell the news. By this, he meant that when there was good news people would buy and bad news would cause the public to sell.

I have noticed as well the oddity of a earnings report that was so impressive and blew away the analyst’s forecasts for the company and then watch the price fall like a rock, in this case almost 10% in one day! It was crazy and I couldn’t understand it. But understanding Mr. Market helps us find the reason behind these fluctuations.

In the case of this companies drop in share price, I saw that the fundamentals were awesome and I bought some more shares will everyone else was being fearful. And over the next two days, the price shot up over 15% and has continued to do well since.

This is how we can use our emotions to profit from the fear and panic that can set in and how we can utilize Mr. Market’s moods to our advantage.

Stock prices will fluctuate from day to day, but this is the short term view. Over time the market will catch up to the intrinsic value of the company and the price will reflect that as well.

Remember again that over the short-term the market is a voting machine and over the long-term, it is a weighing machine.

Every day Mr. Market shows up to work ready to offer you great deals, crazy deals, and deals you should never, ever take him up on. He has an incurable emotional problem and as Buffett once called him a “drunken psycho”. He forgets what happened the day before and will be back the next day offering his wares.

Your job is to take advantage of the prices you find attractive and send him packing on the ones you don’t.

As always thank you for taking the time to read this post. I hope you find some value in it.

If you think it would be of value to some else please share it with them. Remember we are all in this together and anyway we can help each other is the goal.

Take care,

Dave

 



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