Who do people look up as the most successful person in the field of investing?
No prizes for guessing. It’s Warren Buffett.
Buffett bought his first stock when he was 11 years old. “I was wasting my life till then,” he often jokes.
But it wasn’t until Warren was 19 years old that he discovered the real secret of making big money in the stock market.
In 1949, Buffett found a book called The Intelligent Investor. Reading that book had a profound impact on him. The book was written by Benjamin Graham who taught finance in Columbia Business School. So, Buffett packed his bags and headed to Columbia Business School.
What did Graham teach, made Buffett a billionaire?
One of the key concepts that Graham taught Buffett was the idea of Mr. Market. He used Mr. Market as a metaphor for the stock market.
Imagine that you have a business partner called Mr. Market. The gentleman comes to your doorstep every day and quotes a price at which he is either willing to buy your share of the business or sell his share of the business to you.
Interestingly, he doesn’t mind it if you ignore his offer. He keeps showing up every day with a different price quote.
Another thing with Mr. Market is that he’s a very moody fellow. Sometimes, he’s in an excellent mood and ready to buy your stake in the business for a very high price. At other times he sounds very gloomy and is ready to sell his stake to you for a very low price.
What you need to learn is that Mr. Market is there to serve you, not to guide you. Mr. Market’s price quotes don’t necessarily reflect the true value of the business. Your job as an investor is to focus on the real performance of the companies whose stocks you own rather than the everyday price tags offered by Mr. Market.
The key to success in investing is to exploit the moods of Mr. Market i.e. the irrationality of the stock market.
What Benjamin Graham was trying to convey through his Mr. Market example is that the stock market can be a highly illogical place, where time to time irrationality (in the form of greed and fear) prevails and where buyers and sellers sometimes behave in a herd-like manner.
In 2009, while answering a question from a shareholder in the annual general meeting, Buffett said —
If I were running a business school I would only have two courses. The first would obviously be an investing class about how to value a business.
The second would be how to think about the stock market and how to deal with the volatility. The stock market is funny. You have no compulsion to act and a bunch of silly people setting prices all the time, it is great odds.
I want the market to be like a manic depressive drunk. Graham’s Ch. 8, in the book Intelligent Investor, on Mr. Market is the most important thing I have ever read.
Put simply, the value of the share that you own shouldn’t be dictated by the whims of Mr. Market. Instead, you should exploit Mr. Market’s mood swings. Graham’s secret message to Buffett was to profit from market folly rather than participate in it.
The second thing to remember about Mr. Market is that he isn’t always irrational. In fact, most of the times, Mr. Market will quote a price which will be commensurate with the value of the business.
So, dealing with this guy requires extreme patience. The trick is to keep saying No to Mr. Market. At the same, you need to keep a vigilant eye on his emotional state. Any occasion slip-ups — which is guaranteed to happen from time to time — will present an opportunity for you.
In 2016, I was attending a workshop on behavioral finance. The gentleman sitting next to me was an experienced Airline Pilot. He flew Boeing 787 Dreamliner in Air India.
Talking to him I learned that in the modern aircraft, there isn’t much to do for the pilot. Almost everything is controlled by the autopilot systems and the computers installed in the airplane. The main job of the pilot then becomes to sit there and wait vigilantly to take over if something goes wrong.
So when I asked him to describe his work in one line, he quipped —
Hours of boredom punctuated by moments of terror.
That’s also a great way to describe how an intelligent investor operates in the stock market. Legendary investor Howard Marks who manages a $100 billion hedge fund, writes —
Especially during downdrafts, many investors impute intelligence to the market and look to it to tell them what’s going on and what to do about it. This is one of the biggest mistakes you can make.
As Ben Graham pointed out, the day-to-day market isn’t a fundamental analyst; it’s a barometer of investor sentiment.
You just can’t take it too seriously. Market participants have limited insight into what’s really happening in terms of fundamentals, and any intelligence that could be behind their buys and sells is obscured by their emotional swings. It would be wrong to interpret the recent worldwide drop as meaning the market “knows” tough times lay ahead.
…It is the goal of some investors to sell on declines when the subsequent movements will be down, but “buy the dips” when the subsequent movements will be up. If you think you can tell which is which from watching the market movements themselves, then we – again – have a fundamental disagreement.
Future price movements can only be predicted on the basis of the relationship between price and fundamentals. And, given the market’s short-term volatility and irrationality, this can only be done in the long-term sense. The market has nothing useful to contribute on this subject.
When Mr. Market panics, there will be terror all around. But that’s the time to spring into action. That’s the time you were preparing yourself for while sitting patiently during the hours of boredom.
If you can remind that to yourself during the time of market mayhem, you have what it takes to be an intelligent investor.
Disclaimer: The views expressed in this post are that of the author and not those of Groww