Education: Value Investing

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The Parable of "Mr. Market"

Allow me to introduce you to a businessman by the name of Mr. Market. If you are a participant in the stock market, whether you like it or not, he is your business partner. His split personality is enough to drive anyone crazy. If you catch him on a nice day, he can be quite the generous fellow; however, if he wakes up on the wrong side of the bed, his down-in-the dumps attitude can actually…work to your advantage. Yep, that’s right. Let’s see how you can take advantage of this wacky individual.

The Parable of Mr. Market

Ben Graham, one of the most revered investors of all time, developed the tale of Mr. Market. The fable centers on a business relationship between you and the famous Mr. Market. Each day, with the exception of the weekend when Mr. Market retreats to his quarters, he knocks on your door and presents you with an offer. You can either buy his ownership stake of the partnership or, on the other hand, you can sell your share to him. It is completely up to you—the proverbial ball is in your court. But if it were only that easy…

Mr. Market constantly rides an emotional rollercoaster. On the days in which he offers to purchase your stake in the partnership, optimism is flowing out of his ears. He is in a great mood and firmly believes the future is nothing other than bright. As a result, he will freely purchase your piece of the pie—at a premium, nonetheless.

Then there is his other side, when Mr. Market’s pessimism is oozing out of every pore of his body. He sees nothing other than a dismal future for your partnership and wants out as soon as possible. Consequently, he is prepared to sell you his stake at a highly-reduced price. He desires to simply wipe his hands clean of the deal.

Even though Mr. Market’s emotions teeter on the brinks of insanity, and are very difficult to deal with, you should learn to take advantage of them. They can in fact work in your favor.

Greed and Fear Rule the Market

Those who participate in the stock market often find themselves caught up in waves of over-optimism, which can quickly lead to greed. This in turn drives the price of stocks through the roof. There are also those days where investors find themselves weighed down by pessimism, rapidly being overtaken by fear. Stock prices plummet as a result, often to lows never seen before. Investors are human beings after all, and they are not immune to various emotions that can create havoc.

Getting back to Mr. Graham, he once stated, “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 wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market.”

Mr. Market announces his prices to all who currently participate, or plan on taking part, in the stock market’s activities. They can be found on any web site or television program that provides daily stock quotes. But how do you know when prices have fallen to a point where Mr. Market is offering them for a steal of a deal?

Take Advantage of Mr. Market

In a number of other articles that we have written, we introduce you to tools that can be used to uncover companies that Mr. Market is offering at a discount to their fair vale. I suggest you start by familiarizing yourself with a couple valuation metrics, including the P/E ratio, P/B ratio, and PEG ratio (feel free to dive in to the others we provide as well—great stuff).

If you do your homework and your analysis points to a stock that Mr. Market is giving away for a bargain, take advantage of that fool and buy as much as possible—he doesn’t care. If you have indeed uncovered a hidden gem, odds are Mr. Market will come back and present an offer you may not be able to refuse for the exact same stock. You know the old saying: buy low, sell high.