Week in Review: The Intelligent Investor, Part II

Never confuse brains with a bull market. – Humphrey Neill

When you have a tremendous conviction on a trade, you have to go for the jugular. It takes courage to be a pig. – Stanley Druckenmiller

It’s the little details that are vital. Little things make big things happen. – John Wooden

Having a bias toward action – let’s see something happen now. You can break that big plan into small steps and take the first step right away. – Indira Ghandi

The only limit of our realization of tomorrow will be our doubts of today. Let us move forward with strong and active faith. – Franklin D. Roosevelt

Week in Review

This week, we’ll continue with Warren Buffett’s simple advice for you to improve your investing acumen.

If you recall, he says all you need to do is read three chapters in two different books; Intelligent Investor by Benjamin Graham, chapters 8 and 20 and The General Theory of Employment, Interest and Money by John Maynard Keynes, chapter 12.

Before I share the story of “Mr. Market” from The Intelligent Investor, I want to talk a little bit about what’s going on in the stock market.

It’s a good segue into the parable of Mr. Market.

Here’s a headline from the WSJ last Monday…

Anyone who reads that is thinking things are smooth sailing. It’s time to buy!

Here’s another headline from the WSJ. Exactly one week later…

Now, it’s time to sell!

Headlines about a record streak one week. Then, investors fear stocks may fall the next. Confusing, right?

What was so different a week before? (It just shows you how fast things can change. It’s why understanding price and value are so important.)

One more headline from the WSJ. This one was two days later…

So, let’s recap one week in the market… Stocks on a record streak. A week later, investors fearful of stocks falling. Two days after that, stocks rebound.

It’s insane. Investors who followed the financial headlines likely bought when stocks were high due to greed and sold them when prices were lower due to fear.

It’s also likely they were sitting on the sidelines when the market rebounded. Following the hype or doom of the investing crowd is not a recipe for successful investing.

But wait! There’s more…

This morning’s Wall Street Breakfast from Seeking Alpha said, “many are still trying to pin an exact reason for the selloff and wild swings.”

No one even knows why the market sank 10% in the matter of a few days!

What’s an investor supposed to do amid the madness of the crowds?

Chapter 8 of The Intelligent Investor offers great advice for this exact scenario. It’s the famous Mr. Market parable from Benjamin Graham.

Here it is in full…

Let us close this section with something in the nature of a parable. Imagine that in some private business you own a small share that cost you $1,000. One of your partners, 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 to sell you an additional interest on that basis. Sometimes his idea of value appears 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 a 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 will 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 judgement will having 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 with 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 and pays attention to his dividend returns and to the operating results of the company.

The book was originally published in 1949 and this single passage is probably the best advice anyone can give on investing… Ever.

It’s a guide for how you need to think about investing. Once you have this foundation, you’ll be miles ahead of the investing crowd.

You will start to see the panic, fear, and greed that fills the stock market from time to time as opportunity.

End Notes

One last thing…

The past couple of weeks, I’ve had a couple of essays featured over at Early To Rise.

The series is about busting wealth myths. Too many people fall for the hyped-up wealth building traps floating around the internet.

It’s almost as if people don’t want anyone to build wealth. The myths just keep people spinning their wheels.

Leading to a state of inaction.

You can find out the smarter and faster way to build wealth here and here.