Arguably the most important concept in value investing, Warren Buffet called the parable of Mr. Market his favorite chapter in The Intelligent Investor. Let’s explore a simple story to illuminate Benjamin Graham’s view of Mr. Market.
Imagine that you bought a Manhattan gas station last year for $1 million. The gas station is in a great location and it earns you $200,000 per year.
Across the street from you is an identical gas station owned by a man named Mr. Market. Every day Mr. Market stops by and offers you a price to buy your gas station or sell his gas station. On Monday he offers you $800k, on Tuesday $1.1 million, on Friday $900k. He does this EVERY DAY and he rarely offers you the same price. You begin to think this Mr. Market is a little crazy.
Typically, if we buy a stock from Mr. Market for $100 and it goes down in successive weeks [5%, 2%, 3%], we begin to panic, we made a mistake, this stock is a loser! Or the stock has an amazing run up and we say wow we got lucky, lets sell this stock before gravity pulls it back! In reality, the signals market prices send are meaningless to the fundamentals of the underlying company, they benefit us only buy offering an opportunity to buy or sell at any given time.
The Mr. Market parable is the core concept of value investing. In its most basic form, value investing is simply developing a strategy for creating our own price for a stock based on the company’s financials, past performance, management, and future prospects. With our own intrinsic price of a stock we can then decide at what price we should buy it and when we should sell it. If we invest without having a system to analyze a company’s value and determine our own price, we are simply throwing darts at a dart board and spinning stories of our random successes and failures.
Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard.”
Warren Buffet, 2013 Berkshire Hathaway Letter to Shareholders