Protecting Capital
October 14, 2014

A Timely Reminder of the Mr. Market Allegory

Written by PenderFund

During the stock market’s inevitable periodic declines, we believe it is helpful to reread Buffett’s “Mr. Market” allegory because it can help reduce decisions that might be regrettable later (see extract and link below).

Investing tends to be an emotional undertaking. Even more so for those watching the daily action. Although the wisdom of “buy low, sell high” is universally accepted, psychological influences are the main reason why many investors find it so hard to follow/stick to this strategy over time. The truth is that the intrinsic value of most large businesses does not change very much quarter to quarter, or even year to year for that matter. Certainly far less than short-term stock price fluctuations would suggest. Over time stock prices roughly track the value creation path of the underlying business, albeit at an uneven pace until eventually the intrinsic value of a business and the stock price meet. Better to think about what that underlying asset or business will produce in the long term and not about daily price fluctuations.

Felix Narhi, CFA, Portfolio Manager

Warren Buffett on “Mr. Market”

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.

Extract from Letter to Shareholders, 1987 Berkshire Hathaway Annual Report (Third paragraph of “Marketable Securities – Permanent Holdings” section)