Mr. Market

To illustrate the propensity of share prices to fluctuate dramatically in accordance with transitory emotional factors, Benjamin Graham likened the stock market to Mr. Market, a manic-depressive business partner who is constantly knocking on your door to offer you a new price at which to buy or sell shares in the business.

If Mr. Market was feeling overly confident, he might offer to buy or sell shares at an absurdly high price. If he was feeling particularly glum, he might offer a price that was absurdly low.

As Graham pointed out, you should not normally pay attention to Mr. Market – he is obviously completely irrational. However, his manic-depressive nature does allow for occasional opportunities to buy into solid companies that are trading at a substantial discount to their true value. Equally, having bought into such companies, he is likely to offer a chance to sell those shares at a much higher price at a later date, once he has entered a more confident phase.

The value investor therefore largely ignores the moment-to-moment, day-to-day fluctuations of the stock market as irrelevant, except when its irrationality provides an opportunity to buy into solid companies at rock-bottom prices.

But how does the value investor assess whether and to what extent companies are undervalued? To answer this question, the value investor must establish a company’s intrinsic value.