Three Investing Lessons from Benjamin Graham, Part II

 Let’s talk about Mr. Market and how he can be your ally.

Picture of Benjamin Graham, Source: Deepstash

“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.”  

– Benjamin Graham, Chapter 8, The Intelligent Investor

In Part I of this three part series, we discussed that stocks represent a part ownership in a business and how that ownership holds value. But if value exists, then why do prices fluctuate?

Stocks have value, but despite this fact, there is no single number everyone can agree on.

This is a result of several reasons:

• The Market includes people who do not think value exists at all.

• Value is subjective because variables that determine value ultimately require predictions.

• Due to human nature, the direction of this subjectiveness sways greatly from positive to negative.

*We talked more about what exactly “value” is here.

So despite the fact that value exists, market prices fluctuate greatly. If so, how should investors deal with this? Should they react to every tick? Or should they completely ignore what is going on?

As a partial answer, I will let Warren Buffett introduce the second lesson from Benjamin Graham. Here’s what he said during the 1995 Berkshire Hathaway Annual Meeting:

“... your attitude toward the stock market. That’s covered in Chapter 8 of 'The Intelligent Investor'. I mean, if you’ve got that attitude toward the market, you start ahead of 99 percent of all people who are operating in the market. So, you have an enormous advantage.”

Lesson 2: Attitude Toward the Market

At the end of Chapter 8 of The Intelligent Investor, Benjamin Graham introduces a business partner, Mr. Market.

Mr. Market loves to share. He is willing to tell you his views on what he thinks each business in the public market is worth every single working day of the week. Based on his views, he comes over to you to ask for transactions. 

Unfortunately, Mr. Market is a man of emotions, and his views on the value of businesses change greatly from day to day. But fortunately for you, he never takes it personally if you decline to trade with him. He comes back the next day with a new price.

The key here is that you only need to trade with Mr. Market when he offers a price you like. In all other instances, you can decline and wait for a better offer. 

This should be your attitude towards the market. The market is simply a place you stop by when you see an opportunity you find attractive.

To an investor who understands value, market fluctuations provide chances to buy and sell at attractive prices. Thus, the more emotional Mr. Market is, the better. But this kind of thinking greatly differs from what the academics claim.

The academic view of risk

According to academics, risk equals volatility. An asset that fluctuates 5% on a daily basis is riskier than an asset that fluctuates 1%.

Does this make intuitive sense? How do we perceive risk in our daily lives?

Typically, we say something is risky if there is a potential for loss or harm.

The potential for loss increases as volatility increases, but only for the unskilled investor. For investors equipped with a value mindset (Lesson 1) and an appropriate attitude towards the market (Lesson 2), volatility provides opportunity.

To Graham, risk occurs when an investor makes decisions without a well-founded opinion on value. 

Volatility is something every investor experiences. Investing skill, however, is different for every investor. Skill is something that can be developed with effort. This is why academics claim that risk is volatility. If you want to write a paper, you need an objective measure that can be applied to all investors. Investing skill is subjective and cannot be known in advance.

Anyhow, that’s a problem for the academics, not for aspiring investors.

Bottom line: The market is a place we stop by when we want to make a deal. The only thing we need to check is the price Mr. Market is suggesting. If we don’t like it, come back another time.

This article is adapted from a book called “거인의 어깨 1” by a successful fund manager, 홍진채 (Jin Chae Hong). The book has unfortunately not been translated into English. If you are fluent in Korean, I strongly recommend reading this book and his two other books “거인의 어깨 2” and “주식하는 마음”.