Meet Mr. Market
Even though the market is made up of millions of individual buyers and sellers, it forms something of a collective consciousness of its own. Ben Graham, the father of value investing, understood this when he suggested the character of the mythical Mr. Market. He's the guy on the other end of your stock trades. When you buy, it's his shares you're buying. When you sell, you're selling to him. Every moment of every trading day, Mr. Market can be found quoting prices for publicly traded stocks.
To understand Mr. Market, we must begin with the premise that price and value are distinct concepts. On Wall Street--as with any economic transaction--price is simply what you pay, but value is what you get in return. The value of a stock is a function of its capacity and propensity to return cash to its owner. Were Mr. Market a steady, reasonable man, his price offers would reflect these future cash returns perfectly. A $1,000 investment today would provide $1,000 worth of value, no more and no less.
But Mr. Market is not what you'd call a steady business partner. An incurable manic-depressive whose actions define the words fear and greed, Mr. Market will offer ridiculously high prices for a given stock at one point and insanely low prices the next. Mr. Market is the guy who does most of the obsessing about quarterly earnings, economic reports, and so--called technical trends in stock prices. Does anyone really believe that the value of large, well-established, profitable businesses should change 50 percent or more over the course of a year? But Mr. Market's prices fluctuate that widely all the time.
So who's in charge of your money, you or Mr. Market? No one wants to admit to being in Mr. Market's thrall, but the observed collective behavior says otherwise. Rather than buying low and selling high, we see the market's individual participants doing the opposite: buying high and selling low. These are the ancient and ineradicable emotions of greed and fear in action. And if you're interested in seeing what this Mr. Market fellow looks like, you might want to check a mirror. There's at least a bit of him in all of us.
I'm not sure that most of us are prepared to engage Mr. Market, even if the odds can--through great effort--be tipped in the investor's favor. As with any active strategy, the onus of the buy-high-and-sell-low approach is on the stockholder, not the stock. The investor does the bulk of the work to earn his expected return; whatever the underlying business may be up to is of secondary importance. And at the end of the day, success or failure will be measured when the stock is sold: that is, success or failure depends on Mr. Market's attitude shifting from gloom to glee.
