Warren Buffett’s mentor Benjamin Graham, the father of value investing, conceptualized the stock market as an individual, a business partner named Mr. Market who approaches investors on a daily basis with a quote at which they can buy or sell a security. He characterized Mr. Market as a very moody individual. On some days he is quite euphoric and offers up a very high price. On other days he is quite depressed and quotes very low. He can be ignored routinely and without fail, but he always returns. (For related reading, see: Five Wildly Successful Value Investors.)

Furthermore, it is imperative to never heed nor fall under the spell of Mr. Market, to instead make rational business decisions based on a company’s economic fundamentals and intrinsic value.

Be Fearful When Others Are Greedy and Greedy When Others Are Fearful

In the 2013 Berkshire Hathaway Annual Report Warren Buffett offered up a tale of Mr. Market and a parcel of farmland in order to illustrate the machinations of Mr. Market. In this example, the farmland in question is a great asset: it has produced a substantial yield of corn year after year despite the short-term gyrations of locusts, a drought and an early freeze, and it is also projected to do so well into the future. A daily quote is not needed in order to understand that the farm is an economically sound, productive asset. Compared to other similar investments it is superior.

The Moody Neighbor Down the Road

On a daily basis the farmer from down the road approaches and offers to buy the farm or sell his at a quoted price. Our fellow farmer is very moody—a bit of a manic depressive. Some days he is quite euphoric, high on exuberance and quotes a high price. On other days, like a flipped switch, he is quite depressed and quotes low. We can ignore him as much as we want, but he always comes back. 

Given that the fundamentals of our farm are economically sound—increasing revenues, a strong track record of earnings, high rates of return—and with some certainty we can predict that the farm will continue to perform well into the future, then perhaps the time to sell is never. If, on the other hand, we look down and determine that our farm is indeed a “lemon,” perhaps it is time to sell to our neighbor on a day of euphoria in lieu of purchasing a great farm at a good price.  

On down days when the neighbor is utterly depressed and offers up his farm at a low price, a determination can be made: is his farm economically sound, or will it present a substantial rate of return over time based on its intrinsic value and price offered? If so, then perhaps a purchase is made. The depressed lows of our neighbor merely serve up the opportunity to effectuate high rates of return through the purchase of a great asset.

We Did Not Heed

During this entire process at no time did we come under the spell of our neighbor farmer from down the road, not reacting to his exuberant highs nor his depressed lows. We merely rationally analyzed, from a business perspective, the assets at hand.

I’d Like to Buy the World a Coke

Should great farms be purchased on days of the high bid? Perhaps, since it is much better to buy a wonderful business at a good price than a good business at a wonderful price. Case in point: if you had bought Coca-Cola (KO) in 1919 at a price of $40 per share, the next year would have cut the price in half to $19 due to issues with bottlers and a spike in sugar prices. Even so, if you had held the asset until 2010, with reinvested dividends, the stock would have been worth over $2.5 million. Time is the enemy of the mediocre business and the friend of the great business. The price paid also determines the rate of return, though, so it is prudent to buy wonderful businesses at good to great prices and perhaps not so much outlandishly high prices. (For more, see: Investing in Growth Vs. Value in 2016.)

The Bottom Line

The Market—or Mr. Market—is an erratic, moody individual. He appears on a daily basis with an offer that swings from euphoric lofty heights to depressing lows.  Regardless of his offer it is imperative to understand the intrinsic value of the assets at hand and not to come under the spell of our manic neighbor. As a business partner, Mr. Market should be used as a subordinate, not a leader.

The job of the long-term value investor therefore is to identify superior productive assets, the “super farms,” with durable economics that will continue to produce and increase in intrinsic value well into the future; in other words, a business that can be held forever. Despite short-term gyrations, intrinsic value ultimately surfaces.

And if the neighbor down the road shows up in the rain one day, woefully down in the dumps with a low bid for a super farm, take him up on his offer. And don’t literally think farms, think stocks.

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