The Investors Best Friend or Worst Enemy? Meet Mr. Market

The following is an excerpt from an annual letter to Berkshire Hathaway’s shareholders by Warren Buffett in 1987 regarding a way that Buffett views the daily quoting of the share market that he learnt from his renowned teacher and mentor to Buffett, Ben Graham.

It is interesting to note that this was written over 30 years ago by Buffett, while Ben Graham developed it in his acclaimed book, the intelligent investor, in 1949. It lends to the saying “the more things change, the more they stay the same”.

In periods of market volatility and irrational investment behaviour I find comfort in going back to the guru’s of yesteryear to see that the principles and fundamentals of successful long-term investing don’t change, and generally the investors worse enemy is themselves.

“Mr. Market” by Warren Buffett

Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be the 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 we can see only the favourable 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 back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behaviour, 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 either 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.”

Ben’s Mr. Market allegory may seem out-of-date in today’s investment world, in which most professionals and academicians talk of efficient markets, dynamic hedgings and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising “Take two aspirins”?

The value of market esoterica to the consumer of investment advice is a different story.  In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behaviour of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behaviour 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.

Following Ben’s teachings, Charlie (Warren’s business partner) and I let our marketable equities tell us by the operating results— not by their daily, or even yearly, price quotations–whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it.  As Ben said: “In the short run, the market is a voting machine but in the long run it is a weighing machine.” The speed at which business’s success is recognized, furthermore, is not that important as a long as the company’s intrinsic value is increasing at a satisfactory rate.  In fact, delayed recognition can be an advantage: It may give us the chance to buy more of a good thing at a bargain price.

Sometimes, of course, the market may judge a business to be more valuable than the underlying facts would indicate it is. In such a case, we will sell our holdings. Sometimes, also, we will sell a security that is fairly valued or even undervalued because we require funds for a still more undervalued investment or one we believe we understand better.

We need to emphasize, however, that we do not sell holdings just because they have appreciated or because we have held them for a long time. (Of Wall Street maxims the most foolish may be “You can’t go broke taking a profit.”) We are quite content holding a security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business.

However, our insurance companies own three marketable common stocks that we would not sell even though they became far overpriced in the market. In effect, we view these investments exactly like our successful controlled businesses — a permanent part of Berkshire rather than merchandise to be disposed of once Mr. Market offers us a sufficiently high price.  To that, I will add one qualifier: These stocks are held by our insurance companies and we would, if absolutely necessary, sell portions of our holdings to pay extraordinary insurance losses.  We intend, however, to manage our affairs so that sales are never required.

A determination to have and hold, which Charlie and I share, obviously involves a mixture of personal and financial considerations. To some, our stand may seem highly eccentric. (Charlie and I have long followed David Ogilvy’s advice: “Develop your eccentricities while you are young.  That way, when you get old, people won’t think you’re going ga-ga.”) Certainly, in the transaction-fixated Wall Street of recent years, our posture must seem odd: To many in that arena, both companies and stocks are seen only as raw material for trades.

Our attitude, however, fits our personalities and the way we want to live our lives. Churchill once said, “You shape your houses and then they shape you.” We know the manner in which we wish to be shaped. For that reason, we would rather achieve a return of X while associating with people whom we strongly like and admire than realize 110% of X by exchanging these relationships for uninteresting or unpleasant ones.

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