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Mr. Market, again!

Jan 6, 2005

The legendary investment guru, Benjamin Graham once said, '...in the short term, the market is a 'voting' machine whereon countless individuals register choices that are product partly of reason and partly of emotion. However, in the long-term, the market is a 'weighing' machine on which the value of each issue (business) is recorded by an exact and impersonal mechanism.'The current times when market participants seem to be panicking again in their reaction to some cues from the US Federal Reserve, it is time again that long-term investors understand what Graham said about the Mr. Market theory.

This is, probably, one of the best metaphors ever created for explaining how stocks can become mispriced. Through this parable, Graham asks investors to imagine a non-existing person called Mr. Market who is your (investor's) partner in a private business. He appears daily and names a price (stock quotation) at which he would either buy your interest or sell you his. Now, despite the fact that both Mr. Market and you have stable business interests, his quotations are rarely so. At times, he falls so ecstatic that he sees only the favourable factors affecting business. And this is the time he would name a very high buy-sell price because he fears that if he does not quote such a high price, you would buy his interest in the enterprise and rob him of imminent gains.

And then there are times when this very Mr. Market is so depressed that he sees nothing but trouble ahead for both business and the world. These are the occasions when he would name a very low price, as he is terrified that if he does not do so, you would burden him (sell him) with your interest in the business.

Now, Graham says that if you were a prudent investor or a sensible businessman, you would not let Mr. Market's daily communication determine your view of the value of your interest in the enterprise. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But at the rest of the time, you would be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.

What Graham tells investors through this parable of Mr. Market is that they should look at market fluctuations in terms of the Mr. Market example. They should make these fluctuations as their friend rather then their enemy. This means that they should neither give in to temptations that rising markets bring with them nor should they think of doom when the markets are falling incessantly.

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