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Lessons from Warren Buffett - LXII

Apr 19, 2016

Our last article was based on Warren Buffett's 2010 letter to shareholders, in which Mr Buffett wrote about the ill effects of excessive borrowing for both individuals and businesses. If you have missed it, you can read it here.

Let's now look into the 2011 letter. Here, Warren Buffett talks about the folly of the stock markets and how one can deal with it. He tells the story of his eureka moment, which was inspired by the eighth chapter of Benjamin Graham's Intelligent Investor.

  • Charlie and I don't expect to win many of you over to our way of thinking - we've observed enough human behavior to know the futility of that - but we do want you to be aware of our personal calculus. And here a confession is in order: In my early days I, too, rejoiced when the market rose. Then I read Chapter Eight of Ben Graham's The Intelligent Investor, the chapter dealing with how investors should view fluctuations in stock prices. Immediately the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life.

Many investors seem to be obsessed with the near-term direction of the markets. A surge in the markets will make them rejoice, while a correction will make them recoil in panic. Their thought process lingers around these short-term market movements. They are tempted to find ways and means to time the market and make a quick buck. But sooner or later, they realise that all their gains are in vain. And this is where the eighth chapter from the Intelligent Investor comes in handy. Let us understand what it conveys to the speculator.

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The eighth chapter in the Intelligent Investor offers probably the best explanation of how an investor should view the markets. And to explain this clearer, it brings in the explanatory parable of Mr Market.

The chapter asks us to imagine that we have an obliging partner named Mr Market. Everyday Mr Market tells you what your interest is worth in the business you have invested. On that basis, he offers to buy you out or sell you an additional interest. Sometimes the prices he quotes are agreeable to you. But most of the time, Mr Market lets his enthusiasm or despair influence the price he is willing to buy and sell shares. When exuberant, he fixes the price above the fundamental value of the business. When fearful, he sets the price of the business below the fundamental value of the business.

The intelligent investor is not swayed by Mr Market's quotes. He has done his groundwork and knows the fundamental value of his interest. He therefore follows a very different path to get the most from Mr Market. When Mr Market wants to sell at prices far below intrinsic value, the intelligent investor will buy from him. When Mr Market is excited and wants to purchase at price above the fundamental value, the intelligent investor may choose to sell to him. At other times, he forgets about the market movements and pays attention to his dividend returns and the operating results of his company.

What we can learn from the above parable is the importance of looking at opportunities based on value and price rather than emotions. You can expect the prices of your portfolio to change, but that should never allow you to change your investment decisions. This is because the market quotations are there for your convenience. They are either to be taken advantage of or to be ignored. But never, ever, to be taken seriously. As Buffett says, 'The stock market is a no-called-strike game. You don't have to swing at everything - you can wait for your pitch.'

Rahul Shah

Rahul Shah (Research Analyst), Managing Editor, Microcap Millionaires has led the team from the front in developing some of our most stringent and rewarding research processes. As per his own admission, the turning point in Rahul's life as a financial analyst came a few years back when he got introduced to the works of Warren Buffett and Charlie Munger. From Buffett, he understood the value of investing in good quality business with powerful moats and strong management teams. Charlie Munger on the other hand inspired him to be a lifelong learner and use mental models in order to arrive at the crux of matters across most disciplines. Rahul firmly believes that in order to be successful at investing, you have to do the big things right and possess a great temperament and a contrarian streak.

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