Mr. Market Miscalculates

How else can you find winning stocks?

I mentioned one approach yesterday—finding a winning management team and growing with that team. Another approach has to do with the temperamental nature of the market. Benjamin Graham put it best 50-odd years ago:

Imagine you have a business partner named Mr. Market. Every day Mr. Market has a new opinion of what the business is worth, and at that price stands ready to buy your interest or sell you his. Mr. Market presents a constant distraction to his fellow owners, but most of the time you would be best served to form your own ideas of the value of your holdings.  You should only really pay heed when he quotes you a ridiculously high price or a depressingly low one—at those times you should sell out or buy more. Otherwise, stick to operational and financial reports.

This is the essence of value investing: determining a firm’s intrinsic value and comparing that to Mr. Market’s price. Over the long run, stock prices have a strong relationship with the economic progress of a business. But in the short run worries about Greek credit default swaps or optimism regarding Chinese banks affect the value of Olive Garden restaurants—which is crazy.

Mr. Market is manic and he frequently miscalculates. Taking advantage of his mood swings is another way to buy low and sell high, which is easy to say, and hard to do.

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