I remember when I was in high school I saw a movie wherein there were several people standing in front of giant screens shouting. A lot of them were busy talking to the phones and shouting at other people. Most of them have this small slip of paper and there were those who were writing on pieces of papers as if taking orders. I didn’t know how exactly to describe it at first.
It was like a demonstration or a political rally, or perhaps it was more like a restaurant where people are so hungry that they are scrambling to have the orders taken and the waiters were taking their orders as fast as they could. People were shouting and screaming; some were cursing. There were days when people would be jubilant and clapped their hands.
The scenario I just described to you was a movie wherein there was a stock market scene. I grew up wondering what that hullabulla was all about. The stock market intrigued me. I was so fascinated how people could make money that way. That thought stuck to my mind until I formally learned what the stock market is all about. I was just given a glimpse by Hollywood on how the stock market works.
The stock market is a very unique market. It is probably the only type of market where so much emotions are involved. You don’t see people shouting and panicking in the fish market just because there is a huge storm coming. You certainly don’t see them selling their fish in panic because the price of fish will go down by virtue of some external event. In the fish market or any other market they might do a mark down sale because of low demand but you certainly don’t see people doing a panic selling or buying like crazy whenever somebody projects that the price of fish will go up because of some reason.
The stock market is dictated by two things, FEAR and GREED. When there is so much fear in the market the prices goes down. People start to panic and dump stocks irregardless at what price they bought it. When there is so much greed in the market, people go crazy over stocks. They buy without regard to the financials of the underlying business that the stock represents. They want to buy whatever is the latest stock craze. The market is driven by so much emotion that most of the time the decision most stock market players make are often irrational, illogical and just plain dumb and stupid.
In order to give you an insight on how the stock market really works. Consider this illustration given by the late Benjamin Graham, Warren Buffett’s mentor, otherwise known as the Dean of Wall street, father of securities analysis and value investing and author of the masterful treatise, “Securities Analysis” and “The intelligent investor” both considered as classics and the bible of investing.
In “The Intelligent Investor” Graham gives a powerful illustration on how the stock market works. He writes:
“Imagine that you own a small share in a private business, which you purchased for $1,000. One of the other owners of the business, named Mr. Market, approaches you to tell you what he thinks your share of the business is worth. And everyday, he offers to either buy your share of the business for that price, or, to sell you an additional share of the business for that price.Each day, however, he quotes you a different price from the day before. Sometimes the price he quotes sounds about fair. Sometimes it’s high. Sometimes it’s low. If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. 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 the rest of the time you will 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.”
The point that Graham is making is that you as an investor should not regard the whims and caprices of Mr. Market in determining the value of the stocks you own. You should learn to profit from market folly instead of participating in it. Graham concludes that the investor is better off concentrating on the actual performance of the underlying business which a stock represent, rather than being too concerned with the wild gyrations of the market.
Sometimes you can’t believe how such smart, financially savvy and intelligent people could be dictated by fear and greed resulting to their making ridiculous and irrational decisions. Well it does happen and it has been happening for the past centuries ever since the stock market has existed. To show you an example of how myopic, manic depressive and bipolar the market is, the Philippine stock market in particular, the market has valued a retail grocery chain close to 45 billion pesos when its net income could barely even reach 30 million within this year. On the other hand the market only valued a holding company who has a majority stake in a large grocery store chain network for only more or less 40 billion pesos when its income could very well exceed more than 5 billion pesos this year. The intelligent investor would take advantage of this and buy the stock that the market undervalues for the time being.
After all, as Benjamin Graham wisely concludes, in the short run, the market is a voting machine, that is it tallies up popular and unpopular firms but in the long run it is a weighing machine, meaning eventually the market will realize the value of the companies with solid fundamentals and will soon price its stock accordingly. This is how intelligent investors profit from the myopic, manic depressive bipolar and insane Mr. Market.
Zigfred Diaz is a Cebu-based registered financial planner of RFP Philippines. To learn more about personal-financial planning, attend the 89th RFP program this May 2021. To inquire, e-mail email@example.com or text at 0917-6248110.