MINNEAPOLIS, MN--(Marketwired - May 9, 2013) - It's the magic of "Mr. Market" that gives stock market investors a unique benefit in buying and selling stocks at a favorable price, according to author Frederick Martin of Disciplined Growth Investors.
"Mr. Market" is a concept first popularized by the late Benjamin Graham, who was known as the "Father of Securities Analysis." Martin expanded on the concept of Mr. Market in his highly acclaimed book "Benjamin Graham and the Power of Growth Stocks" (McGraw-Hill).
Martin compares the process of purchasing a car with the process of purchasing a stock. "The stock market is more volatile than the car market," Martin writes. "Thus, the price of a company's stock can diverge widely from the actual value of the company itself. This is the key opportunity for investors."
Another advantage, says Martin, is that the stock market is open for business every business day. "If you own a car and you decide to sell it, you must first find a buyer, and even then you have no assurance that you will receive your money in a timely manner."
In the stock market, you can sell a stock at any time, with absolute assurance that you'll get your proceeds in three business days. "The fact that the stock market is continuously open for business presents a wonderful -- and often perplexing -- issue for investors," writes Martin.
Graham addressed this unique feature of the stock market in his book, The Intelligent Investor: "Imagine that in some private business, you own a small share that costs you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers to either buy you out or sell you an additional interest on that basis. Sometimes his idea of value appears plausible and is justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes to you seems to you a little short of silly."
It's those times when Mr. Market is a little too enthusiastic or a little too fearful when investors have the best opportunity to buy or sell their stocks at a favorable price. "If you are a prudent investor or a sensible businessman," added Graham, "will you let Mr. Market's daily communication determine your view of a $1,000 interest in the enterprise? Only in case you agree with him, or 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 the 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."
For patient investors, that means that good opportunities continue to come along as the market goes through its cyclical fluctuations. Unfortunately, most investors get caught up in the moment and allow themselves to be influenced by Mr. Market.
When the prices Mr. Market offers begin to fall, instead of seeing value in the falling prices, investors tend to be influenced by fear that the prices will continue to fall. Instead of seeking out bargains to add to their portfolio, they let Mr. Market get the best of them, and start to sell off their holdings at the lower prices.
When Mr. Market begins to raise his prices, investors again are influenced by the movement of the market. Sometimes that leads investors to sell out their stock at a higher price, but the price still may be below the stock's real value. Or the rising market may influence them to buy more stocks for fear the prices will continue to climb. Either way, the decision is being made based on Mr. Market's changing offer rather than by cold, calculating analysis to determine the optimal possible buying or selling price.
"How should an investor take advantage of the stock market without succumbing to its temptations?" Martin asks. "The answer is clear but not easy to do. An investor must take advantage of the volatility in stock prices at the time of purchase, and do so to a lesser extent at the time of sale. The rest of the time, however, the investor should ignore the market fluctuations and concentrate on the fundamental progress of the companies behind the stocks. The ability to do this requires discipline and preparation."
The next column on the "Power of the Purchase Decision" will help you use the volatility of the market to increase your chances of success by investing based on values rather than on the emotion created by the movement of the market.