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Warren Buffett: Why Stocks Are Like Hamburgers

- By Stepan Lavrouk

One of the most famous metaphors in the discipline of value investing is that of Mr. Market - the manic-depressive business partner who wildly over- and under-estimates the value of your business day-to-day. Invented by Ben Graham, this character is an excellent illustration of how inefficient markets work. But why do people have such trouble avoiding falling into the trap of thinking like Mr. Market?

To my mind, it comes down to an inability to think of equities as real assets. In his 1997 letter to shareholders of Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B), Warren Buffett (Trades, Portfolio) attempts to bridge this gap by comparing stocks to hamburgers.

Do you prefer your car cheap or expensive?

"A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves".

The answer here of course that lower prices are better for the consumers of these products. Similarly, low prices of stocks are good for the "consumers" of those stocks:

"But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying".

Rising prices are not good for those who are about to invest, they are good for those who are already invested, and even then only if they plan to sell in the near future. Buffett considers Berkshire as a "corporate saver" by reinvesting all earnings back into the business via share repurchases, or by acquiring new businesses, Buffett and Charlie Munger (Trades, Portfolio) multiply the invested capital of their shareholders, and the cheaper the price, the more value they get.

"So smile when you read a headline that says "Investors lose as market falls." Edit it in your mind to "Disinvestors lose as market falls -- but investors gain." Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: "Every putt makes someone happy")".

The analogy to consumer goods like hamburgers and cars is useful as it turns something that many people consider abstract and intangible (ownership of a business) into a real asset that can go up and down in price. Unless you are a net issuer of stocks throughout your lifetime (which few of us are), falling prices are almost always going to be a positive development.

Disclosure: The author owns no stocks mentioned.

This article first appeared on GuruFocus.