Introduction
Chapter 8 of the Intelligent Investor talks about The Investor and Market Fluctuations.
This chapter focuses on how to act when the market moves in an unpredictable way rather than how to forecast the market.
For those who don’t know, The Intelligent Investor is referred to as the Bible for Value Investing by many successful investors.
The book is authored by Benjamin Graham, who has laid the foundation principles of Value Investing.
Warren Buffett, who is the greatest investor of all times, not only suggests that everyone reads The Intelligent Investor, but also identifies the two most powerful chapters.
You might also brush through the two chapters: Why Warren Buffett Love Chapter 8 And 20 Of The Intelligent Investor
Chapter 8: The Investor and Market Fluctuations
This blog post will explore the following topics:
- What are Market Fluctuations
- How prices of a stock move
- Difference between investor and speculator
- Understand market valuations and volatility
- Concept of Mr. Market
What are Market Fluctuations
When observing the technical chart of a stock, one can see that the prices consistently move in a zig-zag pattern. These movements are referred to as Market Fluctuations.
The investor needs to know about the possibilities of market fluctuations and be prepared for it financially and psychologically.
The main reason why the author talks about market fluctuations is to understand the ability to benefit from the changes in market prices over a course of time as well as to make purchases at an advantageous price.
Price Patterns of a Stock
The price of a stock depends on many internal and external factors, but the price movement finally gets drawn down to one important factor, that is demand and supply.
There is a constant battle between the buyer and the seller to pull the price in their favour and finally decide the price of the stock in the market.
If the buyers are dominating, the demand will be high, as a result the price will go up. On the other hand, if the sellers dominating, the demand will be less and the price will go down.
Over short time frames, a stock’s price may appear irrational or disconnected from its true value, but in the long run, it tends to align with the company’s underlying fundamentals.
Investor vs Speculator
The most realistic distinction between the Investor and the Speculator is found in their attitude towards the stock market movements.
The following table shows the distinction between Investor and Speculator:
| Investor | Speculator |
|---|---|
| Invests in stocks based on the fundamentals of a company | Invests with a hope to make quick profits |
| Invests for long term benefits | Invests for short term benefits |
| Maintains a disciplined mindset | Tries to time the market |
An investor evaluates the valuations of a stock based on its fundamentals and long term value. While, a speculator’s primary interest lies in anticipating and profiting from market fluctuations.
Author states in this chapter that, most people think they are investing, but in reality they are just speculating. One needs to shift its mindset from Speculating to investing.
Quote from the book: The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices [Page 205, The Intelligent Investor].
Valuations of Stocks
The value of the stock may not truly depict the value of the business behind that stock. For instance, people just look at stocks in a way that it is mere buying at $100 and selling it at $200.
According to the author, this approach is not so right. Imagine, you are not just buying the stock, but even the business behind it.
Act like the owner of that company. This way one will take better decisions in analysing, rather than just speculating over the price of the stock.
The beauty of market fluctuations is that you can own businesses at a price lower than its actual value. Profits are made while buying cheap and selling it when the prices are overvalued.
Concept of Mr. Market
This book has beautifully explained the behaviour of market using the concept of Mr. Market.
Imagine there is a character named Mr. Market, who comes to your door everyday and offers you to buy or sell stocks.
The price is always decided by Mr. Market, and he doesn’t force you to buy or sell it.
Mr. Market is very moody.
When he is optimistic, he will sell the stocks for a higher price. This price can be so vague that it could not even define the underlying objective behind it.
When Mr. Market is pessimistic, he will sell the stocks for a lower price, even if the company has higher valuations.
It is up to you whether you want to initiate the transaction with him or no.
Its not advisable to be emotional like Mr. Market and buy stocks only because you are in a fear of missing out or someone tipped you to do so.
Your objective should not be to follow the mood of Mr. Market, but use his offers to your advantage. Buy low when he is pessimistic, sell high when he is optimistic.
Quote from the book: The intelligent investor is a realist who sells to optimists and buys from pessimists.
Understanding Volatility
Market volatility is defined as the price movement of a stock over a given period of time. It also means how fast and upto what extent a price of a stock can move.
A stock with high volatility means that that there is a greater price difference between its highs and lows.
Volatility of a stock can be used by various factors like economic news, company earning reports, global events etc.
Authors view on volatility makes us understand that, one should not fear volatility of a stock, as it is bound to happen.
One needs to use volatility to its advantage and not to react emotionally to market swings and fluctuations.
Example of Market Fluctuations
This example is of a company named A&P (The Great and Atlantic and Pacific Tea Co.).
The author found the share price fluctuation of this stock very fascinating.
A&P was listed on the American stock exchange in 1929 which went as high as $494.
After 3 years, the price went down to $104.
This was unbelievable price as the company’s intrinsic value was much higher than the price at which it was trading.
If anyone would buy this stock, he would actually buy it for a cheaper price.
By 1937, the price hit as low as $36.
Here the author says, “if a value investor had brought this stock at $100, this drop wouldn’t bother him because he knew that he already purchased it at a discount. All he could think of was to buy more to average the price.”
In 1939, the share price again inclined at $117, which was three times it’s low in the last 2 years.
A&P rose its company with expansions and increased outlets which then took the price up to $700 by 1960.
This price was way above the actual valuation of the company. This is the time when value investors books their profits.
From this example, we can observe that even if the company performed well throughout, the stock prices didn’t replicate its actual growth.
At one particular time the price was at discount, and the other time it was overvalued. This is how the price of stocks work.
Conclusion
Market volatility and price fluctuations cannot be avoided, but can be seen as an opportunity to buy good stocks at a discount and hold them for a long term. The market is there to serve you, not to guide you.
Investors can transform market volatility from a risk to an opportunity by being disciplined and concentrating on the fundamentals.
The Intelligent Investor has also been recommended by Warren Buffett in many of his interviews and public forums.
Fun fact, Graham has also been a mentor to Warren Buffett in his early investing journey.
Also Read: Chapter 20 Of The Intelligent Investor Explained For Beginners
