Books / Finance · May 25, 2021

Chapter 8 Of The Intelligent Investor Explained For Beginners

Introduction

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 all the principles of value investing in one single book.

In this blog post I will try to breakdown chapter 8 of the intelligent investor with as simplicity as possible so that even a beginner with no major experience in stock market will be in a position to digest the knowledge.

Chapter 8: The Investor and Market Fluctuations

What are market fluctuations

If you have seen the chart of any stock, you will observe that the the stock prices have always moved in a zig-zag pattern. These movements are called fluctuations.

Why does price of a stock move in a zig-zag pattern

The price of a stock depends on many external and internal factors, but all gets drawn down to one important factor, that is demand and supply. There is a constant battle between the buyers and the seller to decide the price of a stock in the market.

If the buyers are more, the demand will be high, as a result the price will go up. On the other hand if the sellers are more, the demand will be less and the price will go down.

Investor vs Speculator

The most realistic distinction between the investor and the speculator is found in their attitude towards the stock market movements. A speculator’s primary interest lies in anticipating and profiting from market fluctuations. 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. People just look at stocks at buy at 100 sell at 200. This approach is very wrong according to the author. Imagine you are not buying just the stock, but even the business behind it.

Price is what you pay, value is what you get.

Warren Buffett

Act like the owner of that company. This way one will take better decisions in analyzing, rather than just speculating on the price of the stock.

The beauty of market fluctuations is that you can own businesses at a price lower than it’s actual value. Profits are made while buying cheap and selling it when the prices are overvalued.

Be fearful when others are greedy. Be greedy when others are fearful.

Warren Buffett

Concept of Mr. Market

This book has beautifully tried to explain the behavior of market using the concept of Mr. Market. Imagine there is a guy named Mr. Market who comes to your door everyday who is ready to buy or sell stocks from you. 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 happy he will sell the stocks for a very high price. This price can be so silly that it could not even define the underlying behind it. When Mr. Market is sad, he will sell the stocks for a low price, even if the company has high valuations.

It is up to you whether you want to initiate the transaction with him or no. You should not be emotional like Mr. Market and buy stocks only because you are in a fear of missing out or someone tipped you so. You need to make your own investment decisions and buy stock at a fair valuation, or better at a lower valuation. This has been explained in chapter 20 and I will soon write a breakdown of that chapter too. Join the newsletter to receive updates.

An Example mentioned in the book for better understanding of market fluctuations:

This example is of a company named A&P (The Great and Atlantic and Pacific Tea Co.). The author of this book 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 (the actual value of the company, which includes the cost of assets the company owned, the cash reserves etc.) 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 that he already purchased 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 the value investor books their profits.

From this example we can observe that, even if the company performed well throughout, the stock prices didn’t replicate it’s growth. At one particular time the price was at discount, on the other it was overvalued. This is how the price of stocks work.

Conclusion

I highly recommend you to buy a copy of this book as it will give you a better perspective on value investing. This book has also been recommended by Warren Buffett in many of his interviews and public forums. Fun fact, Benjamin Graham, the author of this book has also been a mentor to Warren Buffett in his early investing journey. I am sure it will help you too.

Also Read: Chapter 20 Of The Intelligent Investor Explained For Beginners

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