This is of course an old article inspired by Mr. Buffet’s thinking – or Mr. Graham’s thinking, language and concept of Mr. Market. It appeared in Moneycontrol long back….however things have not changed much.

Mr. Market: Good trader but a terrible investor.

When you push that ‘Place Order’ button or get that confirmation in the mail (increasingly sms), do you ever wonder who is on the other end of that trade? Who sold you those shares? What does that guy have on the
company that you don’t?

Or could it be ‘Mr. Market’ who is selling his shares to you? Mr. Market, Ben Graham’s mythical investor, acts out his mania and depression with buy and sell orders. He will sell to you when he’s desperate for an out, often at low prices. And he will want to buy shares from you at correspondingly high prices when momentum and ‘news flow’ render valuation meaningless.
And he trades much too frequently, donating heavily to the daily charity drive of brokerage commissions and fees.

These awful psychological characteristics make Mr. Market a terrible investor, but a great person to trade with. The question every investor should ask themselves–before every trade, in fact–is this: Am I being
Mr. Market?

There’s a Mr. Market in all of us, and every once in a while, I still succumb to his way of doing business. But too much Mr. Market in your investment style will almost certainly prevent you from earning a decent
return from stocks.

Do any of these statements fit your approach?

I have my brokers’ telephone number on my speed dial
If you talk to your broker five times a day, the chances are you will keep doing transactions much more than you think you should be doing.

When a stock I own drops 20%, I sell: Plenty of investors employ a rule like this. Some even dump at declines of 5% or 10%. But stocks are volatile. Mr. Market whips the price up and down, putting share prices far from what a knowledgeable, well-heeled buyer would pay for the entire business. Show me a portfolio with sell stops at 5%, and I will show you a portfolio that will lose 5% a year like clockwork.

Think back to Eid Parry and Coromandel fertilizers, are either of these businesses really worth 15% or 20% less than they were at the beginning of the quarter? Has the stream of future cash flows and dividends diminished that greatly? Are customers fleeing to competitors, or simply expiring from the planet? Or is it that people are suddenly not using sugar? Are these companies’ assets materially impaired? Hardly. The actual value of the business is at the whip’s handle – moving to and fro ever so slightly.
The market price is the end of the whip – and that whip has stung the short-term crowd badly.

Never forget that the market price of a stock at any given moment is where the weakest current owners and the most indifferent group of buyers meet. I am not the least bit concerned that ABC has been marked down from Rs 84 to Rs 69 in the past month. Mr. Market can’t have my shares for less than Rs 110.

The good long-term investors – I heard many of them speak – don’t sell at a 20% loss, but they do go back and aggressively review their investment case. If the fundamentals are unchanged, they hold or buy more. If the business is not as strong as they expected – that is, if they made a mistake analyzing the business in the first place–then, and only then, will they sell.

When a stock I own rises 5%, I lock in my gains ‘Nobody goes broke taking a gain,‘ or so goes the old adage. Nobody ever got rich taking gains in 5% increments, either. Peter Lynch calls this tendency by amateur investors to harvest small gains while taking larger losses on the downside ‘watering the weeds’.

To benefit from holding stocks, you have got to be willing to hang on for a long time – a horizon measured in years, not days. The events that drive share prices up in big increments (a surprise improvement in earnings, a big dividend increase, improving sales growth) can’t be pinpointed to a particular day or week. The best approach is ‘don’t just do something, sit there’. Why is this so difficult? Because every anchor for every channel somewhere seems to be working for a broker.

If the fact that a stock is ‘going nowhere’ bothers you, why not consider higher-yielding names that will pay you handsomely – in cash – to wait. A dividend portfolio provides a yield of 3% with annual dividend growth of more than 6%.

I only look for stocks that have been going up ‘The trend is your friend’ is another adage whose timelessness is matched only by its uselessness. Stocks are just about the only items that consumers buy that seem to become more desirable as they get more expensive. All being equal, as the price you pay for a stock rises, its future return potential falls. It’s not just that ‘past performance is not a promise of future results,’ as mutual fund advertisements declare in the fine print, but quite the opposite–yesterday’s performance is just as likely to set the stage for opposite results tomorrow.

I sell when a share announces bad results: I do not actually own any share that is a one ‘six month’ or one ‘quarterly’ result buy. If as a trend it does badly, yes you should sell.

However, if you do not know why the results are bad and you sell, you should not be buying shares, maybe RBI bonds are a better bet for you.

I never make a loss
Chuckle, chuckle, I know a liar when I see one, or when I see a guy or a gal saying that they have not lost money in the market. The only way you can have ‘not made a loss’ is by converting all the ‘short-term buys’ into “investments” thus not booking the loss.

I have a balanced portfolio created by me Creating a balanced portfolio ? one that has cut across industries, business groups, geographies, etc. is a full time job and few individual investors have the skill or the discipline to be able to do it on a continuous basis.

Grab Your Wallet
One of the amazing things about Mr. Market is how much he pays in fees. Make no mistake, these contributions to Dalal Street’s annual bonuses are purely voluntary, and they come straight out of his total returns. A Rs 5 lakh brokerage account that makes just two trades a week at Rs. 10,000 per transaction stands to shell out 4% of its value annually just in commissions. And while that 4% may not sound like much as a percent of assets, it’s a whopping 20% of the market’s historic return before fees.
In absolute terms, over a 10-year period, the fee is 40% of the starting corpus.

Dalal Street has no shortage of cheerleaders, lauding the billions of shares worth of ‘liquidity’. It provides investors and the steady decline in per-transaction commissions. But is a Rs 10 or Rs 20 trade ‘cheap’?
Dalal Street is not dumb – it’s more than made up for this with volume. It’s simple economics: Slash the price of something, and you will sell a lot more of it. This helps explain why banks promoting brokerage houses are good buys.

Every rupee they collect in revenue comes out of investors’ aggregate return. The services they provide create no fundamental business value but the churn that brokerage firms create surely creates value for its
shareholders, if not for its customers.

I am grateful for all this liquidity, but not for the same reason Mr. Market is. The ease with which Mr. Market can make bad decisions creates opportunity for longer-term investors. Every time there is a market fall I have been able to add a MICO, MRF, or the likes to my portfolio at attractive prices.

Make Mr. Market work for you Even though I think an investor can do well owning individual stocks, it’s not for everyone. If you are in the game as a Mr. Market impersonator, odds are you will be better off with an index fund. And if you just can’t stand short-term fluctuations in paper value, a savings account or a shoebox under the bed is the place for you.

I spend a lot of time thinking about the competitive advantages (or disadvantages) as an investor and as manager of an active fund. The way I see it, there are only two ways to play.

One way is to pursue superior information. If you know much more about the business than the average holder of its shares, you are in a better place to judge whether the current price is too high or too low and can act accordingly. But this is very tough to do, even with tiny firms. Dalal Street pays its analyst ranks millions to cover large-cap firms like Reliance and Infosys, yet they’re usually caught off guard on short-term problems like the rest of us.

The other way is to pursue a superior point of view. I can’t tell you whether my portfolio is going to meet, beat, or miss on its next quarterly earnings report. I guess I was late for class on the day they handed out clairvoyance.

My point of view (which is borrowed or stolen from the greats) holds that a stock’s total return over time will equal the dividend yield I get on day one plus the subsequent growth rate of dividends per share. I rely on dividends to provide my return. I can judge that my portfolio yields are attractive and the dividends themselves will continue to grow at very healthy rates. What’s more, by evaluating the businesses from the standpoint of competitive advantage, they should both be able to maintain high rates of dividend growth for very long periods of time. If I hold the stock long enough, my total return will converge to this combination of yield and growth and I won’t have to donate to Dalal Street’s charity drive to earn it.

So if i do not want to learn about portfolio construction, market timing, dollar trades, carry trades, risk, …etc. and I want to separate the “ego” of my stock picking skills and my wealth creation, I should choose an Index fund.

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