Buffett has always recommended Graham’s The Intelligent Investor as required reading for any successful investors. He believed the concepts of Mr. Market and Margin of Safety are amongst the most important pieces of investment advice ever written. When it comes to “Mr. Market”, Buffett has said, “Basically price fluctuations have only one significant meaning for the true investor. They provide him with the opportunity to buy wisely when prices fall sharply and sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”
The classic parable of Mr. Market is something I’ve written about a number of times and despite its seemingly simple message it can be easily misunderstood and is often opposed by behavioral finance frameworks designed to combat ‘the endowment effect’ and ‘sunk cost fallacy’.
You likely have seen the behavioral finance counterargument to the advice of just forgetting about the stock market without even realizing it. For example, I’m sure many of you have all seen the advice that goes something like “holding is identical to buying” or “every day you wake up, you are choosing to buy the portfolio you currently hold at today’s prices” or “if you wouldn’t be buying at these levels than you should be selling.” Even Buffett himself has said something to the effect of if you wouldn’t buy 100% of a company at this current share price then you shouldn’t hold a single share.
These sayings all are designed to help investors overcome the risks that they value their own holdings simply due to the fact that they currently hold them and that investors tend to think of buying and holding as different decisions simply because of what they originally paid.
So how can a disciplined investor square the tension between the advice to “ignore the market” and “if you wouldn’t buy at today’s price, you should be selling.”
To resolve this tension I think you need to consider a few key points.
First, adhering to the advice that is effectively that you should effectively re-evaluate your positions daily under the “if you wouldn’t be buying, you should be selling” type of mantra is likely a quick path to day trading. It further misconstrues that holding is the same as buying, it’s not. One thing we know is that churning a portfolio triggers taxes and fees, known drags on returns that severely crimp compounding power.
Second, let’s be honest, most of us likely have no real idea of what “fair value” is of the underlying businesses we own. There can be a lot of room for argument in whether an investment is ‘under’, ‘fairly’, or ‘over’ valued. Investors like Howard Marks’ have argued that most serious investors probably can identify what they feel are strongly ‘undervalued’ or strongly ‘overvalued’ scenarios, but that it can be difficult to discern whether something is ‘fairly’ vs. ‘over’ valued and in those scenarios the investor is unlikely to be buying, but should not necessarily be selling, they should likely be holding. Again, churning portfolios lead to known and certain costs and violate the idea of ‘never interrupting compounding unnecessarily.’
Part of the wisdom of the parable of Mr. Market is that it helps overcome another behavioral bias, the bias to act. When we ignore the market ticker we can better focus our attention on the performance of the underlying businesses and better inform an opinion of the valuation, remembering that returns ultimately come from the business operations.
The parable of Mr. Market is not a parable to never consider the market prices, but it’s a reminder that the market is not a binary switch of "screaming buy" and "immediate sell." There is a vast, quiet middle ground. As Howard Marks brilliantly points out, when you are wracking your brain trying to decide if a stock is fairly valued or overvalued, it is clearly not a "buy". But that does not make it a "sell."
If you sell a truly exceptional business the moment its P/E ratio looks a little full, you commit what Nick Sleep called the greatest mathematical error in investing: the premature sale of a spectacular compounder. Mathematically, selling a Wal-Mart or an Amazon in the early stages of their multi-decade run is far more damaging to your net worth than holding a company that eventually goes bankrupt. The market consistently struggles to value the sheer longevity of a great business franchise.
Holding a great business for decades is not passive; it requires a muscular, daily decision not to sell. It requires the "intestinal fortitude" to stick with positions that are made highly uncomfortable by their temporary variance from popular opinion
To resolve the tension, you must separate your analytical thesis from your trading execution:
Use "Would I buy this today?" exclusively as a psychological audit of your thesis, not your price. Ask yourself: If I didn't own this today, would I still believe in the management, the competitive moat, and the long-term earning power? If the answer is no, then maybe the business engine is actually broken and you should sell.
If the answer is yes, then your thesis is intact, retreat to the hold zone. Ignore Mr. Market's daily, emotional mood swings. Accept that the current price is full, let go of the need to optimize every minor swing, and focus entirely on the compounding earnings of the enterprise.
As Buffett wisely mused, your investing would be far more intelligent if stocks were quoted only once a year. Do your work, check your parameters, and then shut the door.
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