Wednesday, June 25, 2008

Analytical Review 101 – Part XIV

Money Talks, Bullshit Walks: You and Mr. Market

Ultimately, as Intelligent Investors, we are only concerned about one thing. What is the value of the shares we are buying, truly worth? Based on our analysis, if we feel the company is worth between a range of RM30-35 per share and it is currently trading at RM25, then it worthwhile to purchase the shares in the company. Eventually, the market will price the Company's shares according to its’ underlying value.

Consequently, before investing, it is important to carry out an analysis backed up by financial data, rather than relying on speculation and market rumors. In future posts, we shall see how to use these historical data in conjunction with the market data to assess whether investing in a company is worthwhile.

Sources of Market Data
The Business Week website gives you free access to the market price and volumes traded, of major companies’. Most of the market price and trading volume, of major listed companies are free available on the Internet, so just Google for such information.

The link to view the share price of Nestle is here:

The Real Deal: Share Price
Up to now, we have been analyzing historical information based on the annual audited financial statements. Such historical information furnishes us the track record of management's ability to generate returns for its’ investors. However, we are missing a vital link: the Share Price!

The Share Price of a Company on a particular day represents the last transacted price between a willing buyer and willing seller. For an Intelligent Investor, the Share Price of a company DOES NOT represents the worth of a Company.

WHAT! WHAT [insert expletive here] ARE YOU TALKING ABOUT?

Mr. Market
Well, the reason is very simple. Markets are IRRATIONAL! I shall let Warren Buffett explain further on this concept. This is extracted from one of his letters to the shareholders of Berkshire Hathaway.

Ben Graham
Ben Graham taught me that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values. The true investor welcomes volatility. Ben Graham explained this in Chapter 8 of The Intelligent Investor. There he introduced "Mr. Market," an obliging fellow who shows up every day to either buy from you or sell to you, whichever you wish. The more manic-depressive this chap is, the greater the opportunities available to the investor. That's true because a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to either ignore the market or exploit its folly.

Ben Graham told a story 40 years ago that illustrates why investment professionals behave as they do: An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. “You’re qualified for residence”, said St. Peter, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, “Oil discovered in hell.” Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. “No,” he said, “I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all.”

The Risk
Sometimes, the share price of a company (say ZGL) appears to be trading at a large discount from their underlying values. In reality, say that this is not the case. Mr. Market has correctly priced the shares due to business risks and other factors that you had overlooked. Here, you may have bought the shares at RM25 as your (erroneous) analysis, indicates that the underlying value should be around RM30-35 per share.

During this period, the share price of ZGL has plunged from RM25 to RM10 in the span of one year. Do you still keep your shares in ZGL in the belief that Mr. Market has incorrectly priced its’ shares? Or do you dump all your shares in ZGL and sell out?

As an Investor, you have to rely on something important called JUDGEMENT. Not even the world’s greatest investor, Warren Buffett is perfect. Expect to make some missteps, when joining the world of investing. The best thing to do is to set your tolerance level for losses. You may set a trigger point to sell ZGL shares, if it falls below a certain value. This is important as most of us are reluctant to admit when we have made a bad call. It is not easy to cut your losses but you must do so! Don’t throw good money after bad!

For instance, you could set your trigger point to sell ZGL shares if it falls by 40% from your initial purchase price (i.e. the market price of ZGL's shares drops to RM15 per share). Even though you have lost 40%, at least you preserved the remaining 60% of your capital. Obviously if the shares price shoots up to RM40 a year later, then the fact you were RIGHT, would be of cold comfort.

We have looked at how to obtain the current share price of our target company. In addition, we have briefly explored the key investment strategy of an Intelligent (or Value) Investor. Please also keep in mind, Warren Buffett's illuminating explanation on the concept of Mr. Market, and how one can profit from market foibles and irrationalities . In my future posts, we shall use the share price of the company in conjunction with historical data, to assess the underlying value of a company.


Oleg G. Kildyushov

I've read your article.
Thank you for the good content.
Best Wishes to you.

Jeff -

Looking forward to learning how to assess the TRUE value of a company.

I do have a question though...isn't it true that most companies trade at some multiple of their actual value? Therefore isn't it more complicated than just seeing if the current price is a discount to the actual value? Don't you also have to determine if the current price is a reasonable multiple of the the actual value?


Dear All,

Thanks for visiting and appreciate your comments.

As to Jeff's question, you are right! Things are not as simple as they seem. You've a good question and I'll cover this in detail in future posts since I can't do justice it here.

However, in brief, sometimes investors value the company based on future prospects, which make sense, since you are investing money in the company now, due to its' future earning potential.

Still, this may be a risky strategy and that's where Benjamin Graham's concept of 'MARGIN OF SAFETY' comes into play.

Hope this makes sense, but if it does not, don't fret. My future post will cover this in detail.

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