The uncertainty surrounding the outbreak of the coronavirus and its human and financial consequences is on all of our minds right now. Global stocks have fallen a lot and very quickly. The markets are fluctuating wildly.
The situation made me think of the message from the “The Intelligent Investor”, a book written by Benjamin Graham, “the father of value investing” (as he has often been called). The book was published in 1949, but still is relevant and contains words of wisdom for any investor. Perhaps the most famous investor of all time – Warren Buffett – studied under Benjamin Graham, and often credits Graham as a major influence shaping him as an investor.
Price is what you pay; value is what you get
“The Intelligent Investor” would perhaps not pass as modern financial theory, but I still think the book has something to teach us in these testing times.
Meet mr. Market!
In the book, Graham introduces a fictitious person he calls mr. Market. You and Mr. Market are business partners and together you own a company.
Every day your business partner will tell you a price he believes the company to be worth and offer you an opportunity to buy or sell the company’s shares for that price. Often the price he suggests will be a reasonable projection of the underlying value, but sometimes mr. Market’s feelings and emotions will take the upper hand. One moment he can be exuberant and will buy your shares for what seems to you a high price, next he can gloomy and would sell to you for a price you deem too low according to your estimates of the true value.
Graham points out that if you are a sound and sensible investor you will not let mr. Market’s daily price announcements influence your assessment of the underlying value. You will make up your own mind on the value based on the company’s operations and the financial balance. In other words, you have to do that job yourself! You won’t know the underlying value of the company by following mr. Market’s daily price announcements, which ultimately will be up or down based on his mood.
INSPIRATION: The billionaire Warren Buffett says "The Intelligent Investor" changed his life. The investing manual written by Benjamin Graham was first published in 1949
What does mr. Market think about today’s situation?
Much has happened since 1949. Mr. Market is still here, however, and right now he has become worried. That he is bewildered and uncertain is entirely understandable – the world looks very different and much less safe right now than only a few weeks ago.
For over ten years stocks have gone only one way: up. Only rarely has mr. Market had bad weeks.
Now his world has turned upside-down. A virus has gained a foothold and uncertainty prevails.
This crisis is putting mr. Market’s nerves to a test – both with regards to his financial affairs and his health. He’s stressed. The price on the stocks he owns has fallen significantly the last three weeks; never has he seen such rapid deterioration in prices. Everything is down and it is affecting everyone. Stocks can fluctuate in the double digits on a daily basis, not to mention intraday.
Can mr. Market make bad judgments when he’s stressed?
Looking back, mr. Market might think to himself that he has become too complacent after ten good years… For many years he has steadily adjusted his price estimations upwards – perhaps he has failed to distinguish different companies from each other?
And then suddenly we see this massive drop in share prices in a period of great uncertainty. Perhaps it’s better to reduce the price estimations considerably?
Mr. Market is generally very good at estimating the value of companies, but when emotions take the upper hand and he is stressed, he does make mistakes. These mistakes create opportunities.
There is – undeniably – great uncertainty facing us going forward. The duration of the measures taken to curb the spread and the effect these have on the affected countries remain to be seen. We are, however, quite certain that right now, many good companies are being severely undervalued by mr. Market.
What can we learn from Buffett’s mentor?
Graham’s message is that a reasonable investor should not let mr. Market’s daily price announcements influence your estimations of a company’s underlying value.
As professional asset managers we try to live by that principle.
We therefore do now what we always do. Regardless of short-term market fluctuations we look for companies that we believe are well managed, have good positions in their respective markets, and that we believe have a greater upside based on our estimates of their underlying value. Without taking excessive risks.
As for the financial sector, which I follow closely, the companies have focused on capital accumulation and risk management following the global financial crisis. We believe that the sector is in a better position today than it was more than ten years ago.
What’s our view of the financial sector going forward?
We are optimistic with regards to the future. We believe the world will get through this crisis just like it has in the past.
The population, the companies, authorities and the central bank are all taking powerful measures to bring the crisis under control. The powers that be seem to have a great understanding that the economy needs help in this situation.
When it comes to the aftermath, we believe there might be some changes. Perhaps we’ll travel less? Perhaps we’ll buy more groceries online? Perhaps we’ll conduct more videos using video conferences?
Nevertheless, we believe the financial sector will continue to play a significant role in society. The financial sector is needed to facilitate growth and efficiency. Both during and after the crisis precipitated by the coronavirus we will continue to save for the future. We’ll continue to need mortgage loans. Businesses with great ideas will continue to need financing. We will still buy insurance, perhaps more than before!
We also see that the financial sector is priced record low versus the broader market. Mr. Market seems to have lost faith. We believe that this is a very good basis for us – as managers – to create good returns, both absolutely and relatively, over the coming years.