My Key Takeaways From Chapter 8 and Commentary 8 of the Intelligent Investor. Part 9/16. To Be Continued.

Chapter 8 The Investor and Market Fluctuations

To the extent that the investor’s funds are placed in high-grade bonds of relatively short maturity-say, of 7 years or less-he will not be affected significantly by changes in market prices and need not take them into account. (This applies also to his holdings of U.S. savings bonds, which he can always turn in at his cost price or more.) His longer-term bonds may have relatively wide price swings during their lifetimes, and his common-stock portfolio is almost certain to fluctuate in value over any period of several years.

Market Fluctuations as a Guide to Investment Decisions

Since common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings. There are 2 possible ways by which he may try to do this: the way of timing and the way of pricing.

By timing we mean the endeavor to anticipate the action of the stock market-to buy or hold when the future course is deemed to be upward, to sell or refrain from buying when the course is downward.
By pricing we mean the endeavor to buy stocks when they are quoted below their fair value and to sell them when they rise above such value.

We are equally sure that if he places his emphasis on timing, in the sense of forecasting, he will end up as a speculator and with a speculator’s financial results.

Those formulas that gain adherents and importance do so because they have worked well over a period, or sometimes merely because they have been plausibly adapted to the statistical record of the past. But as their acceptance increases, their reliability tends to diminish. This happens for 2 reasons: 1st the passage of time brings new conditions which the old formula no longer fits. 2nd in stock-market affairs the popularity of a trading theory has itself an influence on the market’s behavior which detracts in the long run form tis profit-making possibilities.

Buy-Low-Sell-High Approach

We are convinced that the average investor cannot deal successfully with price movements by endeavoring to forecast them. Can he benefit from them after they have taken place-i.e., by buying after each major decline and selling out after each major advance?

Nearly all bull markets had a number of well-defined characteristics in common, such as (1) a historically high price level, (2) high price/earnings ratios, (3) low dividend yields as against bond yields, (4) much speculation on margin, and (5) many offerings of new common-stock issues of poor quality.

The market’s behavior in the past 20 years has not followed the former pattern, nor obeyed what once were well-established danger signals, nor permitted its successful exploitation by applying old rules for buying low and selling high. Whether the old, fairly regular bull-and-bear-market pattern will eventually return we do not know. But it seems unrealistic to us for the investor to endeavor to base his present policy on the classic formula-i.e., to wait for demonstrable bear-market levels before buying any common stocks.

Formula Plans

The moral seems to be that any approach to moneymaking in the stock market which can be easily described and followed by a lot of people is by its terms too simple and too easy to last. Spinoza’s concluding remark applies to Wall Street as well as to philosophy: “All things excellent are as difficult as they are rare.”

Market Fluctuations of the Investor’s Portfolio

A serious investor is not likely to believe that the day-to-day or even month-to month fluctuations of the stock market make him richer or poorer. But what about the longer-term and wider changes?

A substantial rise in the market is at once a legitimate reason for satisfaction and a cause for prudent concern, but it may also bring a strong temptation toward imprudent action. If he is the right kind of investor he will take added satisfaction from the thought that his operations are exactly opposite from those of the crowd.

Business Valuations versus Stock-Market Valuations

The impact of market fluctuations upon the investor’s true situation may be considered also from the standpoint of the shareholder as the part owner of various businesses. The holder of marketable shares actually has a double status, and with it the privilege of taking advantage of either at his choice. On the one hand his position is analogous to that of a minority shareholder or silent partner in a private business. Here his results are entirely dependent on the profits of the enterprise or on a change in the underlying value of its assets. He would usually determine the value of such a private-business interest by calculating his share of the net worth as shown in the most recent balance sheet. On the other hand, the common-stock investor holds a piece of paper, an engraved stock certificate, which can be sold in a matter of minutes at price which varies from moment to moment-when the market is open, this is-and often is far removed from the balance sheet value.

The development of the stock market in recent decades has made the typical investor more dependent on the course of price quotations and less free than formerly to consider himself merely a business owner. The reason is that the successful enterprises in which he is likely to concentrate his holdings sell almost constantly at prices well above their net asset value (or book value, or “balance sheet value”).

The better a company’s record and prospects, the less relationship the price of its shares will have to their book value. But the greater the premium above book value, the less certain the basis of determining its intrinsic value-i.e., the more this “value” will depend on the changing moods and measurements of the stock market. Thus we reach the final paradox, that the more successful the company, the greater are likely to be the fluctuations in the price of its shares.

If he is to pay some special attention to the selection of his portfolio, it might be best for him to concentrate on issues selling at reasonably close approximation to their tangible-asset value-say, at not more than one-third above that figure. A caution is needed here. A stock does not become a sound investment merely because it can be bought at close to its asset value. The investor should demand, in addition, a satisfactory ratio of earnings to price, a sufficiently strong financial position, and the prospect that its earnings will at least be maintained over the years. More than half of the DJIA issues met our asset-value criterion at the end of 1970.

The A.& P. Example

There are 2 chief morals to this story. The 1st is that the stock market often goes far wrong, and sometimes an alert and courageous investor can take advantage of its patent errors. The other is that most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies’ performance like a hawk; but he should give it a good, hard look from time to time.

Basically, price fluctuations have only 1 significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to 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.

Summary

The most realistic distinction between the investor and the speculator is found in their attitude toward stock movements. The 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.

As in all other activities that emphasize price movements first and underlying values second, the work of many intelligent minds constantly engaged in this field tends to be self-neutralizing and self-defeating over the years.

He would not be far wrong if this motto read more simply; “Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.

Good managements produce a good average market price, and bad management product bad market prices.

Fluctuations in Bond Prices

The investor should be aware that even through safety of its principal and interest may be unquestioned, a long-term bond could vary widely in market price in response to changes in interest rates.

The price fluctuations of convertible bonds and preferred stocks are the resultant of 3 different factors: (1) variations in the price of the related common stock, (2) variations in the credit standing of the company, and (3) variations in general interest rates.

Over the past decade the bond investor has been confronted by an increasingly serious dilemma: Shall he choose complete stability of principal value, but with varying and usually low (short-term) interest rates? Or shall he choose a fixed-interest income, with considerable variations (usually downward, it seems) in his principal value.

Commentary on Chapter 8

“The happiness of those who want to be popular depends on others; the happiness of those who seek pleasure fluctuates with moods outside their control; but the happiness of the wise grows out of their own free acts.” – Marcus Aurelius

Dr. Jekyll and Mr. Market

The manic-depressive Mr. Market does not always price stocks the way an appraiser or a private buyer would value a business. Instead, when stocks are going up, he happily pays more than their objective value; and, when they are going down, he is desperate to dump them for less than their true worth.

Can You Beat the Pros at Their Own Game?

One of Graham’s most powerful insights is this: “The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.”

But investing isn’t about beating others at their own game. It’s about controlling yourself at your own game.

The single best choice for this lifelong holding is a total stock-market index fund.

Your Money and Your Brain

Why, then do investors find Mr. Market so seductive? It turns out that our brains are hardwired to get us into investing trouble; humans are pattern-seeking animals. Groundbreaking new research in neuroscience shows that our brains are designed to perceive trends even where they might not exist.

 

Deserunt quisquam corrupti aut. Incidunt natus minima unde ut.

At corrupti ipsam magni reiciendis blanditiis. Excepturi quibusdam sit quis aspernatur. Dolores autem iste aliquid odio ex dolor. Omnis sint voluptate sit aut quia consequatur doloremque.

Similique error minima corporis similique totam. Aut tempore omnis harum nisi eum. Ut qui veniam repellendus modi perspiciatis.

I'm an AI bot trained on the most helpful WSO content across 17+ years.

Career Advancement Opportunities

March 2024 Investment Banking

  • Jefferies & Company 02 99.4%
  • Goldman Sachs 19 98.8%
  • Harris Williams & Co. (++) 98.3%
  • Lazard Freres 02 97.7%
  • JPMorgan Chase 03 97.1%

Overall Employee Satisfaction

March 2024 Investment Banking

  • Harris Williams & Co. 18 99.4%
  • JPMorgan Chase 10 98.8%
  • Lazard Freres 05 98.3%
  • Morgan Stanley 07 97.7%
  • William Blair 03 97.1%

Professional Growth Opportunities

March 2024 Investment Banking

  • Lazard Freres 01 99.4%
  • Jefferies & Company 02 98.8%
  • Goldman Sachs 17 98.3%
  • Moelis & Company 07 97.7%
  • JPMorgan Chase 05 97.1%

Total Avg Compensation

March 2024 Investment Banking

  • Director/MD (5) $648
  • Vice President (19) $385
  • Associates (86) $261
  • 3rd+ Year Analyst (13) $181
  • Intern/Summer Associate (33) $170
  • 2nd Year Analyst (66) $168
  • 1st Year Analyst (202) $159
  • Intern/Summer Analyst (144) $101
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
Betsy Massar's picture
Betsy Massar
99.0
3
Secyh62's picture
Secyh62
99.0
4
BankonBanking's picture
BankonBanking
99.0
5
DrApeman's picture
DrApeman
98.9
6
CompBanker's picture
CompBanker
98.9
7
dosk17's picture
dosk17
98.9
8
GameTheory's picture
GameTheory
98.9
9
kanon's picture
kanon
98.9
10
Jamoldo's picture
Jamoldo
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”