October has been a tough month for investors around the world. Jon writes in his blog novelinvestor.com about the recent declines in share prices. Benjamin Graham wrote that in most periods the investor must recognize the existence of a speculative factor in his common stock holdings. It is his task to keep this component within minor limits, and to be prepared financially and psychologically for adverse results that may be of short or long duration.
Graham made another point in Security Analysis that is often ignored: …the market is not a weighting machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotions. Why does a company’s “value” change so drastically in a short time? Because price is not the same as value. There’s a speculative element within every price that changes based “partly of reason and partly emotion.”
In The Little Book that Still Beats the Market, Joel Greenblatt’s explanation as to why is the best: Who knows and who cares? Maybe people go nuts a lot. Maybe it’s hard to predict future earnings. Maybe it’s hard to decide what a fair rate of return on your purchase is. Maybe people get a little depressed sometimes and don’t want to pay a lot for stuff. Maybe people get excited sometimes and are willing to pay a lot. So maybe people simply justify high prices by making high estimates for future earnings when they are happy and justify low prices by making low estimates when they are sad. But like I said, maybe people just go nuts a lot (still my favorite). The truth is that I don’t really have to know why people are willing to buy and sell shares of most companies at wildly different prices over very short periods of time. I just have to know that they do!
As a value investor, months like these are fun. Not scary fun either. Because when emotion overpowers reason the drastic changes can present opportunities to profit.
Finally, again Benjamin Graham reminds investors that 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.
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