Value Investing: Intrinsic Values versus Emotional Values (Market Prices)

Value investing works if stock prices fluctuate around business value.  ONLY then can stocks be bought at discounts to business value (or sold at premiums to business value).

Value investors believe that markets price stocks in ways that produce such gaps.

Graham's metaphor described this behaviour as Mr. Market, viewing market action as the collective psychological behaviour of human beings prone to periods of excessive optimism and pessimism.  The conception yields several insights for what value investing is.

Numerous complex factors influence stock market prices.  The idea that anyone can predict the outcome of this process (market timers), or that it works in a way that yields prices just equal to value (efficient market hypothesis followers), is far-fetched.  Value investing considers trying to measure market sentiment a waste of time.  Value investing focuses primarily on business value (intrinsic value), not market price (emotional value placed by the market.).

Emphasizing businesses over prices enables value investors to know that owning stock means owning an interest in a going concern.

• That mental quality promotes the discipline necessary to define a circle of competence, do financial analysis, and assess value-price (intrinsic value-emotional value) relationships.  
• Pervasive market price data makes it harder for equity investors to appreciate that they are part owners of a business, making disciplined analysis elusive.

The only reason to consider market sentiment is because in times of general economic despair and market malaise, the odds of successful stock picking rise.  Three factors contribute:

1. there are more companies likely to be priced below value,
2. there are fewer investment competitors likely to wade into the thicket, and,
3. the media and regulatory pressure tend to promote quality management and conservative accounting.