Sunday, 4 March 2012

The Investor and Market Fluctuations: The Single Most Important Paragraph in Graham's entire book for the Bear Markets (5)

Let us return to our comparison between the holder of marketable shares and the man with an interest in a private business.  We have said that the former has the option of considering himself merely

  • as the part owner of the various businesses he has invested in, or 
  • as the holder of shares which are salable at any time he wishes at their quoted market price.

But note this important fact:
The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus 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. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.†

* “Only to the extent that it suits his book” means “only to the extent that the price is favorable enough to justify selling the stock.” In traditional brokerage lingo, the “book” is an investor’s ledger of holdings and trades.

This may well be the single most important paragraph in Graham’s entire book. In these 113 words Graham sums up his lifetime of experience. You cannot read these words too often; they are like Kryptonite for bear markets.  If you keep them close at hand and let them guide you throughout your investing life, you will survive whatever the markets throw at you.

Incidentally, a widespread situation of this kind actually existed during the dark depression days of 1931–1933.  There was then a psychological advantage in owning business interests that had no quoted market. 
  • For example, people who owned first mortgages on real estate that continued to pay interest were able to tell themselves that their investments had kept their full value, there being no market quotations to indicate otherwise. 
  • On the other hand, many listed corporation bonds of even better quality and greater underlying strength suffered severe shrinkages in their market quotations, thus making their owners believe they were growing distinctly poorer. 
In reality the owners were better off with the listed securities, despite the low prices of these.
  • For if they had wanted to, or were compelled to, they could at least have sold the issues—possibly to exchange them for even better bargains. 
  • Or they could just as logically have ignored the market’s action as temporary and basically meaningless. 
But it is self-deception to tell yourself that you have suffered no shrinkage in value  merely because your securities have no quoted market at all.

Returning to our A. & P. shareholder in 1938, we assert that as long as he held on to his shares he suffered no loss in their price decline, beyond what his own judgment may have told him was occasioned by a shrinkage in their underlying or intrinsic value. 
  • If no such shrinkage had occurred, he had a right to expect that in due course the market quotation would return to the 1937 level or better—as in fact it did the following year. 
  • In this respect his position was at least as good as if he had owned an interest in a private business with no quoted market for its shares. 
  • For in that case, too, he might or might not have been justified in mentally lopping off part of the cost of his holdings because of the impact of the 1938 recession—depending on what had happened to his company.

Ref:  Intelligent Investor by Benjamin Graham

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