Who is Mr. Market?

Who is Mr. Market?

Mr. Market is the character Benjamin Graham uses to explain illogical mindset of traders . The story goes something like this:

Imagine that you own 50% of a business, which you purchased for RM3,600 mil. Mr. Market approaches everyday to tell you what he thinks the business is worth based on latest news. And everyday, he offers to either buy your business for a price which he forms in his head, or, to sell you his share of the business for that price.

Each day, however, he quotes you a different price from the day before. Sometimes the price he quotes sounds about fair. Sometimes it’s high. Sometimes it’s low.

Let’s say the whole business is producing on average, RM 1,200 mil free cash flow with net profit of RM 600 mil. What is the value of the business to you?

By owning 50% of the business, you own RM 600 mil FCF and net profit of RM 300 mil per annum.You paid around RM 3,600 mil for this business a year ago. Hence, you bought this business for 6 times its FCF and 12 x earnings.Let’s say the nature of the business is stable and you anticipate the FCF and net profit will increase over time,you might not want to sell it unless Mr. Market offers you a ridiculously high price.

One day, Mr. Market offers you an additional 40% extra of what you paid a year ago. He offers RM 5,040 mil to for your holdings.Most of us will let go after making 40% profit per annum.

But if you are a sensible businessperson, you won’t let Mr. Market’s daily communication determine your view of the value of 50% interest in the business. He is a sweet talker and convince you with various economic prediction,charts,information and etc to create doubt and fear in you.

Most of us will be swayed by Mr Market ’s offer.

But as a sensible business owner, you may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.

Remember, fluctuations in the market price for a given business don’t really affect the fundamental value of that business. If you own a share in a company, the value of each share is a function of the business ’s profitability/cash flow/management/branding and not a related to the price quoted in Bursa M’sia.

So, as long you understand the business you’re buying, today’s market price is totally irrelevant.



Ref:

Who is Mr. Market?

http://boyboycute.wordpress.com/2009/03/29/who-is-mr-market/