THRIVING IN EVERY MARKET
Value Investing Made Easy (Janet Lowe):- THRIVING IN EVERY MARKET
- MR. MARKET
- SUITABLE SECURITIES AT SUITABLE PRICES
- PAYING RESPECT TO THE MARKET
- TIMING VERSUS PRICING
- BELIEVING A BULL MARKET
- THE PAUSE AT THE TOP OF THE ROLLER COASTER
- MAKING FRIENDS WITH A BEAR
- BARGAINS AT THE BOTTOM
- SIGNS AT THE BOTTOM
- BUYING TIME
- IF YOU ABSOLUTELY MUST PLAY THE HORSES
This passage explores the irrational nature of the market and how value investors navigate it.
Market Irrationality: Unlike normal consumer behavior, investors often buy stocks at high prices and avoid them at low prices. Markets are prone to overreact, swinging wildly above and below intrinsic value—a behavior likened to a hunting dog frenetically searching for a scent.
The 1987 Crash Example: The rapid 44% rise and subsequent 23% single-day crash in 1987 demonstrated that market prices can dramatically diverge from the underlying value of businesses.
Mr. Market's "Scatterbrained" Behavior: The case of Chrysler in 1995 shows how a stock can remain undervalued until an event (like a takeover bid) suddenly corrects the price, revealing the market's emotional and erratic pricing mechanism.
The Value Investor's Approach: Value investors acknowledge and use market cycles (the "wavelike advances and retreats") but do not try to predict their timing or extremes. Instead, they focus on buying undervalued stocks, knowing that market fluctuations will eventually correct the price toward intrinsic value, which is essential for their success.
This passage introduces the allegory of "Mr. Market," created by Benjamin Graham to illustrate the stock market's irrational and emotional behavior.
Mr. Market is depicted as a manic-depressive, compulsive business partner who offers to buy or sell you shares every day. His prices are driven by his volatile moods—euphoric optimism leads to unrealistically high offers, while pessimism leads to absurdly low ones. However, his mood swings are irrelevant to the underlying value of the business.
The key lesson is that Mr. Market exists to serve you, not guide you. A wise investor should ignore his emotional extremes and only act when his price is advantageous—buying when he is irrationally pessimistic and selling when he is overly optimistic. His offers are opportunities to be used, not signals to follow.
This passage outlines the core value investing principle of focusing on price rather than prediction.
The investor's main goal is to acquire and hold suitable securities at suitable (low) prices. Market movements are practically useful only because they create these opportunities: low prices to buy and high prices to avoid buying or to sell.
However, while these market cycles are obvious in hindsight, they are impossible to predict in advance. The investor's success depends on both the market's future behavior and the prices it offers, yet neither can be controlled or forecasted. Therefore, the strategy relies on disciplined action when prices are favorable, not on trying to time the market's unpredictable turns.
While value investors don't try to predict the exact timing of market highs and lows, they agree with timers that market movements are fundamentally linked to intrinsic value. They operate on the conviction that, due to changing conditions or investor recognition, a stock's price will ultimately rise or fall to reflect its actual worth, just as the moon influences the tides.
Bull markets are typically characterized by:
High Prices: Price levels and P/E ratios are historically elevated.
Low Dividend Yields: Yields are low relative to bonds or the stock's own history.
Speculative Excess: There is heavy margin buying (borrowing to invest) and a flood of new stock offerings, particularly low-quality IPOs, which seasoned investors often view as overpriced during these periods.
Sell everything, take profits, and wait for a market decline to find new bargains.
Hold stocks with long-term potential, selling only the clearly overvalued ones, and again wait for a decline.
This patience pays off during a correction, as well-chosen value stocks tend to hold their price better. The example of Walter Schloss in 1987 shows that while value portfolios may lag in a bull market's peak, they often protect capital and outperform during downturns, preserving long-term returns.
In contrast, speculative "hot stocks" that crash put investors in a difficult position: selling locks in permanent losses, while holding on involves a long, erosionary recovery.
This passage recounts Benjamin Graham's experience with the 1929 crash and its aftermath.
Even though he recognized the market was dangerously high and had carefully chosen and hedged his investments, Graham was still badly damaged by the crash due to incomplete hedges and excessive use of borrowed money (margin).
Despite these losses, he persevered, rebuilt his portfolio, and soon played a key role in triggering a market recovery by publicly declaring it was time to start buying again. His story illustrates both the severe risks of a crash and the resilience of a disciplined value investor.
In 1932, during the Great Depression, Graham survived through various financial jobs and began buying defunct companies.
In 1942, he published a series in Forbes noting that many companies were trading for less than their cash holdings. His argument that businesses were "worth more dead than alive" gave discouraged investors confidence and helped start a sustained market recovery.
In 1974, during another market downturn, Graham gave a speech declaring a "Renaissance of Value," noting that stocks were again deeply discounted. He urged investment managers to buy these bargains. His call contributed to a market revival, with the Dow Jones Industrial Average rising from 600 to over 900 by 1976.
The core theme is Graham's repeated use of value investing principles—buying stocks far below their intrinsic value—to signal market bottoms and inspire investor action.
This passage explains that identifying a market bottom is theoretically simpler than spotting a top, based on clear quantitative evidence.
The key signs are found in corporate financial data (like balance sheets and P/E ratios) and in broad market metrics. As a primary example, it states that the dividend yield for the Dow Jones Industrial Average historically cycles between approximately 6% at a market bottom (signaling undervaluation) and 3% at a market top (signaling overvaluation). While it can sometimes move beyond these points, this yield range is presented as a reliable historical indicator.
This passage explains that a falling market is the ideal time for value investors to buy, but it requires overcoming fear and exercising patience.
Opportunity in Downturns: When markets fall sharply, value investors see a "harvest time" with many undervalued companies available. Figures like Seth Klarman and Warren Buffett view these periods as advantageous.
The Psychological Hurdle: This best buying time coincides with widespread investor fear and negativity, making it psychologically difficult to act.
The Strategy: The key is to buy affordable undervalued stocks during these bear market depths, as bargains are not found in strong markets.
The Need for Patience: Undervalued stocks often remain dormant for long periods. Therefore, successful investing requires identifying a bargain, taking a position, and then waiting—often a protracted and trying experience—for the market to recognize the value.
This passage outlines a strict, disciplined strategy for combining market timing with value investing, as acknowledged (but not recommended) by Benjamin Graham.
The method, attributed to Roger Babson, is structured and demands significant patience, as it may cause an investor to miss parts of a bull market. The strategy works as follows:
Select: Choose a diversified portfolio of stocks, such as those in the DJIA, focusing on undervalued ones.
Value: Determine a "normal value" for each stock using a multiplier applied to its 7-10 year average earnings.
Buy: Purchase shares only when they trade at a substantial discount (e.g., two-thirds) to that normal value, potentially starting to buy as the price declines to 80% of value.
Sell: Sell the stocks when their price rises substantially above normal value (e.g., 20-50% higher).
The core mechanism is to buy during market declines and sell during rallies, based strictly on predetermined price-to-value calculations rather than emotion.
