Buffett On Mr. Market

by Joe Ponzio

People are always asking me about "must read" books on business, investing, and other topics to help with their investing. One of the finest "Buffett" books on the market is Lawrence Cunningham's The Essays of Warren Buffett: Lessons for Corporate America. Unlike most books that try to pick apart Buffett's investment style, The Essays of Warren Buffett organizes Buffett's annual letters, reports, and other teachings in an easy-to-read format.

If you are not entirely, 100%, unwaveringly confident in your investing, buy this book. Let's take a look at what Buffett has said about Mr. Market.

On Buying Stocks

Whenever Charlie and I buy common stocks...we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price we must pay. We do not have in mind any time or price for sale.

The intrinsic value of a company lies entirely in its future. Don't just look at the economic past of the business; try to predict the future by looking at the economic prospects of the business. In addition, take a look at management. Mr. Market will present you with thousands of opportunities to buy businesses when they appear to be on sale. Bad or unethical management can do a lot of things to screw up the prospects of the business.

Meet Mr. Market

Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

On Uncertainty and Stock Prices: Buffett and Pabrai Come Together

Here is where you see a screaming correlation between Mohnish Pabrai and Warren Buffett:

Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.

Mohnish Pabrai speaks often of high risk vs. high uncertainty (with low risk). One example of this was Buffett's purchase of American Express in 1964. At the time, American Express saw its stock clobbered in the markets after it revealed that it lost millions when it bought salad oil that turned out to be nothing more than water.

The world was selling American Express, and Buffett was buying - ultimately investing 41% of his partnership's assets into the company. Mr. Market panicked, saw nothing but doom and gloom, and priced the $400-$500 million business at $100 million.

Buffett On American Express

...Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie [Munger] and I have not learned how to solve difficult business problems. What we have learned is how to avoid them.

He goes on to say:

...[In some instances] a great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, problem as was the case many years back at both American Express and GEICO.

Look For "Debacles"

In the current sub-prime debacle, a lot of builders, banks and mortgage companies have seen their stocks tank. This presents some seemingly "mouth-watering" investment opportunities. Now the question: Which of these companies are in real trouble, and which have encountered a one-time huge, but solvable, problem?

Mr. Market will beat up the businesses that won't survive; Mr. Market will also throw in a few that he doesn't know how to handle.

The market may ignore business success for a while, but eventually will confirm it. As Ben said: "In the short run, the market is a voting machine but in the long run it is a weighing machine."