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Monday, February 9, 2009

An Investment Parable

The Sensex seems to be in a frivolous mood - going up 150 points one day, and down 200 points the next day. There is no clearly discernible trend. Investors who are experiencing a bear market for the first time are bewildered about what to do now.

So how do investors tackle such market fluctuations? Try to learn from Graham's parable (The Intelligent Investor, Chapter 8, The Investor and Market Fluctuations).

"Imagine that in some private business you own a small share that cost you $1,000. One of your partners, Mr Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest ... Sometimes his idea of value appears plausible and justified by business developments and prospects... Often... Mr Market lets his enthusiasm or his fears run away with him, and the value he proposes seems... a little short of silly.

If you are a prudent investor or a sensible businessman, will you let Mr Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. 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.

The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgement and inclination. He must take cognizance of important price movements, for otherwise his judgement will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed - this... means that he is to sell his shares because the price has gone down, foreboding worse things to come... Such signals are misleading as often as they are helpful...

Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies."

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