• Saniya

Best Investment Advice = Plain English + 6th grade Math

Updated: May 1, 2018

Being an Investment Management Professional during the day and a Blogger at night, I thought why not combine the two and share the best advice I have ever received in my ten plus years of looking at stocks and investments.

I try to read a lot of books, articles and watch tons of documentaries on the field of Investments. I try to follow the footsteps of some of the great Investors, and my all-time favorite is Benjamin Graham - "Father of Value Investing". Naturally, I tend to gravitate towards people like Joel Greenblatt and Warren Buffet, who follow the principles of Value Investing. (I do invest in some growth companies - but that's generally a smaller portion of my portfolio).

Recently, I was re-reading one of the old books "The little book that beats the market" and I thought I would share something interesting from it. It's written in plain English and 6th grade math to make it super easy to follow along.

Imagine that you are partners in the ownership of a business with a crazy guy named Mr. Market. He is subject to wild mood swings. Each day he offers to buy your share of the business or sell you his share of the business at a particular price. Mr. Market always leaves the decision completely to you, and every day you have three choices:

  1. You can sell your shares to Mr. Market at his stated price,

  2. You can buy Mr. Market’s shares at that same price, or

  3. You can do nothing

Sometimes Mr. Market is in such a good mood that he names a price that is much higher than the true worth of the business. On those days, it would probably make sense for you to sell Mr. Market your share of the business.

On other days, he is in such a poor mood that he names a very low price for the business. On those days, you might want to take advantage of Mr. Market’s crazy offer to sell you shares at such a low price and to buy Mr. Market’s share of the business.

If the price named by Mr. Market is neither very high nor extraordinarily low relative to the value of the business, you might very logically choose to do nothing.

In the world of the stock market, that’s exactly how it works. The stock market is Mr. Market! If, according to the daily newspaper, General Motors is selling for $37 per share, you have three choices:

  1. You can buy shares in General Motors for $37 each,

  2. You can sell your shares in General Motors and receive $37 each, or

  3. You can do nothing

If you think GM is really worth $70 per share, then you might consider $37 a ridiculously low price and decide to buy some shares.

If you think GM is really worth only $30 or $35 per share (and you happen to own some shares), you might decide to sell to “Mr. Market” at $37.

If you think each share of General Motors is worth between $40 and $45 per share, you may decide to do nothing. At $37 per share, the price is not at a big enough discount for you to buy, nor is $37 a generous enough offer to make you want to sell.

In short, you are never required to act. You alone can choose to act only when the price offered by Mr. Market appears very low (when you might decide to buy some shares) or extremely high (when you might consider selling any shares you own to Mr. Market).

Graham referred to this practice of buying shares of a company only when they trade at a large discount to true value as investing with a margin of safety.

The difference between your estimated value per share of, say, $70 and the purchase price of your shares of perhaps $37 would represent a margin of safety for your investment. If your original calculations of the value of shares in a company like General Motors were too high or the car business unexpectedly took a turn for the worse after your purchase, the margin of safety in your original purchase price could still protect you from losing money.

I love how easy and simple this read is. I understand not everyone is comfortable with evaluating the true price of a stock or a company, but I like this story because it can be applied to anything and not just the stock market.

Mr. Market can be your sibling offering you to buy/sell/do nothing to a pack of chocolates or it could be your friend offering you to buy/sell/do nothing to a concert ticket. You see, the possibilities are unlimited. It's good to learn the tricks of trade, so next time you encounter a Mr. Market you would know how to best take advantage of his/her mood swings!

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Have a lovely day!