The Stock market and its price action is a beautiful thing. Millions of market participants with opposing convictions and investing styles, interacting through an auction market. A mosaic of buyers and sellers, pushing and pulling the price around a stock’s hypothetical intrinsic value.
These dynamic forces make the market seem like it has a mind of its own, and it is often taught in financial theory that the market is in fact making a ‘Random Walk’. Up and down, back, and forth – you never know where it’s going to go next. We tend to agree with this theory and as such, do not try to predict market fluctuations, only the quality company’s you hold in your portfolio.
This theory of a ‘random walk’ appears to have some validity with individual stocks as well. A company may be posting stellar financial performance, but a stock cannot go up in a straight line forever. And after a stock has increased by 100%, a 20%-40% pullback in the price could be viewed as completely ordinary. Sellers taking profit and new investors trying to bid (buy the stock) as low as they can – simply the ebb and flow of the auction market. Two steps forward, one step back.
It is often very difficult to claim with certainty what is causing a 5%-15% swing on a stock. No new press releases from the company, no new material information for investors to react to, simply buying or selling pressure. The fight between optimism and pessimism, much like a game of tug-of-war.
Warren Buffett’s mentor, Benjamin Graham, described it best with his theoretical investor, “Mr. Market”, in his 1947 book, The Intelligent Investor. He says that Mr. Market is an investor driven by panic, euphoria, and apathy, who randomly acts on his mood (Optimism and Pessimism), rather than fundamental analysis. But luckily for prudent investors, it is Mr. Market’s emotional outbursts that can lead to investment opportunities. However, it is uncovering these opportunities when Mr. Market is having an emotional outburst which can be the difficult part. Buying when a stock is undervalued and selling when it is potentially overvalued.
The key is to always know why you own a stock and to not let Mr. Market get the better of you. The market or an individual stock may swing rapidly, if you do not know why you own it and its price begins to fall, you will likely not know what to do about it. Is it time to sell, time to buy more? Surely it is a careful practice, but if time is taken to assess the fundamentals of a business and to interview management – as long as the investment thesis is still intact – Mr. Market is only taking you for a short blip over a much greater ride.