Michael Mauboussin is the author of The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing (Harvard Business Review Press, 2012), Think Twice: Harnessing the Power of Counterintuition (Harvard Business Press, 2009) and More Than You Know: Finding Financial Wisdom in Unconventional Places-Updated and Expanded (New York: Columbia Business School Publishing, 2008). More Than You Know was named one of “The 100 Best Business Books of All Time” by 800-CEO-READ, one of the best business books by BusinessWeek (2006) and best economics book by Strategy+Business (2006). He is also co-author, with Alfred Rappaport, of Expectations Investing: Reading Stock Prices for Better Returns (Harvard Business School Press, 2001).
Visit his site at: michaelmauboussin.com/
“If you want to make money on Wall Street, you must have the proper psychological attitude. You must look at things under the aspect of eternity.” – Ben Graham
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Michael Mauboussin: The Legacy of Ben Graham
- To be an active investor, you must believe in market inefficiency to get opportunities and in market efficiency for those opportunities to turn into profits. T
- he Mr. Market metaphor is very powerful because it makes an abstract idea concrete, encouraging an appropriate way to think about markets.
- One way to animate Mr. Market is to consider the wisdom of crowds. What’s key is that crowds are wise under some conditions and mad when any of those conditions are violated.
- Diversity breakdowns, which can happen for sociological as well as technical reasons, lead to extremes.
- Look for cases where uniform belief has led to a mispricing of expectations and hence a way to make money.
Michael Mauboussin: The Proper Psychological Attitude
Ben Graham, a renowned investor and revered teacher, opened his course at Columbia Business School by saying, “If you want to make money on Wall Street, you must have the proper psychological attitude.”
Referring to a passage in Ethics by the philosopher Baruch Spinoza, he added, “You must look at things under the aspect of eternity.” Translated loosely, this means you need to take an objective point of view.1
Warren Buffett, chairman and chief executive officer of Berkshire Hathaway and Graham’s most famous student, suggests you need to read three chapters in order to shape that attitude2:
- Chapter 8 from The Intelligent Investor by Ben Graham (“The Investor and Market Fluctuations”);
- Chapter 20 from The Intelligent Investor (“‘Margin of Safety’ as The Central Concept of Investment”);
- Chapter 12 from The General Theory of Employment, Interest and Money by John Maynard Keynes (“The State of Long-Term Expectation”).
The focus of this discussion is chapter 8, and in particular Ben Graham’s parable of Mr. Market. We have three goals:
1. Argue that the Mr. Market metaphor remains a powerful way to think about markets;
2. Introduce a handful ideas, some of which were not fully developed when Graham introduced the metaphor, to help animate the concept;
3. Provide some concrete ways to think about using Mr. Market to your benefit.
Graham opens chapter 8 by noting that stocks fluctuate (of course) and that there are two ways that a participant in the market can profit from those swings. The first is “timing,” the endeavor to anticipate the action of the stock market. The second is “pricing,” buying stocks for less than they are worth and selling them for more than they are worth.
He adds quickly that timing doesn’t work for an investor and remains the purview of the speculator.3 Notwithstanding the parade of commentators in the media, the evidence that experts predict poorly in complex domains is quite clear and well documented. The best work in this area in our opinion is by Philip Tetlock, a professor of psychology at the University of Pennsylvania, who studied the predictions of hundreds of experts making political, economic, and social forecasts over 20 years. His conclusions would have come as no surprise to Graham: “. . . many pundits were hardpressed to do better than chance, were overconfident, and were reluctant to change their minds in response to new evidence.”4
Graham goes on to argue that a useful way for an intelligent investor to think about the market is through the parable of Mr. Market. In Graham’s version, you own a small stake in a private company that costs you $1,000 (approximately $10,000 in today’s dollars). One of your partners is an obliging fellow named Mr. Market who tells you, every day, what he thinks your stake is worth and, further, offers a price at which he’s willing to buy you out or offer you an additional interest.
In his telling of the Mr. Market parable, Warren Buffett adds that Mr. Market has “incurable emotional problems.”5 Sometimes he is euphoric and sees only favorable outcomes and hence names a very high buysell price. Other times he is depressed and sees only negative outcomes and provides a very low buy-sell price.
See full PDF below.