The

 Intelligent  Investor  
Chapter  8:  The  Investor  and  Market  Fluctuations  
• Both  long-­‐term  bonds  and  common  stocks  are  susceptible  to  wild  fluctuations  in  value  over  
intermediate  periods  
• Being  prepared  financially  and  psychologically  for  these  fluctuations  is  crucial  to  investment  
success    
• The  intelligent  investor  strives  to  profit  from  these  swings  by  making  advantageous  
purchases  of  securities  below  their  intrinsic  value  
• Price  swings  are  dangerous  because  they  often  times  lead  the  investor  into  speculative  
behaviors  
• The  two  ways  to  profit  from  market  fluctuations  are  timing  and  pricing  
• By  timing  the  investor  is  anticipating  the  action  of  the  stock  market  
• By  pricing  the  investor  is  buying  stocks  when  they  are  quoted  below  fair  value  and  
selling  them  when  they  rise  above  fair  value  
• The  intelligent  investor  can  achieve  satisfactory  results  by  using  the  pricing  method  
• Attempting  to  employ  the  timing  method  will  most  likely  turn  the  investor  into  a  speculator  
• A  great  deal  of  time  and  effort  is  expended  on  market  timing,  but  it  rarely  produces  positive  
investment  results  
• Timing  is  only  important  to  the  speculator  because  he  wants  to  make  his  profit  quickly  
• Forecasting  and  timing  methods  that  have  proven  to  be  successful  in  the  past  very  rarely  
work  going  forward  for  two  primary  reasons  
• The  passage  of  time  brings  new  conditions  which  the  old  formula  no  longer  fits  
• Popularity  of  the  method  will  influence  market  behavior  which  will  limit  its  profit  
potential  in  the  future  
• Buying  during  bear  markets  and  selling  into  bull  markets  is  a  natural  pursuit  for  the  
intelligent  investor,  but  it  is  a  hard  strategy  to  implement  
• Waiting  until  a  bear  market  to  buy  would  keep  the  investor  out  of  undervalued  
securities  in  normal  market  conditions  
• Formula  based  plans,  like  the  Dow  Theory,  are  also  unlikely  to  work  over  the  long  run  
• Any  approach  in  the  stock  market  that  is  easily  described  and  followed  by  too  many  
practitioners  is  too  simple  to  last  
• The  investor  should  resign  himself  to  the  fact  that  his  stocks  will  advance  50%  above  their  
low  point  and  decline  one-­‐third  or  more  from  their  high  point  over  a  five  year  period  
• The  holder  of  marketable  securities  has  an  advantageous  double  status  that  he  can  take  
advantage  of  
• He  is  the  equivalent  of  a  minority  partner  in  a  privately  held  business  
• He  is  also  the  owner  of  a  stock  certificate  that  can  be  sold  at  anytime    
• As  a  minority  owner  in  an  operating  business  his  value  is  dependent  on  the  operating  results  
of  the  business  and  the  net  worth  shown  on  the  balance  sheet  
• The  value  of  the  stock  certificate  on  the  other  hand  is  derived  from  the  price  buyers  and  
sellers  are  willing  to  pay  and  often  times  is  significantly  different  from  the  balance  sheet  
value  
• A  great  paradox  in  the  stock  market  is  that  the  better  a  company’s  operating  record  the  
farther  it  will  deviate  from  book  value  
• These  companies  will  therefore  be  more  dependent  on  the  mood  of  the  market  and  
be  more  prone  to  price  fluctuations    
• Selecting  securities  that  are  trading  close  to  their  tangible  asset  value  is  an  advisable  method  
for  the  intelligent  investor  
• Simply  trading  at  a  level  close  to  tangible  assets  is  not  reason  enough  to  make  it  a  
sound  investment    
• The  security  should  also  have  a  strong  financial  position  and  a  reasonable  ratio  of  
price-­‐to-­‐earnings  
• At  times  the  market  will  place  companies  on  sale  for  less  than  their  net  working  capital,  
which  means  that  the  investor  is  getting  the  operating  business  for  free  
• The  intelligent  investor  watches  a  company’s  operating  results  closely  because  he  knows  
that  over  time  the  characteristics  of  a  business  can  change  for  the  better  or  the  worse  
• The  true  investor  is  never  forced  to  sell  a  security  and  is  free  to  disregard  current  market  
quotations  
• The  investor  who  worries  about  unjustified  market  declines  is  turning  his  basic  advantage  
into  a  disadvantage    
• He  would  be  better  off  if  his  stocks  had  no  quotations  at  all  
• Mr.  Market  is  your  silent  business  partner  who  offers  to  buy  your  share  of  the  business  on  a  
daily  basis  at  a  different  valuation  
• Sometimes  his  offers  are  plausible  and  other  times  they  are  exaggerated  by  enthusiasm  or  
fear  
• The  intelligent  businessman  sells  his  interest  to  Mr.  Market  at  ridiculously  high  prices  and  
buys  shares  from  him  when  prices  are  low  
• The  rest  of  the  time  it  is  best  to  ignore  Mr.  Market  and  focus  on  dividend  returns  and  
operating  results    
• The  speculator’s  primary  interest  lies  in  anticipating  market  fluctuations    
• The  investor  is  interested  in  acquiring  suitable  companies  at  reasonable  prices  he  has  no  
desire  to  sell  stocks  because  they  have  gone  down  or  buy  them  because  they  have  gone  up  
• Good  managements  produce  good  average  market  prices,  and  bad  managements  produce  
bad  average  market  prices  
• Management  can’t  be  held  responsible  for  short  term  price  fluctuations  that  bear  no  
relation  to  the  underlying  business  valuation  
• Long-­‐term  bonds,  even  if  the  principal  and  interest  are  completely  secure,  will  also  see  price  
fluctuations    
• With  bonds  there  is  an  inverse  relationship  between  price  and  yield  
• When  prices  rise  the  yield  on  the  bond  decreases  
• Price  fluctuations  occur  in  convertible  bonds  and  preferred  stocks  for  three  reasons  
• Variations  in  the  price  of  the  related  common  stock  
• Variations  in  the  credit  standing  of  the  company  
• Variations  in  general  interest  rates  
• Bond  investors  who  can’t  deal  with  price  fluctuations  should  invest  in  shorter  term  bonds  
with  lower  interest  rates  
• Longer  term  bonds  will  provide  greater  interest  rates,  but  are  more  likely  to  
experience  price  fluctuations  
• Commentary  on  Chapter  8  
• “The  happiness  of  those  who  want  to  be  popular  depends  on  others;  the  happiness  of  
those  who  seek  pleasure  fluctuates  with  moods  outside  their  control;  but  the  happiness  
of  the  wise  grows  out  of  their  own  free  acts.”  –  Marcus  Aurelius  
• The  majority  of  the  time  the  market  does  a  very  reasonable  job  of  valuing  
businesses,  but  occasionally  Mr.  Market  gets  things  completely  wrong  
• The  intelligent  investor  should  not  ignore  Mr.  Market  entirely,  but  he  should  only  do  
business  with  him  when  it  serves  his  own  interests  
• There  are  several  handicaps  faced  by  large  institutional  investors  
§ With  billions  of  dollars  under  management  they  can  only  invest  in  the  
largest  companies  
§ Investor  inflows  increase  when  markets  rise  forcing  managers  to  buy  more  
of  companies  they  already  own  at  high  valuations  
§ If  investors  ask  for  their  money  back  during  market  declines  managers  are  
forced  to  sell  at  low  valuations    
§ Many  portfolio  managers  are  judged  against  the  S&P  500  and  therefore  are  
incentivized  to  index  against  it  
 § Fund  managers  are  expected  to  specialize  in  specific  company  types  or  
industries    
• Neuroscience  has  shown  that  we  are  wired  to  perceive  trends  even  when  they  don’t  
exist    
• When  an  event  takes  place  several  times  our  brain  begins  to  anticipate  it  
• Dopamine  is  released  in  the  brain  each  time  the  event  takes  place  creating  a  natural  
euphoria  
• This  effectively  creates  an  addiction  to  our  own  predictions    
• When  stocks  drop  financial  loss  fires  up  our  fight  or  flight  response    
• We  experience  twice  the  reaction  to  financial  loss  than  we  do  to  financial  gain