One of the enduring coinages of investing is “Mr. Market,” which is attributed to Benjamin Graham and his 1949 book The Intelligent Investor. Graham’s disciples include Warren Buffett and the Memphis-based Longleaf Partners mutual funds.
The idea is that companies have an underlying true value and another price offered by Mr. Market who, like Macy’s, puts things on sale sometimes and marks them up other times. Research and analysis, the theory goes, can uncover the true value and guide decisions about when to buy and sell. This may or may not be a good investing philosophy. It is undeniably good salesmanship.
In May, Mr. Market put Longleaf’s managers and investors to the test as two of the fund’s biggest holdings — Chesapeake Energy and Walt Disney Company — were making negative (Chesapeake) and positive (Disney) headlines that made them impossible to ignore in the annual Longleaf shareholders meeting May 1st. There are general lessons for anyone who invests.
(Disclosure: I have owned Longleaf shares in my retirement account for some 20 years.)
The share price of Chesapeake, a natural gas company, dived due to falling gas prices and controversy over CEO Aubrey McLendon, who gave up his chairmanship of the firm after being pressured by Longleaf managers Mason Hawkins and Staley Cates and other big investors.
“We had 364,000 questions about Chesapeake, and all but three of them were hostile,” Cates joked to Longleaf partners on a day Chesapeake’s stock fell 14 percent. The next day it fell some more.
Longleaf is staying the course but will take a more active role in management.
“Despite the short-term pain that has temporarily pushed the stock price down to $18, the long-term outlook for compensation and governance has just gotten better,” Cates said at the meeting.
When it was his turn to speak, Hawkins put up a chart of Disney’s up-and-down long-term stock performance against Longleaf’s estimate of its true value to illustrate the fickleness of Mr. Market. This time, the news that broke later that week was good. The movie The Avengers set box-office records with a $200 million opening weekend, validating Disney’s $4 billion acquisition of Marvel Entertainment and Longleaf’s big bet. Mr. Market raised his price a couple bucks.
How you feel about Mr. Market and the theory that there is a true value of companies in a world of stock market bulls, bears, and ruthless “short sellers” trying to drive down prices depends on a third factor: your timing and your luck.
The Longleaf Partners fund started in 1987, when the Dow Jones Industrial opened the year at 1897 and ended it at 1939. On October 19, 1987, Mr. Market went crazy. The Dow fell 505 points or 22 percent, the biggest single-day decline in its history. Investors and mutual funds that stayed the course (and lived long enough) were richly rewarded for the next 20 years, as the Dow reached 14,164. They did especially well if they reloaded from 2000-2002 when the market went down each year, and Longleaf earned its stripes by far outperforming the pack.
But in 2008, Mr. Market went crazy again, and Longleaf Partners fund lost 50 percent of its value. The fund has made gains since then but, at $29 and change recently, it is well below its 2007 high of $39.90 when Mr. Market was not in a discounting mood.
What’s the lesson? When you invest is as important as where you invest. Pity the investor who has to cash out in hard times.
As Longleaf’s prospectus says, “Our relationships are long-term. The average direct account tenure is between 5-10 years.” That doesn’t mean all holdings will pay off in that time frame. Dell, for example, was $25 in 2002 and it is $15 this year. Its biggest gains were from 1997 to 2000. A long-term investor who made periodic investments would even out the highs and lows but still show a loss. That’s why funds diversify.
For an individual investor, outsmarting Mr. Market is hard, as pros remind us. They should know, because it’s hard for them, too.