Sometimes the market is wrong


In January, Indian Premier League franchise Rajasthan Royals paid the equivalent of £1.2m for the services of bowler Jaydev Unadkat (in blue above); he is a great player, but statistically, Benny Howell of Gloucestershire (yellow, above) is the better player, but he was not involved in the IPL auction. The market values Jaydev more than Benny; sometimes the market is wrong.


In 2002 Billy Beane, working with a shoestring budget, assembled a team based on free agent signings, players overlooked in the draft or discarded by other teams despite having good statistical records. These players went on a remarkable 20 game unbeaten run, finishing the regular season on top of their division; sometimes the market is wrong.

In March 2000, the share price of Inktomi Corp, an internet search software company, hit US$231, a rise of 1900% since launch. In the three months to Dec 99, the company sold more products and services than in all of 1998, and if the twelve month growth rate could be sustained for five years (!) revenues would explode to $5bn a month. The market valued Inktomi at $25bn; at that point Inktomi hadn’t made a penny (cent) profit, and had lost $54m in just over two years.

Just over two years later, the shares closed at 25c, taking the “value” of the company to around $40m, despite the company generating $113 in revenue over the previous 12 months, nearly three times more than when the share price was $231. Yahoo acquired Inktomi three months later, in December 2002, for $1.65 a share; history is likely to show this to have been a bargain. Sometimes the market is (perpetually) wrong.

Benjamin Graham’s 1949 book “The Intelligent Investor” anthropomorphizes the market into “Mr Market”; you have a modest stake in a private enterprise and Mr Market is your partner. Every day he tells you what he thinks your stake is worth, and either offers to buy you out or sell you an additional stake. The offers are usually sensible and justifiable, but often (too often perhaps) Mr Market lets his emotions get the better of him and his valuation seems plainly silly.

The issue is that Mr Market does not always price stocks the way Ms Investor might, and makes the wrong calls, happily paying more than stocks are worth when they rise, then accepting materially less when they fall.

We do not have to let Mr Market dictate our actions any more than we would allow our neighbour to tell us whether or not we are happy each morning, based on what side of bed she got out of. There will be times when you agree with Mr Market, and take advantage accordingly – selling when the market is high, and buying when it is low – but more often you should be looking at fundamentals, cash flow, balance sheets and dividends. The market’s job is to provide prices, it is the investor’s job to decide whether or not to act.

We should also remember that when markets are “destroying value” in one area, they are often creating it elsewhere: in the calendar year 2008 the FTSE 100 gave a negative total return of -28.3%; the Ruffer Total Return fund gave a positive return of 20.8%.

Volatility is not necessarily our enemy, nor is it a good measure of risk. Volatility is a measure of short term fluctuations in capital value, whereas the true risk in the long term is the permanent loss of capital. Volatility is a poor proxy for that loss; why would capital values over a three month period have relevance for investors with 10, 20 or 30 year investment horizons?

An individual’s view on markets and volatility depends on whether he is an investor or a speculator: a speculator’s main interest is on anticipating market moves; an investor’s is the acquisition of suitable stock at suitable prices, and holding that acquisition.

So the next time Classic FM finishes playing “The Lark Ascending” for the fifth time this week, and tells us that the FTSE 100 has fallen by 1%, pay it no heed and certainly do not fret over it. The market can and does get it wrong; tune out the noise, focus on underlying tangibles and keep an eye on the sports pages for Benny Howell.

doug brodie