Take Advantage of Mr. Market

Once upon a time, in a village far from Wall Street's bustle, a visitor arrived. Mr. Market, as he called himself, had made a small fortune trading momentum stocks on the Nasdaq. He'd made so much, in fact, that he'd decided to call it quits and retire from the trading game to live out his days in leisure in the country (or so he thought).

And so he moved to the village. And bought himself a cottage. And raised geese in his back yard. As the days passed by, however, Mr. Market found himself strangely unhappy. The cottage, you see, lacked high-speed broadband Internet access. And the geese made a terrific racket whensoever Mr. Market exited his cottage, honking angrily and nipping at Mr. Market's heels. All this troubled Mr. Market mightily, to be sure. But most of all, Mr. Market missed the excitement of his trading. He fancied himself a savvy businessman, you see, having discovered Travelzoo (Nasdaq: TZOO  ) at $10 and Sirius Satellite (Nasdaq: SIRI  ) at $2, and sold both profitably before his retirement. And so, Mr. Market began looking for a means of reentering the "business world" once again.

Now in that village, there also lived a tradesman, Joe Fool by name. Mr. Fool owned a diamond shop, which had been the family business for many generations. Tiffany (NYSE: TIF  ) it wasn't, but Mr. Fool did all right in his business, cutting and setting raw stones in beautiful arrangements, the better for the village men to use in wooing their village brides.

The meeting
Late one evening (Feb. 11, as it happed), as Mr. Market strolled the paths and alleys of the village, he happened upon Mr. Fool's humble establishment. He noticed a line of customers stretching from store door and down the street, all the way to the village promenade, and he thought to himself, "Savvy businessman that I am, I have discovered a capital business here. Clearly this will make for an excellent investment. I shall meet with the proprietor and make him an offer to purchase half of his business."

And so he did. Pushing past the line of customers, frantic to purchase presents to gift their sweethearts on the coming morn, Mr. Market met with Mr. Fool and said to him, "Kind sir, I wish to buy an interest in your business and I am prepared to offer $1 million for a 50% share. What say you?"

Now Mr. Fool knew right well that $1 million was a price that no Fool in his family would ever tender for the diamond shop. Why, the store did barely $20,000 in profits on an average year! He tried to tell Mr. Market as much, but to no avail. And so, reluctantly, Mr. Fool shook hands with Mr. Market and the deal was done.

The next day
The next day (Feb. 12), Mr. Market paid a visit to his new partners and smiled in satisfaction as the stream of customers continued to flow in -- each gentleman more eager than the next to make a purchase. Why, as the day turned into eventide, and as the sales actually increased, Mr. Market turned to Mr. Fool and inquired, "Dear partner, I've mis-underestimated the profitability of our business. Clearly this diamond shop is a gold mine. Will you accept another $1 million in exchange for another 25% interest in our venture?"

Mr. Fool shook his head in pity. But knowing that argument was futile, he agreed. And so ended the second day, with Mr. Market in possession of 75% of the diamond shop, and Mr. Fool in possession of 25% -- and $2 million.

The crash
On day three of the gentlemen's partnership, Mr. Market awoke bright and early. He donned his finest suit. Dusted off his bowler and grabbed his ivory-handled cane. He rushed out the door and, cane swinging wildly, shooed away his geese left and right and rushed down the street to the diamond shop. And stopped.

"Why, where are all the customers?" wondered Mr. Market aloud. "Mr. Fool must be opening up late this morning," he mused. But on entering the shop, he saw that this was not so. The doors were unlocked. The lamps were all lit. And nary a buyer in sight.

"Alas!" exclaimed Mr. Market to Mr. Fool. "Our business is doomed! The customers have forsaken us and all have run off to buy their presents on Overstock (Nasdaq: OSTK  ) and Blue Nile (Nasdaq: NILE  ) !"

Mr. Fool tried to comfort his partner, assuring him that while business was always good in the days leading up to St. Valentine's Day, the day after was almost always a slow one. But Mr. Market would not be consoled. "No, sir," he declared. "I want out. This business is doomed. We're naught but a diamond-hawking Kmart (Nasdaq: KMRT  ) , adrift on a rushing Amazon.com (Nasdaq: AMZN  ) . And the worst part is -- I made a lot of money on Amazon, back in the day! Take back my shares, Mr. Fool. I'll sell them to you cheap. One million dollars and the business is yours again."

Clucking in disapproval, but already aware of both his partner's mood swings and his stubbornness, Mr. Fool agreed. And so ended the third day, with Mr. Fool again a sole proprietor, but now a wealthy one, with $1 million in the bank. And Mr. Market? He was out of business and back tending his geese, $1 million poorer and not one cent wiser.

The moral
Every story has a moral, and this one is no different. Like it or not, as individual investors, we're all partners in business with Mr. Market. And we know he's a moody chap. While we certainly don't advocate trading stocks daily, the fact remains that some days Mr. Market's going to look at a perfectly ordinary business and think it extraordinary. If you've done your homework beforehand and know the business' true worth, you just might want to take him up on his offer and pocket the profit.

Other days, Mr. Market will look at the very same business and call it a dog. He won't be swayed by talk of strong free cash flow or low enterprise value. He won't give a hoot what the price-to-book value ratio might be. He'll just want out. On those days, too, you'll be well rewarded for having done your homework ahead of time. You'll be reclining on your Barcalounger, cash in hand, happy to take the shares off Mr. Market's hands at a discount.

We're well aware of Mr. Market's moodiness at Motley Fool Hidden Gems. It's a prime reason why we advocate a "dollar-cost averaging" approach to investing. We encourage our members to research their investments thoroughly and buy them steadily over time. Investors who stick with this approach will find that when Mr. Market is in a foul mood, they get more shares for their money. Conversely, when Mr. Market waxes enthusiastic, bidding up shares to insane valuations, a disciplined investor will buy fewer of them and consequently suffer less when Mr. Market's mood later turns ornery.

Is all this fair to Mr. Market? Fair or not, it really doesn't matter. The old gent has been this way for over a century now. He's set in his ways and not about to change just because doing so might keep him from losing some money. So we might as well indulge him. And if that means we get to keep on collecting 22% annualized profits to Mr. Market's mere 6% returns, well, we'll just have to live with that.

If you're ready to meet and do business with Mr. Market, Hidden Gems can show you how. Every month we pick two small companies boasting strong profits, cheap valuations, and a team of crackerjack Foolish analysts watching their every move. Join now for a free one-month trial and we guarantee that, when Mr. Market wants to trade these stocks, you'll know whether he's offering you the right price.

Fool contributorRich Smithhas no position in any companies mentioned above. The Motley Fool's patented disclosure policy is always a "buy," never a "sell."


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