I’m going to show you how inefficient the stock market is.
In the past year Amazon’s stock has traded as low as $110 a share and as high as $190 a share. That’s a 70 percent fluctuation. In a year. For one of the biggest, most recognizable companies in the world.
Based on this stock price fluctuation, the market value of the company has fluctuated between about $1.1 trillion and $2 trillion in a year.
Imagine owning all of Amazon and being willing to sell the company at one point during the year for $1.1 trillion and at another point for $2 trillion. Sounds insane, right? It is. And that’s how the stock market operates.
Here is U.S. gross domestic product (economic output) over the past 10 years:
And here are U.S. stock prices (the S&P 500) over the same time period:
Gross domestic product is fairly smooth. Stock prices aren’t.
Prices will fluctuate
Legendary financier JP Morgan developed a pithy response a century ago when asked what the stock market will do. He said: “It will fluctuate.”
And it will.
Values of businesses change slowly over time, like gross domestic product. Stock prices, however, change quickly. They anticipate what other investors are going to do in the short term.
In the short term the stock market resembles more of a casino than anything. Investors are betting on what other investors are going to bet on. Which stock prices are going to move up.
John Maynard Keynes likened it to a beauty contest, where judges are trying to pick not who is the most beautiful contestant but who they think other judges will think is the most beautiful.
Benjamin Graham called the stock market in the short term a voting machine. Similarly, investors are voting on which stocks they think other investors will vote on.
In the long term, however, the stock market becomes a weighing machine. It weighs long term business results.
Stay Calm
Don’t get excited or depressed by price movements. Prices fluctuate more than values. Stock quotes are there simply for your convenience. To buy or sell.
Ben Graham put it like this:
The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizeable declines nor become excited by sizeable advances. He [or she] should always remember that market quotations are there for his [or her] convenience, either to be taken advantage of or to be ignored.
Don’t turn their advantage into a disadvantage. Many people do.
Think Like a Private Owner
When you invest in stocks you want to think like a private business owner.
If you were a private business owner, you wouldn’t adjust the value of your business daily. You shouldn’t either with stocks.
You should take a measured view on the value of your businesses. Judge them, over time, with changes in business results.
Wild Ride
No example perhaps demonstrates the madness of the stock market better than Microsoft.
Microsoft has been an outstanding company for years—one of the best in the world. Today it is the largest company in the U.S. by market value, at $3 trillion.
Here’s a chart of Microsoft’s stock price since the late 1990s:
What do you notice here?
Microsoft’s stock price went sideways for over a decade. It did nothing. Then boom. It shot up like a rocket.
What happened?
The stock price was bid up in the late 1990s during the tech bubble. Then after the tech bubble popped no one wanted to touch it for a decade. Meanwhile the business kept growing. Results kept getting better.
Eventually the market weighed its results.
The stock market is a rollercoaster.
It doesn’t always get it right—except in the long term.
Focus on the Playing Field
Those who win the game are those who focus on the playing field not the scoreboard.
Focus on where businesses are going long term.
Disregard short-term noise.
Casino
The casino nature of the stock market in the short-term drive’s prices.
A relatively small number of transactions drive prices.
These large fluctuations can cause you to question your judgement. They shouldn’t.
Frenzy
Our society is becoming more short-term oriented.
There’s more information. More of an urge to do something than ever.
But investing is a long-term pursuit.
Victory goes to the patient.
Bottom Line
Stock prices fluctuate more than values.
You want to focus on the values.
It’s values—long term—that drive prices.
Not the other way around. Don’t ever get confused.