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As we approach the dawn of 2025, it’s a time to reflect, reassess, and perhaps unlearn old habits. One of the most valuable lessons we can carry forward, especially in investing, is the power of rational thinking.
In his timeless work, The Intelligent Investor, Benjamin Graham discusses the daily fluctuations of the stock market and cautions investors to focus on long-term strategies rather than being swept up by short-term price movements.
He stresses the importance of buying businesses at a price that offers a “margin of safety” and emphasizes understanding a company’s “intrinsic value.” But what exactly does “intrinsic value” mean?
Understanding Intrinsic Value(Valuation)
Intrinsic value refers to the true, inherent worth of a business — what it is really worth beneath the surface. It’s not just about looking at a stock price or plugging numbers into a formula like discounted cash flow (DCF), which only offers a limited view. Instead, intrinsic value is a deeper, broader concept that includes factors such as the business’s historical performance, the character of its management, its competitive edge, the growth potential of its industry, and the strength of its “moat.”
The moat of a business is its competitive advantage — things that make it difficult for others to replicate or compete with. This could be anything from a strong brand, unique product offerings, or high barriers to entry in the industry. The more robust the moat, the more likely the business can protect its earnings and grow over time.
The Role of Rationality in Investing
In Chapter 8 of The Intelligent Investor, Graham warns that the investor’s worst enemy is often themselves: “The investor’s chief problem—and even his worst enemy—is likely to be himself.” This is where rationality becomes crucial. If you let emotions, market noise, or short-term trends influence your decisions, you’ll struggle to make sound investments.
Charlie Munger, the business partner of Warren Buffett, often talks about the importance of seeing things clearly and without bias. He defines rationality as simply “seeing things as they are.” Investors must resist the urge to follow the crowd and instead focus on what truly matters to them.
Graham’s concept of “margin of safety” is a great example of this rational approach. As he writes in Chapter 20 of The Intelligent Investor, “The margin of safety is always dependent on the price paid.”
In other words, a rational investor must always assess whether they are paying a reasonable price for a business, factoring in its true value. The margin of safety offers a cushion, reducing the risk of loss even if things don’t go as planned.
The Stock Market and Real-World Business Performance
To truly understand how the stock market interacts with business performance, let’s look at a few examples. Take Infosys, the software giant in India. After going public, the company experienced massive revenue growth, which naturally led to a rise in its stock price. But as growth slowed in later years, its earnings growth (EPS) stagnated, and so did its stock performance.
Similarly, we’re seeing a similar situation with HDFC Bank in 2024. While it once experienced explosive growth, the banking sector as a whole is facing stagnation. Market sentiment often views this negatively, even if the company is still fundamentally strong.
Another example is Varun Beverages, which went public in 2016. For several years, the stock didn’t perform well. But after the company launched a new product in 2021, its revenue grew significantly, and the stock price responded in kind. This shows that the market often reacts to new growth, but it can also overlook potential if it doesn’t immediately see it.
Investor Biases and Emotional Pitfalls
Humans are emotional creatures. As humans, we are naturally prone to making irrational decisions, especially in uncertain situations. One common bias is fear of missing out (FOMO), which often leads investors to buy stocks that have been underperforming simply because they appear “cheap.” This approach often ignores the underlying fundamentals of the business.
Another bias is loss aversion — the tendency to fear losses more than we value gains. This fear can result in holding on to losing investments for too long or selling off winning stocks too early. As Peter Lynch in his book said “cutting the flowers and watering the weeds”.
There’s also anchoring bias, where investors fixate on a certain number or data point, such as the price they originally paid for a stock, and fail to adjust their expectations when new information becomes available.
Overconfidence is another bias, where investors believe they know more than they actually do, leading them to take unnecessary risks.
Charlie Munger famously said, “The human mind is an incredible machine, but it’s filled with bugs.” These “bugs,” or biases, are what often get in the way of making rational investment decisions. The key is awareness — understanding these biases and working to minimize their impact.
The Mindset of a Value Investor
One of the first rules for value investors is to think of yourself as the owner of the business, not just as someone buying shares. As Munger puts it, “The big money is not in the buying and selling, but in the waiting.” Value investing is about patience. It’ss about being patient.
Warren Buffett famously said, “Be fearful when others are greedy, and greedy when others are fearful.” This is a reminder that the best opportunities often arise when others are too emotional, too fearful, or too greedy to make rational decisions.
Final Thoughts
In a world dominated by rapid market movements and emotional reactions, rationality is the cornerstone of successful investing. By focusing on intrinsic value, understanding the true nature of a business, and managing our biases, investors can navigate the complexities of the financial world with clarity and confidence. The teachings of Graham, Munger, and Buffett continue to provide invaluable guidance for anyone looking to invest wisely and successfully in the long term.
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