How did Graham view the relationship between intrinsic value and market price?

Responses:

Hey there, friend! This question hits the nail right on the head – it could be considered the cornerstone of Graham's entire value investing system. Understanding this is essentially like getting the key to unlocking the door of value investing.

Simply put, Graham saw the relationship between intrinsic value and market price much like the relationship between "reality" and "mood".

Intrinsic Value: This is "reality". It's what a company is truly worth based on its assets, earnings capacity, and future prospects. This value is relatively stable and requires deep analysis of a company's financial statements and business model to estimate. It doesn't fluctuate wildly just because the market is up or down today.
Market Price: This is the "mood". It's the constantly changing price of a stock on the exchange. It's influenced by all sorts of factors, like economic news, public panic or greed, analyst reports, and so on. The market price is extremely volatile, sometimes overvalued, sometimes undervalued.

To help people grasp this relationship better, Graham created a classic analogy – Mr. Market.

The Story of Mr. Market

Imagine you own shares in a company, and you have a highly emotional partner named Mr. Market.

He shows up every day: Mr. Market comes to you daily, telling you the price at which he's willing to buy your shares or sell you his.
He is extremely moody:
- When he's wildly optimistic and euphoric, he'll quote you an absurdly high price. He thinks the future is all sunshine, willing to pay any price for your shares.
- When he's deeply pessimistic and dejected, he'll quote a ridiculously low price. He thinks the sky is falling and is desperate to offload his shares.
The most crucial point: You can ignore him completely: Although Mr. Market quotes you every day, he never forces you to trade. If you think his price is unreasonable, you can simply say, "Thank you, but I'm not interested today." Then, close the door and go about your life.

What Should the Intelligent Investor Do?

Graham believed that an intelligent investor is someone who takes advantage of Mr. Market's "mood swings" to benefit themselves.

Your task is not to predict whether Mr. Market will be happy or sad tomorrow, but to focus on two things:

Do your homework to estimate a company's "intrinsic value." Just like evaluating the location, size, and layout of a house before buying it, you need to analyze the company's financials, understand its business, and arrive at a range you consider its "true worth."
Wait patiently for your opportunity. When a depressed Mr. Market offers you a bargain price significantly below your estimated intrinsic value, that's your signal to step in decisively and buy.

The Core Concept: Margin of Safety

This is the cornerstone of Graham's philosophy. The Margin of Safety refers to the difference between the intrinsic value and the market price.

Take this example:

Based on thorough analysis, you determine a company's intrinsic value is $10 per share.

If Mr. Market now offers $9.50, would you buy? Graham would say "no." The discount is too small; what if your calculation is off?

But if market panic drives Mr. Market's offering price down to $6, then the opportunity presents itself!

The $4 ($10 - $6) difference represents your Margin of Safety. Think of it like the extra load-bearing capacity of a bridge. Even if your estimate contains errors (e.g., the true value might only be $8), or unexpected negative events occur in the future, this sufficiently wide safety buffer protects you from significant loss.

To Summarize

So, in Graham's view, the relationship between intrinsic value and market price is:

They are distinct entities: Price is a product of market sentiment, while value reflects the company's fundamentals.
The market is a voting machine in the short run, a weighing machine in the long run: Short-term, price is determined chaotically by popularity (voting). But long-term, price will eventually move toward the level dictated by the company's "weight" (intrinsic value).
Opportunities arise from their misalignment: An investor's profit comes from capitalizing on Mr. Market's folly—buying when the price is significantly below the value.
Margin of Safety is your talisman: Only act when the price is cheap enough to provide a sufficient Margin of Safety.

Ultimately, Graham teaches us a way of thinking: Don't regard the market as an instructor guiding you; think of it as a waiter offering you opportunities. You are the master; you decide when to use his service.