What does this famous quote mean?

The quote “in the short term, the market is a voting machine. In the long-term, it is a weighing machine” is attributed to Benjamin Graham, the father of value investing* and the mentor of Warren Buffett. It captures the essence of how stock prices can deviate from the true value of a company based on the emotions and opinions of investors, but eventually the investment’s value will align with it’s profitability and growth potential.

How does the market act as a voting machine?

The market acts as a voting machine when investors buy and sell stocks based on their short-term reactions, beliefs and often their emotional response to surprising events or announcements.

These factors can create temporary fluctuations in the demand and supply of stocks, resulting in overvaluation or undervaluation of certain companies. For example, between Aug 2 – Aug 5, 2024, the Australian sharemarket fell by almost 5% due to fears that our economy may fall into recession, led by some weak economic data out of the US. Investors panicked and sold off stocks, regardless of their long-term prospects or competitive advantages.

How does the market act as a weighing machine?

The market acts as a weighing machine when investors evaluate stocks based on their intrinsic value, driven by their fundamental characteristics. This value depends on the actual performance and growth of the company, not on the whims and fancies of the market.

Over time, the market tends to correct its mistakes and converge to the true value of a company, as its earnings and dividends become more visible and predictable. Often a company’s share price will rise or fall significantly post the reporting of their actual financial results. The closing share price following this is a better representation of it’s fundamental value.

What are the implications for investors?

If you are an investor, the implication is that you should focus on the long-term value of a company, rather than the short-term price movements. It’s difficult, but you should ignore the market’s mood swings and instead look for opportunities to buy undervalued companies or potentially reduce/sell overvalued companies.

You should also have patience and discipline to hold your investments until the market recognises their worth. In our experience, too often there is an expectation that a company must perform within the first couple of years. While an early sugar hit enacts a lovely dopamine response (the body’s ‘happy’ hormone), our experience shows that ‘slow and steady’ wins the race.

As Warren Buffett once said, “The stock market is a device for transferring money from the impatient to the patient.”

*Value investing is an investment strategy that involves selecting stocks that appear to be trading for less than their intrinsic or book value. Value investors actively seek stocks of companies that they believe the market has undervalued.