Celebrated value investor and economist Benjamin Graham has been dead for 45 years, but his teachings and books live on.
Warren Buffett, his most famous student, goes from strength to strength, and if you haven’t read Graham’s The Intelligent Investor — preferably in the updated edition with the commentary by Jason Zweig (no investing slouch himself, either) — then I’ve only one thing to say: read it.
One of Graham’s most popular teaching devices is the notion of ‘Mr Market’. First introduced in The Intelligent Investor, the purpose of the ‘Mr Market’ analogy is to illustrate the irrational and illogical nature of stock markets.
I’m going to simplify things a bit here, but the idea of Mr Market is this: he’s a kind of manic-depressive, swinging wildly between gloom and euphoria, as company news and the general investing climate changes.
And the key thing about Mr Market is that he shows up at your front door every day, wanting to either buy some of the shares that you hold, or sell you some more. When he’s euphoric, he’s in a buying mood, and he’ll offer you high prices. But when he’s gloomy, he’s likely to want to dump his stocks at a low price.
Mr Market is very real
Now, The Intelligent Investor was first published in 1949. Today’s Internet-driven real-time electronic stock markets were far in the future.
But you don’t have to be a genius to see that Mr Market is actually a very accurate analogy for what we as investors see every day in our portfolios. When market sentiment is buoyant, prices are high. When market sentiment is gloomy, prices are low.
And often, it doesn’t take much to trigger quite significant oscillations in price. Mr Market is very real, and — through the price mechanism — every day offers to buy our shares, or sell us some more.
At any point, we can sell to Mr Market, or buy from him.
All of which came to mind on 27 July, when household products manufacturer Reckitt (LSE: RKT) released its half-yearly results.
Big brands, big numbers
Reckitt is no minnow. With a market capitalisation of £39 billion, and global brands that include Dettol, Finish, Strepsils, Lemsip, Nurofen, Lysol, Cillit Bang, Harpic, Vanish, Clearasil, and Durex, Reckitt is a seriously big business.
The headline numbers weren’t bad. Sales up 3.7% on the first half of 2020, and 17.6% up on the first half of 2019 — when you sell brands like Dettol and Harpic, there’s nothing quite like a global pandemic to boost sales.
Investors had for some time been urging the company to ditch its Chinese infant nutrition business, the purchase of which had been a rare strategic mis-step. That sale had now been achieved, albeit at a significant loss. Also going was the Scholl footcare brand, which had always struck me as something of an oddity among Reckitt’s brands, anyway.
There were lots of numbers to like, in terms of the future prospects of the business: R&D investment up, brand investment up, new product pipeline up, e-commerce sales up, and future revenue expectations up.
There were also a few numbers that were down, for which quite reasonable explanations existed. Cash flow, for instance. And with all the social distancing that has been going on, flu and cold treatments hadn’t been in such big demand, and so their sales were down.
Don’t panic, Mr Market
But there were also two numbers that spooked Mr Market.
One, the business swung to a loss. Which was entirely to be expected, given that getting rid of the Chinese infant nutrition business had incurred the business in a significant writedown, hitting profits.
And two, operating margins were down. From a prior year 25.6%, they had slipped to 22.7%. To blame: adverse margin movements (in other words, the business hadn’t been able to sell as much of its most profitable products — such as those cold and flu treatments), higher investment, and cost inflation. While Reckitt didn’t say, I expect that cost inflation was the most significant of these factors.
I wrote about cost inflation a few weeks back. It’s going to be a feature of 2021, and probably 2022 as well, as the global economy roars back. Personally, I was entirely unsurprised to learn that Reckitt was experiencing what almost every other business on the planet must be experiencing, but there you go. Mr Market was spooked.
Another gift from Mr Market
The share price tanked 10%, and fell further the next day. As I write, they’re down 14% on the month.
A few weeks ago, Reckitt’s shares were trading at around 6,500p; now, they’re trading at around 5,550p.
Yet the business fundamentals of Reckitt’s proposition haven’t really changed. Reckitt is an enormous business, with strong finances, strong brands, and a global reach. It was a solid business a week ago, and it’s just as solid now — just a lot cheaper.
An over-reaction? I think so. But then, that’s what Mr Market is famous for.
And our opportunity, as investors, is to take advantage of that, and buy when he’s selling, and sell when he’s buying. He’s the gift that keeps on giving.
