In trying to explain the market’s inefficiencies, the father of value investing, legendary market analyst, Benjamin Graham, devised an allegory about a mythical Mr Market.

Mr Market was explained by Graham devotee, Warren Buffett, in his 1987 shareholders letter, where Buffett stated:

Imagine market quotations as coming from a remarkably accommodating fellow named Mr Market who is your partner in a private business. Without fail, Mr Market appears daily and names a price at which he will either buy your interest or sell you his.

Even though the business that the two of you own may have economic characteristics that are stable, Mr Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favourable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.

In recent times, Mr Market is especially pertinent in relation to telco stocks, notably Telstra. Between 1997 and 2000, Telstra was a market favorite, rocketing from a float price of $3.30 to a high of $9.00 shortly before the tech crash of 2000. A turn in sentiment and weakening profit sent Telstra shares plummeting, eventually hitting of low of $3.44 last August.

Since then, Mr Market has been in a good mood, with Telstra’s share price leaping by around 20% to $4.35. This recent rise was not due to Telstra’s earnings improving, but a global shift towards telco stocks (AT&T is up 42% this year, Singapore Telecom up 40%).

Telstra is currently trading on a forward price earnings ratio more than 16 times 2007 earnings. This is the multiple of a company with a track record of solid earnings growth (like Woolworths or Wesfarmers) not a stagnant utility with reducing earnings operating in a terribly competitive market.

Telstra is having its high margins eaten away by tough mobile competition (from the likes of 3 and Optus), while fixed line phone revenues will be further weakened with the continued take up of VoIP and mobile services. All the while Telstra is stuck in a regulatory quagmire with a hostile ACCC.

While Mr Market continues to smile on Telstra (it was up four cents yesterday despite the market dropping overall), not all brokers remain so confident. Citigroup recommends Telstra as a ‘hold’ (with a price target of $3.60 to $3.75) while Merrill Lynch was even less generous, recommending Telstra as a “sell”.

While T3 investors happily lap up their short term windfall, Sol will need to deliver some impressive numbers to vindicate Mr Market’s enthusiasm.

Peter Fray

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