The Stock Warehouse in a Crisis

The stock warehouse is a simple example of how to explain value versus price in the stock market can get forgotten in a crisis or major event to my kids.  In order for some to grasp the concept of value versus price it sometimes takes putting the explanation in real world terms, so they can identify with it. The stock market warehouse is similar to a Costco warehouse store.  Imagine a large warehouse, just like a Costco, where interested buyers and sellers of stock go to find or sell stocks. When you walk into this warehouse there are big tall shelves that have all kinds of different boxes that represent stocks in different companies.  If you want a stock you take the box and pay for it at the register. If you want to sell your stock you go to the return counter and sell it back to them at the day’s current price.

The year is 2008 and there’s a financial crisis occurring.  The owner of this stock warehouse is afraid, and fears that all of his inventory of stocks will become worthless, so he begins to lower the price on every stock, so buyers will come and buy them.  Some sellers of stock show up to sell him stock, but he turns them away. He wants his cash back quickly, and doesn’t want any new stock. He’s afraid of going out of business.  

The first day he lowers his prices and no one shows up, so the second day he lowers the prices more, and still not enough buyers arrive to buy.  On the third day he lowers the price again, and now a few buyers show up, but they buy very little. The news reports worsen, so he begins to panic, so on the fourth day he lowers his prices again only to get a few more buyers.  He waits a day to see what happens, and on the fifth day more buyers come and take advantage of the lower prices, so he starts to feel better.  

On the sixth day the news reports that the government is concerned and has no plan of how to fix the crisis, and that everyone should get prepared for the worse.  No buyers show up on the sixth day, so on the seventh day the warehouse owner is afraid of losing all of his money, so he has a fire sale and puts everything on sale at 50% off just so he can get some of his money back.  

On the seventh day a nice little man named Warren comes into the warehouse along with a friend named Charlie and they start buying a bunch of the stocks on sale.  As they are doing this, a few more people show up named Monish, Bill, Guy, and Joel to do the same. The warehouse owner notices that these people all seem to know each other.  

On the morning of the eighth day, when the owner arrives at the warehouse, there’s a number of people in suits waiting outside.  When he opens they begin to buy large amounts of the stocks, so the owner starts raising his prices, since he realizes his prices are too low, and his inventory is getting low.  

On the ninth day the news reports better news.  The government says it has figured out how to handle this crisis, and there will only be a mild financial set back.  On the tenth day people start lining up at the warehouse in the morning before it opens. By this time the owner has raised his prices back to close to where they were before this ordeal started.  He continues to raise prices that day and the next day until the pace of buying slows and things get back to normal.

I explain to my kids that the little man named Warren and his friends didn’t panic and did their homework.  Warren and his friends knew the true value of the stocks on sale at the stock market warehouse. The owner of the stock warehouse dropped the prices so low that the selling prices became less than the actual value of what the stocks were worth, lowering the downside risk of buying the stock.  The warehouse owner panicked. Warren and his friends knew that chances of them being able to profit handsomely from the low prices at some time in the distant future was now much higher than before the crisis, so they bought what they needed while everyone was selling and ignored the true value of the stocks.  The people in suits that came the next day after Warren and his friends were the institutions. They got wind that Warren and his friends were buying. The point here with this story is to never lose sight of value. Especially in the face of a panic or a worrisome event.