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Why were Morrisons shares so cheap?

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The takeover battle for Morrisons (LSE: MRW) is hotting up. The supermarket chain was initially approached by US equity firm Clayton, Dubilier & Rice with an indicated price of 230p per share (though no firm offer). The board reckoned that undervalued Morrisons shares.

Then on Saturday came an offer from a consortium led by Fortress Investment Group. At 252p, it values Morrisons at approximately £6.3bn. That’s enough for the board to agree. But the story might not be over. Apollo Global says it’s now considering an offer, but it hasn’t yet made an approach.

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Morrisons shares climbing

Morrisons shares are soaring. At 266p, the price has now soared by 49% since the bidding war commenced, and it’s up 43% over 12 months. But if Morrisons is worth that much, why were the shares so cheap before these bids? The answer to that question, I think, offers some valuable lessons for long-term Foolish investors.

Benjamin Graham, mentor to Warren Buffett, summed it up decades ago. Graham, often known as the father of value investing, famously said that in the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.

At any given time, a share price represents the balance of buys and sells. Graham was reflecting on the factors that drive those buys and sells. In the short term, they can be many and diverse. And one of them is even just the share price itself.

Contrarian courage

If everyone else thinks Morrisons shares are worth 178p, it can take a lot of nerve to go against the crowd. And that’s especially so in the case of big institutional investors. If an investment firm buys a stock that all its competitors are shunning, it’s taking a big risk. If it doesn’t pay off in the next few months, customers might not be too happy.

The short-term ‘voting’ effect can be seen in share price volatility. Whatever drives people’s votes on a day-to-day basis can lead to big share price changes. And that’s regardless of anything actually happening to the company.

The ‘weighing machine’ part of Graham’s wisdom suggests that the fundamental valuation of a stock will find its way out, given sufficient time. Over the long term, sentiment, emotion, fashion, crowd psychology… all will even out, and the value of the company will win through.

Long-term investors’ advantage

The Morrisons story shows just how long a short-term undervaluation can last (assuming the bidders have it right). But it also shows that we, as private investors, have an advantage. We can buy whatever we think is good value and hold for as long as we want, without the pressure faced by the professionals. And we can ignore the latest fad and fashion, and short-term share price movements.

There’s always a chance that bidders offer too much, mind. To judge that, we’ll have to wait and see.

And that’s exactly what I’d do if I owned Morrisons shares. I’d just wait and see who offers me the most for them. One thing I wouldn’t do is buy a share in the hope of a higher bid. It can pay off, but it’s too risky for me. And too short term. So I’m not one of those investors jumping in and pushing Morrisons’ share price higher today.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Morrisons. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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