Investing is not Speculation
Why you shouldn't confuse the two
In my previous post, I mentioned that thinking stocks are just ticker symbols that go up and down, and that the way to make money is to buy when its down and sell when its up, was a terrible way to go about it.
Today we’re going to be talking about what investment is, what differentiates it from Speculation, and how you as a shareholder can Invest rather than Speculate.
What is investing? What makes it different from speculation?
In Benjamin Grahams book “Security Analysis” he and his co-authors tried to define investing and speculation in the following manner:
An Investment operation is one which, upon through analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.
It’s not a bad definition but like he mentions it is one that is perhaps too vague and therefore subject to the winds of change of the market, after all, whether we are investors or speculators, ultimately we are dealing with uncertainty and risk.
No company, not matter how good it may be can promise total safety of principal, let alone a return.
In many cases even the market as a whole, no matter how blue chip and diversified it may be can offer us such safety. We need only look at japan to see what has happened to the Nikkei in the past 30 years.
But then again, does that mean investing in Japanese stocks is fundamentally speculation? After all, we have 30 years of data saying it is not safe!
Personally, I think a much better indicator as to whether what an investor is doing is speculation or investment, is to ask a simple question:
How will you make back your investment?
How do you make money from owning a certain company? At the end of the day how do you get a return on your investment?
If your plan to making back your investment does not involve the company returning cash directly to you, then you are a speculator.
If your plan for making back your investment does not involve some third party being involved, then you are an investor.
Speculation gets a bad rap, but it’s not all necessarily all that bad. It’s just important to know that you’re doing it, and what you expect to get out of it.
All the same, most (if not all) investors do have some speculator in them, and vice versa.
There is nothing wrong with selling a company at a price that is not in line with its fundamental value.
After all, as a shareholder you own that company, and if you can make significantly more money by selling to some greater fool than you will by merely owning the company, then do so!
Investing isn’t just ownership, it is also keeping an occasional eye on the market, so that you may take advantage of it inefficiencies, whether that is by buying an under-priced company, or selling an overpriced issue.
The stock market is a value creation tool, by gathering investors and companies in need of investment, we can fund worthwhile enterprises, while benefiting everyone involved.
Companies get the funding they need to grow, or turnaround their business, providing jobs and goods and services to everyone, and in turn investors are rewarded by the profits from that investment.
It’s that shareholder value creation that differentiates the stock market from a Speculative Market to an Investing Market.
Any man can take a stone off the ground and pass it off to some greater fool. He, and even the fool he passes it on to might make some money off of this speculation.
Indeed this may go on for a long time, and through many fools, but ultimately this is nothing more than speculation. And at the end of the day there will be one fool stuck with a stone from which he gains no benefit, and whose only option to regain his “investment” is to pass on the stone to some other greater fool.
The stone can be anything, from stocks, to currencies (both fiat and crypto), to even well established commodities like gold.
The important distinction here is that the benefit that the owner derives from it is entirely from the process of selling it to someone else.
For a stock however, because it is ownership in a business, it possesses the intrinsic value of that business. Both of its long term earning capacity or even the simple ownership of its assets.
As an investor the market is an oportunity. As a speculator it is your lifeline.
You can make money doing both, but I sleep better if I don’t have to worry about having to find a greater fool.
Ownership and its Responsibilities
I’ve talked about this before, but it bears repeating.
Behind every ticker symbol is a company with real assets and real people working for it.
As a shareholder you own that company, the buildings and factories the company owns belong to you, and the people that work for it, from the janitor to the CEO are your employees.
The money that the company makes is your money.
The money that the company loses is your money.
So it’s important to keep a close eye on the company (not its stock price!), to ensure that your employees, from the board of directors to the CEO, to the janitors cleaning its facilities are working honestly and effectively.
And if they are not, you must act!
Be proactive and prevent problems at its root.
In general I find that companies with a lot of cash on hand often waste it, either on wild goose chases that don’t have viable business models, or on Di-Worsifications and acquisitions that the company would best do without. Or worse, sometimes management helps themselves to the cash as “performance bonuses”.
Companies should be lean, and any cash beyond what is necessary and prudent to keep should be returned to its shareholders, either in the form of dividends, or share buybacks, or better yet, both!
If some new investment pops up that they need cash for, they should simply raise new capital as needed. This won’t be a problem for healthy companies with a long history of creating and returning shareholder value.
Your role in the Company
The Stock Market allows us to be silent partners in many businesses, but it doesn’t require us to be silent, and so as responsible investors we should take some time out of our days each year, and ensure that our companies are in the right path, and correct their course when they are not.
The way we do this is by voting in the companies Annual Shareholders meeting.
Once a year the companies you own will send you documents inviting you to attend the annual shareholders meeting, and to vote on proposals.
You’re not required to attend, but as a usually silent investor this is the one way you can make your views heard by both management, as well as by your fellow partners in this enterprise (other shareholders).
As a general rule there are 3 types of proposals to be voted on, two come from management, and the other comes from shareholders like you.
The first type is usually related to the board of directors. The board are the people you hire to look over the company and ensure that the day to day managers of the company (the CEO and his team) are doing a good job, and not just getting rich at your expense.
The members of this board must be elected by shareholders, and so in almost every shareholders meeting some of them will be up for re-election.
The second type are specific proposals that management makes that they believe will be good for the company. This can be something as mundane as approving the auditing firm that will be looking over the companies records, or as serious as approving a merger or acquisition.
Look carefully over these proposals, since it is usually here that management puts things that will bite you in the back. Beware of authorising the issuing of shares, or overly generous compensation packages for management!
Finally we have the third type. These are proposals from shareholders like you, who for some reason or another have something that they want to bring to your attention or change in the firm.
Nowadays it is common for activist shareholders to make ESG proposals, perhaps they want to require management to drop the use of plastic. More traditionally these proposals involve firing the CEO and his team and hiring someone else to turn around the company. Or perhaps they want the company to divest from certain unprofitable businesses.
Whatever the case may be, look at the proposals and see if you agree. If you do, vote for them, otherwise vote against.
As owner of the company you have absolute authority over it, and it is here that you exercise this authority!
Wield that power wisely, and don’t just nod along as dishonest management robs you of your wealth!
Let me know what you think, and comment down below, or tweet at me. I am always open to listening to other views.
I’ll see you next time!