Definition of Investing by Benjamin Graham.

Definition of Investing by Benjamin Graham.

Elaboration of Section 20

This section serves as a crucial philosophical anchor, returning to the absolute bedrock principle from which all intelligent investing flows. It reposts Benjamin Graham's precise, formal definition of an investment operation to remind the reader of the standard against which all potential investments must be measured.

The definition is broken down into its three non-negotiable components:

1. Upon THOROUGH ANALYSIS
This is the foundation. An investment cannot be based on a tip, a rumor, a gut feeling, or a chart pattern. It demands:

• A Detailed Study: Scrutinizing the company's financial statements, competitive position, industry trends, and management.

• Established Standards: Using reasoned, established standards of safety and value to evaluate the facts.

• Eliminating Speculation: This requirement automatically disqualifies most of what is passed off as "investing" in the public discourse.

2. Promises SAFETY OF PRINCIPAL
This is the primary goal. The number one job of an investor is not to make money, but to avoid losing money.

• Protection Against Loss: Graham clarifies that "safety" does not mean absolute guarantee. It means "protection against loss under all normal or reasonably likely conditions."

• A Safe Investment: Is one where, after thorough analysis, the prospect of losing the money you paid is quite unlikely, barring a disaster.

• Buffett's Rule #1: This is the direct source of Warren Buffett's famous two rules: "Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1."

3. Promises a SATISFACTORY RETURN
The return must be reasonable and relative to the goal of safety.

• "Satisfactory" is Subjective: It can be a low return, as long as it meets the investor's personal objectives and is achieved with "reasonable intelligence."

• Includes Income and Profit: The return can come from dividends, interest, or capital appreciation.

• Not "Maximum" Return: The focus on a "satisfactory" return is key. Chasing the highest possible return almost always involves sacrificing the first two criteria (thorough analysis and safety).

The Critical Corollary: The Cynic's Definition
Graham acknowledges a cynical but insightful view: "An investment is a successful speculation and a speculation is an unsuccessful investment."
This highlights the fine line between the two and how outcomes can blur definitions. However, the intelligent investor does not rely on luck. They rely on a process that maximizes the probability of success by adhering to the three pillars.

The Consequence of Confusion
The section ends with a grave warning: the failure to distinguish between investment and speculation was a primary cause of major market bubbles and crashes (like the 1929 crash). This confusion continues to lead would-be investors into speculative behaviors that jeopardize their capital.

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Summary of Section 20

Section 20 reiterates Benjamin Graham's foundational definition of an investment operation, establishing the three essential pillars that separate true investing from speculation.

• An INVESTMENT OPERATION is one which, upon:

  1. THOROUGH ANALYSIS, promises...

  2. SAFETY OF PRINCIPAL, and...

  3. A SATISFACTORY RETURN.

• Any activity that fails to meet all three of these requirements is, by definition, SPECULATION.

In essence, this section is a call to discipline and intellectual honesty. It forces the investor to constantly ask: "Have I done the work? Is my capital safe? Are my return expectations reasonable?" By returning to this definition, the section ensures that the complex strategies and stock analysis discussed in previous sections are always grounded in the core philosophy of intelligent, business-like, and safe investing.

Investing versus Speculation

 What is the difference between investing and speculation?

Benjamin Graham addressed the differences between them on the very first page of his book, The Intelligent Investor.

Graham wrote, "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return."  

Based on this definition, there are three components to investing:  

• thorough analysis, 
• safety of principal, and 
• adequate return.  

Graham added, "Operations not meeting these requirements are speculative."

To this, we can add:

(1)  Any contemplated holding period shorter than a normal business cycle (typically 3 to 5 years) is speculation, and 

(2) any purchase based on anticipated market movements or forecasting is also speculation.

Value investing meets Graham's definition of investing, addressing on:  its focus on individual company analysis to determine intrinsic value,  the margin of safety concept, and its success over the long term.

The distinction between investing and speculation is important for a reason Graham cited in 1949 and remains true today:  "... in the easy language of Wall Street, everyone who buys or sells a security has become n investor regardless of what he buys, or for what purpose, or at what price...."

The financial media often refers to "investors" taking profits, bargain hunting, or driving prices higher or lower on a particular day.  However, these actions are rightly attributed to speculators, not investors.

Investors and speculators approach their tasks differently.

Investors want to know what a business is worth and imagine themselves as owning the business as a whole. Unlike speculators, investors maintain a long-term perspective—at least 3 to 5 years. They look at a company from the perspective of owners. This means they’re interested in factors such as corporate governance, structure, and succession issues that may affect a company’s future and its ability to create wealth for years to come. Investors may use their voting rights to assist in enhancing company value over the long term.

Speculators, on the other hand, are less interested in what a business is actually worth and more concerned with what a third party will pay to own shares on a given day. They may be concerned only with short-term changes in a stock’s price, not in the underlying value
of the company itself.

The problem with speculation is simple:

• Who can predict what a third party will pay for your shares today, tomorrow, or any day?  

• Stock market prices typically swing between extremes, stoked by the irrational emotions of fear and greed.

Focus on the long term business value

Such dramatic price fluctuation on a day-to-day basis can test long-term investors’ mettle in maintaining their focus on business value.

• Remember, the tendency is for business values day-to-day to remain relatively stable.
• Day-to-day price changes should hold little interest for the long-term investor, unless a price has fallen to the “buying level” that represents a sizable margin of safety.

But that’s often difficult to remember when newspaper headlines, TV news anchors, friends, and coworkers are lamenting or lauding the market’s most recent lurch forward or back.

Investment success requires an appropriate mind-set

Investing is a serious business, not entertainment.

If you participate in the financial markets at all, it is crucial to do so as an investor, not as a speculator, and to be certain that you understand the difference.

Investors must be able to distinguish Pepsico from Picasso, and understand the difference between an investment and a collectible (speculation).

When your hard-earned savings and future financial security are at stake, the cost of not distinguishing is unacceptably high.

Investments and Speculations: Similarities and One critical difference.

Financial-market participants can be divided into two groups,

• investors and 
• speculators.

Similarly, assets and securities can often be characterised as either

• investments or 
• speculations.

Both typically fluctuate in price and thus appear to generate investment returns.

But there is one critical difference:

Investments throw off cash flow for the benefit of the owners; speculations do not.

The return to the owners of speculations depends EXCLUSIVELY on the vagaries of the RESALE MARKET.



Examples:

Investments, even very long-term investments, will eventually throw off cash flow:

• A machine makes widgets
• A building is occupied by tenants who pay rent
• Trees on a timber property are eventually harvested and sold.

By contrast, speculations, like collectibles, throw off no cash flow; the only cash they generate is from their eventually sale.  

• The future buyer is likewise dependent on his or her own prospects for resale.
• The value of collectibles, therefore, fluctuates solely with supply and demand.  
• Collectibles have not historically been recognized as stores of value, thus their prices depend on the vagaries of taste, which are certainly subject to change.
• The apparent value of collectibles is based on circular reasoning: people buy because others have recently bought.  This has the effect of bidding up prices, which attracts publicity and creates the illusion of attractive returns.  Such logic can fail at any time.

Total Assets and Total Liabilities

The totals of assets and liabilities appearing on the balance sheet supply only a rough indication of the size of the company.   Balance sheet totals may be readily inflated by excessive values set upon intangibles, and in many cases also the fixed assets are arrived at a highly exaggerated figure.

On the other hand, we find that in the majority of strong companies, the good will which constitutes one of their most important assets either does not appear upon the balance sheet at all or is given but a nominal valuation (usually $1).  There was once a practice of writing down the fixed assets, or plant account, to virtually nothing in order to save depreciation charges.  Hence it is a common occurrence to find that the true value of a company's assets is entirely  different from the balance sheet total. 

The size of a company may be measured in terms either of its assets or of its sales.  In both cases, the significance of the figure is entirely relative, and must be judged against the background of the industry.  The assets of a small railroad will exceed those of a good sized department store. 

From the investment standpoint - especially that of a buyer of high-grade bonds or preferred stocks - it may be well to attach considerable importance to large size.  This would be true particularly in the case of industrial companies, for in this field the smaller enterprise is more subject to sudden adversity than is likely in a railroad or public utility. 

Where the purchase is made for speculative profit, or long-term capital gains, it is not so essential to insist upon dominant size, for there are countless examples of smaller companies prospering more than large ones.  After all, the large companies themselves presented the best speculative opportunities while they were still comparatively small.


Benjamin Graham

Investing as opposed to Gambling

Some aspects of investing can be very similar to gambling.

• Not knowing what you are doing.
• Not understanding what you own.
• Trading in and out of the market.
• Following the advice of interested parties.
• Being in a hurry to get rich.
• Relying on luck rather than skill.

Investing and wealth building is different.

• It is both an art and a science and can be emulated.

Genuine News and Noises

Intrinsic value cannot be determined with precision, which makes it hard to prove that stock prices deviate from intrinsic value.


An important principle at the heart of the Efficient Market Hypothesis is the law of one price.  The law asserts that in an efficient market, the same asset cannot simultaneously sell for two different prices.  If that happened, there would be an immediate arbitrage opportunity, meaning a way to make a series of trades that are guaranteed to generate a profit at no risk.


News and Noises

The only thing that makes an investor  change his mind about an investment is genuine news.

But humans might react to something that does not qualify as news, such as seeing an ad for the company behind the investment that makes them laugh.  In other words, there are many who make decisions based on noises rather than actual news.  These are called "noise traders".  They trade on noise as if it were information.  "THERE ARE IDIOTS.  Look around."

Speculators, Investors and Market Fluctuations

Speculators versus Investors

Mark Twain mentioned the two times in life when one shouldn't speculate: "when you can't afford it, and when you can!". 

Speculators buy in the hopes or assumptions that others will want to buy the same asset (be it a painting, a baseball card, or a stock) later.

Investors buy the cash flow the investment returns to its owner. (As such, a painting can never be an investment by this definition!)

Stock Market Bubbles

Bubbles in the stock market form due to faulty logic that first propels speculators to bid up prices followed by the inevitable bursting which destroys the wealth of many.

What determines whether an investor will make money in the market or not?  

The answer is his psychological make-up. 

If he does his own stock analysis and views the prices offered by Mr. Market as an opportunity to buy low and sell high, he will do fine. 

If Mr. Market's offering prices guide the investor's outlook of what the stock price should be, he should get someone else to manage his money!

Market fluctuations

Most market fluctuations are the result of day-to-day distortions between supply and demand of particular stocks, not of changes in fundamentals.

Investors who take advantage of these distortions by focusing on the fundamentals will be successful. 

Those who invest with their emotions are sure to fail in the long-run.

Read also:

• 
  
• Your investments using Mutual Funds or Money Managers
• Trading and portfolio management from a value investing point of view
• Value Investor's Opportunities in Distressed Securities
• Value Investing Opportunities in the Banking Sector
• Look at FUNDAMENTALS and POTENTIAL CATALYSTS when making investment decisions
• Where to look for Investment Opportunities
• Business value cannot be precisely determined. Make use of ranges of values
• Central elements to a Value Investing Philosophy
• The Philosophy of Value Investing and Why It Works
• Philosophy of value investing. Need to have clear strategies too
• How Wall Streets can create investment fads? The Junk Bond Market of mid-1980s
• Understanding these changes in the investment world allows investors to earn superior returns
• What's good for Wall Street is not necessarily good for investors
• Speculators, Investors and Market Fluctuations

Speculation

http://www.slideshare.net/thadeshvar/basics-of-wealth-mgt

What is the difference between investing and trading?

Investing and trading are two very different methods of attempting to profit in the financial markets. The goal of investing is to gradually build wealth over an extended period of time through the buying and holding of a portfolio of stocks, baskets of stocks, mutual funds, bonds and other investment instruments. Investors often enhance their profits through compounding, or reinvesting any profits and dividends into additional shares of stock. Investments are often held for a period of years, or even decades, taking advantage of perks like interest, dividends and stock splits along the way. While markets inevitably fluctuate, investors will "ride out" the downtrends with the expectation that prices will rebound and any losses will eventually be recovered. Investors are typically more concerned with market fundamentals, such as price/earnings ratios and management forecasts.

Trading, on the other hand, involves the more frequent buying and selling of stock, commodities, currency pairs or other instruments, with the goal of generating returns that outperform buy-and-hold investing. While investors may be content with a 10 to 15% annual return, traders might seek a 10% return each month. Trading profits are generated through buying at a lower price and selling at a higher price within a relatively short period of time. The reverse is also true: trading profits are made by selling at a higher price and buying to cover at a lower price (known as "selling short") to profit in falling markets. Where buy-and-hold investors wait out less profitable positions, traders must make profits (or take losses) within a specified period of time, and often use a protective stop loss order to automatically close out losing positions at a predetermined price level. Traders often employ technical analysis tools, such as moving averages and stochastic oscillators, to find high-probability trading setups.

A trader's "style" refers to the timeframe or holding period in which stocks, commodities or other trading instruments are bought and sold. Traders generally fall into one of four categories:

Position Trader – positions are held from months to years
Swing Trader – positions are held from days to weeks
Day Trader – positions are held throughout the day only with no overnight positions
Scalp Trader – positions are held for seconds to minutes with no overnight positions

Traders often choose their trading style based on factors including: account size, amount of time that can be dedicated to trading, level of trading experience, personality and risk tolerance. Both investors and traders seek profits through market participation. In general, investors seek larger returns over an extended period through buying and holding. Traders, by contrast, take advantage of both rising and falling markets to enter and exit positions over a shorter timeframe, taking smaller, more frequent profits.


http://www.investopedia.com/ask/answers/12/difference-investing-trading.asp

Warren Buffett - Speculation Vs Investment

Investing is NOT Speculation

There is a difference between speculation and investing.  

One distinction defined this by the length of time over which the investor expects to realise their investment; or to put it another way, how quickly one expects to make money.  

Speculation is high-risk-get-rich-quick territory.

Investing is managed risk over long periods of time where you can acquire wealth slowly.  

[  I am an investor by nature, not a speculator.
I am in it for the long haul, and having bought many good shares at fair or bargain prices in the past and presently, I intend to hang onto to them.
My view is that they will move yet higher over time.
Sometimes, the massive and largely unprecedented increase in the share price of my stocks over a short period was not anticipated by me or probably by many others.
So, did I get lucky?  Well, yes and no.
It was my view that the share price of these companies would rise further or eventually recover from recent corrections, whilst the past is no way of accurately predicting the future, I felt that it would rise to around a certain price in the medium term.
The difference between my expectations and what happened is that I would have been happy for it to return to that price within five years.  As it happened, it did so in less than a few months.  ]

Having Reasonable Expectations in Your Investing

Unreasonable expectations of how your portfolio should perform can lead to poor decisions, such as taking more risk to make up the difference  between your expectations and reality.

What is an unreasonable expectation?

1.  Expecting to gain 25 percent per year when the broader market is returning 8% is unreasonable.

2.  Expecting your portfolio to not fall when the market is down 35% is unreasonable.

3.  When investors fall behind in reaching financial goals, the temptation is to become more aggressive, which leads to unreasonable expectations.  If you choose more risky stocks (young technology companies, for example), you may have some winners that will help make up lost ground, but the odds are higher that you will simply fall farther behind.  The stock market and the economy don't care about your goals or investment choices.  They move due to a variety of actors and will go up or down with no regard to your plans.


What is a reasonable expectation of portfolio performance?

It depends.

1.  If your stocks are more heavily weighted toward growth, it is not unreasonable to expect to do better than an index of the broader market that is more heavily weighted toward growth.

2.  When the market is rising, your portfolio should also rise (and perhaps a little faster) and when the market falls, your portfolio should not drop as far or as fast.  That's the best you can hope for and if you hit, it, you are ahead of the game.

Do you regard commodities as investments? If an asset’s value is totally dependent on the amount a future buyer might pay, then its purchase is speculation.

Zweig:

In your book, Margin of Safety, you said as a general rule that commodities, with the possible exception of gold, are not investments because they don’t produce cash flow. Do you regard commodities as investments in today’s market?

Klarman:

No, I don’t. In the book, I was mostly singling out fine-arts partnerships and rare stamps—addressing the commodities that were trendy then. Buying anything that is a collectible, has no cash flow, and is based only on a future sale to a greater fool, if you will—even if that purchaser is not a fool—is speculating. The “investment” might work—owing to a limited supply of Monets, for example—but a commodity doesn’t have the same characteristics as a security, characteristics that allow for analysis. Other than a recent sale or appreciation due to inflation, analyzing the current or future worth of a commodity is nearly impossible.The line I draw in the sand is that if an asset has cash flow or the likelihood of cash flow in the near term and is not purely dependent on what a future buyer might pay, then it’s an investment. If an asset’s value is totally dependent on the amount a future buyer might pay, then its purchase is speculation. The hardest commodity-like asset to categorize is land, an asset that is valuable to a future buyer because it will deliver cash flow, not because it will be sold to a future speculator.  Gold is unique because it has the age-old aspect of being viewed as a store of value. Nevertheless, it’s still a commodity and has no tangible value, and so I would say that gold is a speculation.  But because of my fear about the potential debasing of paper money and about paper money not being a store of value, I want some exposure to gold.

Zweig:

Benjamin Graham drew a sharp and classic distinction between investment and speculation. I believe his exact words were, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”  But Graham sometimes speculated over the course of his career. So, maybe regarding commodities as speculative doesn’t  preclude you from owning them, right?

Klarman:

I would say that a commodity’s speculative nature is not what precludes investment. When Graham was talking about safety of principal, he was not referring to currency.  He wasn’t really considering that the currency might be destroyed, but we know that can happen, and has happened, many times in the 20th century.  The investing game has historically been closer to checkers, but now it is more like chess—almost in three dimensions. The possibility that the dollars you make could be worth much less in the future leads an investor to think, How can I protect myself?  Should I be shorting the dollar against another currency, and if so, which one?

Differences between investment and speculation

Differences between investment and speculation

1.  Investment:  Investment is rationally based on the knowledge of past share price behaviour.  From such knowledge, it is possible to compute the probability of future return.  

• A common method of investment analysis is to study the past range of PER or DY of a particular share or a class of shares. 
• From this study of its past price range, we can predict the likelihood of its price being out of this range in the future. 
• By comparing its current price with the expected future price range (future price = future PER x future earnings) we know whether the current price is too high or too low and take the necessary action accordingly.

Speculation:  Speculation is purely based on the HOPE that the future price will be higher rather than on anything tangible.

2.  Investment:  Investment requires an investor to do some work before hand and decisions are made based on known facts and figure.  

• Such work typically may consist of estimating future level of Earnings Per Share and computing the past range of the PER. 
• By multiplying the future EPS with the likely PER, we have an estimate of the future level of price. 
• If the present price is very low compared with the future price, we buy and vice versa.

Speculation:  Speculation is usually based on wild rumours and unsubstantiated hearsays which cannot be checked for accuracy.  Undoubtely, speculation is a lot easier than investment but one tends to reap what one sows.

3.  Investment: Investment is made for the long term (i.e. two years or more)based on the idea that one is much more certain when one is trying to predict the cumulative results of many daily movement.  Once invests with the knowledge that over the long run, the real investors will always make a gain.

Speculation: Speculation is usually for the short run (i.e three months or lessunless one is caught whence a speculator is then forced to become an investor), based on the idea that certain events may result in a rise in price (bonus, rights, takeovers, and others).

4.  Investment: Over a long period of time, true investment tends to produce a positive result.  Based on many years of research in the US and Europe, Long Term Investment consistently produced much higher return than fixed deposit or the inflation rate.  The Malaysian experience has mirrored the Western experience.

Speculation: Since speculation is not based on anything concrete, its result is not at all predictable.  Speculation can occasionally produce very high gains just as it can produce very high losses.  Over a long period of time, speculation is most unlikely to produce better return than true investment.  

5.  Investment: True investors can sleep soundly at night since they have a fairly good idea of the possible extent of their loss and gain before hand. Besides, since they are investing for the long term, they can forget about short term movements and ignore the market most of the time.  

Speculation: Speculation is likely to lead to many sleepless nights and anxious days since its result is so uncertain.  The speculator will have to be always on the alert to take the necessary quick action to catch the right moment. 

Previously posted in this blog on SUNDAY, OCTOBER 25, 2009

1929 Wall Street Stock Market Crash

“So what do I do with my money?”

IT'S A NEW WORLD OF INVESTING AND ONE QUESTION IS ON EVERYONE'S MIND:“So what do I do with my money?”

Learn More

The New World
Today’s markets are as uncertain as ever. But there is one certainty – that the future is coming. It may no longer be enough to simply preserve what you have today; you also have to build what you will need for tomorrow. So don’t put off speaking to your financial adviser. Isn’t it time to be an investor again?


"SO WHAT DO I DO WITH MY MONEY?"

Start taking action. Build a more dynamic, diverse portfolio based on your goals, your investment time horizon and appetite for risk.

"So what do I do with my money?"

It’s no secret that some economies are struggling, but that doesn’t mean all companies are. Consider high-quality companies with strong balance sheets, robust business models, sound company management and attractive growth prospects in fast-growing areas of the world. Many of these companies also pay real and growing dividends, offering investors the flexibility to either draw their income to fund their lifestyle today or reinvest it to grow their total return in the long run.



All financial investments involve an element of risk. The value of your investment and the income from it will vary and your initial investment amount cannot be guaranteed. Past performance is not a guide to future performance and should not be the sole factor of consideration when selecting a product. Overseas investments may involve risk of capital loss from unfavourable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Investments in fixed interest securities such as corporate or government bonds pay a fixed or variable rate of interest and behave similarly to a loan. These securities are therefore exposed to changes in interest rates which will affect the value of any securities held. Companies which issue higher yield bonds typically have an increased risk of defaulting on repayments. In the event of default, the value of your investment may reduce. Economic conditions and interest rate levels may also impact significantly the values of high yield bonds. Under certain market conditions, liquidity in bond markets may fall significantly without warning. Therefore it may not be possible to sell a security at the last quoted price or at a value considered to be fair. In extreme market conditions, it may be difficult to realise your investments.

Exchange Traded Funds (ETFs) and index tracking mutual funds seek to track a benchmark and holdings are not altered during rising or falling markets. Some ETFs are optimised and therefore may not hold all securities within the benchmark index. Performance may differ from the underlying benchmark index. ETFs trade on exchanges intraday at the current market price which may differ from net asset value. Transaction or brokerage fees will apply. Liquidity is not guaranteed. Active and index tracking mutual funds can usually be accessed at a single valuation point each business day at net asset value adjusted for applicable dealing charges and fees.

Passive Investing Theory: Investing versus Speculating

Secrets to successful investing

Secrets to successful investing.

1. Know the business well. Do you understand the business?
2. Know the intrinsic value of the business. Is it increasing its intrinsic value consistently?
3. Know the management. Are they with integrity?
4. Know the price. Is the company's price attractive, that is, undervalued?

It is just so simple, everyone can adopt these.

Theory of Investment: Why it is so important to buy good quality growth company and not paying too much for it.

The rest take care of themselves.


Investing vs. Speculation, according to Benjamin Graham