Investing or speculating?

The key is to understand a crucial distinction between speculation and investing, first drawn by the great investor Benjamin Graham, who was Warren Buffett’s teacher. Stocks and businesses are not the same thing. Stocks flit around all the time; you can watch them moving up and down on your computer screen all day long. In New York, it’s not unusual for the price of a stock to change at least 10,000 times in a single day of dealing, and it’s not very different in Mumbai. Stock prices are in constant flux, but business values are not. The underlying value of an ongoing enterprise does not change every day. Something like 99% of all the trading activity in the typical stock is meaningless. The future value of a business has nothing to do with the current price of its stock. What you should do is learn to look past the noisy twitching of stock prices to the enduring value of businesses as living organisms. Is the business run by honest people who treat outside investors fairly? Does it make products or provide services for which customers are willing to pay higher prices if necessary? Can you understand its financial statements? These constitute the reality of the business and determine its future value. The ‘story’ behind the stock is almost certainly nothing more than the stampede of thousands of speculators in and out of the shares. Train yourself to ignore them.

Graham’s formal definition of investment has never been improved upon: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.” Notice carefully that this is neither an ‘or’ nor an ‘and/ or’ definition; all three components — analysis, safety, and an adequate result — must be present. If any of them is missing, you are not investing. You are speculating.

Most people who call themselves ‘investors’ are not investors at all. They are speculators. In the short-run, particularly while the Indian capital markets were rapidly going up, speculators were able to earn high returns by rapidly trading stocks without doing thorough analysis. But in the long-run, you cannot earn sustainably high returns from mere ‘gut feelings’. And that has clearly come into light after the stock market crash. Many people have been caught holding onto stocks that were going up at a very fast pace and are now falling at an even faster pace. In a society with cultural traditions of great patience and acute analytical ability, so many people trade as if their knickers were afire, scoffing at the long-term and analysing nothing but the craziness of the crowd.

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