Bookworm: Five words that separate investors from speculators
A passage from Warren Buffett’s favourite finance book poses an important question to every investor.
Welcome to the next edition of Bookworm, where I explore and share useful insights from investing and business writing.
Each insight falls under one of three themes: Owning high quality assets, fostering a long-term mindset, and putting process over emotion.
Today’s insight is in the process over emotion bucket.
Today’s insight
A few months ago, I scored a copy of Ben Graham’s Intelligent Investor from a book exchange in my neighbourhood. The version I have is a reprint of the 1973 edition, and many of the methods and examples seem of little use in today’s stock market.
The methods and examples themselves, however, are not why I still occasionally dip into the Intelligent Investor. Instead, I read it seeking the principles and wisdom that underpinned those methods. The why behind the what.
Today I’d like to share a short quote from the book that I think is worth dwelling on.
It concerns the contrast that Graham draws between investment and speculation, however, it doesn’t come from his famous opening chapter on this topic. Instead, it is buried in the middle of chapter 8, which is titled ‘The Investor and Market Fluctuations’.
Here it is:
“The most realistic distinction between the investor and the speculator is found in their attitude towards stock market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices.”
I think that those two final sentences – and especially the last one – align closely with the investing approach that we try to encourage at Morningstar.
Boring instead of brave
Of the two different behaviours described by Graham, one sounds a lot more fun than the other.
“Profiting from market fluctuations” sounds daring and exciting. “Finding suitable securities at suitable prices” sounds serious and maybe even a bit boring.
But that is exactly how Graham wanted investment to be. He didn’t want the stock market to be an arena of speculation and gambling anymore. That is what led to the 1929 market crash and the ensuing economic depression that scarred his generation.
Above all else, Graham argued that investing should be businesslike. Based on sound processes and rational judgement of the facts, rather than adrenaline or a search for dopamine.
This raises an important question that we should all answer honestly:
How do you see and treat the stock market? Do you see it a source of excitement and entertainment? Or as a serious opportunity to acquire real ownership stakes in companies and assets?
I’m the first to admit it: I have often treated it like a game, a hobby, a source of excitement. But then something happened. The amounts I was investing grew, and I also grew older. More aware of the need to fund retirement and – deep breath – future kids.
I now realise how crucial it is to treat the stock market as the serious wealth creation vehicle that it is. And as something that should be approached, to borrow my phrasing from Graham, in a businesslike manner. Buying suitable assets at suitable prices.
What are suitable assets?
A few years ago, I would have said that the most suitable asset is whatever stock is cheapest and has a decent change of going up in the next couple of years. The best risk/reward, if you will. That is fund manager speak, and I now take a different view.
A suitable asset is one that fits the strategy you have set for reaching your investing goal. If you are buying individual shares, that means companies that you are comfortable buying and holding in a way that exploits the edge you are you trying to pursue.
For more on devising your investing strategy and pursuing an investing edge, I recommend this article by colleague Mark LaMonica.
And what is a suitable price?
I want the price I pay to enable a return big enough to achieve my goals.
If you follow our method for setting an investing goal and strategy, this is the “required return” that we talk about seeking from your portfolio.
Over the long-term, a stock’s total return will likely resemble a combination of growth in the company’s earnings power or asset value; returns of capital to shareholders over time; and changes in the valuation multiple given to it by markets.
I want to buy companies that fit my strategy at prices where a change in valuation multiple in the future is more likely to be a tailwind than a headwind. Or in other words, at times where sentiment is closer to being depressed than it is elated.
I also seek to buy at prices where readily achievable levels of growth in the company’s earnings or asset value should deliver the investment returns that I require over the long-term. If that sounds fairly obvious or boring, that’s because it is.
