Value Investing. Growth Investing. Momentum Investing. Trading. Real Estate. Precious Metals. Shorting.
A million different ways to lose your money (We should include failed startups to this now shouldn’t we? Heh Heh).
I am going to review some of the lessons I have learned about investing over several future posts but lets spend some time clarifying what we are talking about. Being exact is helpful in a situation where we are surrounded with many different voices in chaotic confusion.
An asset is something that puts money in your pocket either today or in the future. Today it might be cash in your pocket, and in the future it may be the result of an investment, a gamble or a speculation.
Value Investing (or Investing) is the act of acquiring an asset for less than what its worth. Once the asset reaches the point where it is valued at what it is worth (or more), we have made a profit. Agreed?
Speculation is the act of (well speculation, I guess!) an informed (yes, informed…maybe incorrect but informed) betting on the movement in the price of an asset or a presumed asset. If the speculation is correct, a profit is made, and if not, a loss is suffered.
Gambling is the act of largely (not uniquely, no) uninformed speculation that most often results in losses for the gambler and winnings for the counter-party. The counter-party may be a speculator or an investor.
Now lets be theoretical for just a second and invoke math (or maths, if you are British). The only guarantee of profit in the above scenarios comes from buying an asset for less than its worth, i.e. value investing. Its more complicated than that but lets start with the numbers.
When you speculate, you position a bet to take into account certain unperceived or less perceived visions of a future wherein the asset you purchase will sell for more than you paid for it, regardless of whether it is worth what you paid or what the next person pays you for it (Greater fool theory).
That last bit is important. Its important because it underlies the idea of “margin of safety”. The concept of margin of safety says that you have purchased an asset for so much less than it is worth, that even in the likelihood that the greater fool theory did not apply, you would either minimize your losses or make a profit when the asset is fully valued.
A value investor lives or dies by his margin of safety.
A speculator is less concerned by it.
A gambler does not even know it exists.
Every situation where you buy an asset for less than its worth is therefore an example of value investing (stocks in 2009, real estate in 2010, Europe for the longest time etc).
Every time you don’t do that but you believe something good will happen to you, (i.e. currency trading, buying and selling gold, real estate in 2007, European debt over the past few years etc), you are speculating. There is nothing wrong with it, but its good to know what you are doing very clearly isn’t it?
The difference then between these two methods of generating wealth is therefore predicated on whether there is a difference between the price of an asset and its intrinsic value. That in turn is predicated on the estimation of value, the most important item in our arsenal.
Let me be very clear on this so there is no doubt where I stand. If you are unable to ascertain the value of an asset, you are a speculator and if you don’t even know that there may be an intrinsic value that you are missing, you are a gambler and one that will lose to the house every single time.
Every single time.
You have no business investing/speculating/gambling if you are unable to ascertain value.
Am I clear?
Would you perform surgery on yourself without going to medical school?
Exactly. (sigh..I can see the gamblers in the audience going..Hmm.. Why not give it a try?)
If you insist on doing this without the fundamental knowledge of valuation, I have some news for you. You have a name on Wall Street.
Sucker. Muppet (if the counter party is Goldman Sachs).
Warren Buffet says and I paraphrase “Every game has a sucker. If you don’t know who that sucker is, its you. Sucker”
I know the wider world thinks buying and selling stocks and “playing” the market is easy. Dead Wrong.
The market makes its money off of you.
Ok, lets summarize what I said so far.
The least risk (or most sure way) to generate positive returns is by investing and specifically by buying an asset for less than it is worth.
Speculation done well is an art that is beautiful to behold. Some of the richest people in the world are successful speculators. However, its extraordinarily difficult to do and to do it consistently over time is a rare feat. When you see the best at their game, its sometimes difficult to tell whether they speculated or whether they are very savvy value investors.
Most speculators are lousy and should be reclassified as gamblers.
Its more risky and much more stressful.
I don’t need to say anymore about gambling, do I?
In future posts I will discuss the concepts of valuation, its pitfalls and what you must learn in order to perform a reasonably good valuation.
We will then go over the principles of value investing (There are only three principles, my wide eyed acolytes, so don’t worry!!).
Among these posts in the future, I will discuss why these principles can and should be generalized to entrepreneurship and perhaps even to the Right Thinking principles I have been discussing so far.
Flood me with your comments, but please only positive ones.
I have a fragile ego.