I am actually mad at myself for not picking it up long ago. It was highly regarded but never decided to pick it up. Shame on me. Within the first 20 minutes of reading the book, I quickly realized that I had been missing out all of these years. If you have waited to read it, don’t. Make it your next purchase. Get this book in your hands as quickly as possible
One of the first chapters opens my eyes to the real world of the stock market. There are investors and there are speculators.
I want us all to be successful INVESTORS, not a successful SPECULATORS.
Investor vs Speculator
An Investor is defined on the internet as a person that allocates capital with the expectation of a future financial return. Does this mean that anyone who owns shares of a company is considered investors?
Not necessarily. There is a large difference between being an investor and speculator. The deadly reality is that the latter is often mistaken for the former.
There are a lot of people who believe they are investors when in fact they are nothing more than gamblers using a different type of medium to get them rich. Instead of a blackjack table instead, they use a brokerage account.
My goal is to make everyone that reads this aware of the difference. Then with the newfound knowledge, they can begin to move from being a speculator to an investor. A move that everyone is capable of making.
Long-term stock market wealth comes from being a successful investor, not a speculator. But don’t take it from me, take it from the people who have embraced the true investor lifestyle. Individuals like Warren Buffett, Benjamin Graham, and Peter Lynch.
Allow me to enlighten you on the difference between the two.
I think to fully illiterate the difference between investor in speculator I will use a quote straight out of the book that opened my eyes. “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.”- Benjamin Gramham, Intelligent Investor, page 37
There were 3 main aspects that Graham used to identify an investment operation that an investor embodies 1) thorough analysis 2) promises safety of principal and 3) an adequate return.
These will be discussed in detail below.
First) Thorough Analysis
An investor is someone who does a lot of homework.
Finding great investment doesn’t come easy. These findings belong to those who are willing to put in the time. The person who will “Turn over every rock possible” as Peter Lynch might say.
All of these rocks include annual reports, letters to shareholders, all possible presentation that might have been given; anything that might lead to a possible hidden gem. It is essential, an investor is well aware of the business and everything in between. He or she studies the management, the economic outlook for the industry, how well the product or service is regarded by the consumers.
All of these little things add up, an investor understands that thorough analysis is needed to succeed. Without a deep analysis, an investor will be unable to accurately identify this value.
The ability to accurately identify the intrinsic value of a business is the determinant as to whether the investment will be successful or not. An investor will not make an investment unless he can purchase the security at a steep discount to intrinsic value.
What is an intrinsic value? Intrinsic value is the giant rock that one must uncover. This is where the gems are found.
Intrinsic value is defined as the actual value of a business based on the underlying perception of its true value including all aspects of the business, including tangible and intangible assets.
This total value of a business may or may not be the same as the current market value. When the intrinsic value of a company is more than the current market value a true investor will become interested.
This purchase below intrinsic value is what creates the massive returns for great investors.
You can see the identification of a business’s intrinsic value is quite possibly the most important aspect of investing. Without a thorough analysis of the business, an investor would not be able to accurately identify the total value.
As described in the definition the intrinsic value is made up of all things tangible and intangible. It is fairly easy to estimate the worth of tangible assets. When it comes to the estimation of the value of intangible assets, it can get a little hairy.
There is no clear-cut formula for estimating the intrinsic value of a business, every investor has their own way of estimating it. Business valuation is more of an art form rather than a quantitative measure. Each investor has his own way of painting the picture.
I will use Warren Buffett as an example. There is no debating that he is likely the most successful investor of all time. This didn’t just happen by magic or luck. Its because he is a great artist.
He has been able to successfully estimate the intrinsic value of each company he has invested in through his own type of process. This process can not simply be put into an equation. If it was that simple then every single quantitative trading firm would be making boatloads of money.
Investing in businesses cannot be a quantitative process because it is close to impossible to truly identify the exact dollar amount of value a business withholds.
This is why each investor has a different way of valuing a business. A lot comes from a gut feeling. This gut feeling is developed through the deep analysis of each company of interest. The deeper you dig the more and more prominent the feeling becomes.
You can use as many models as you want but it all comes down to developing the gut feeling for good businesses. Warren Buffett’s gut feeling has been groomed from constant learning and thorough analysis of each company.
Without deep analysis, no investor will be successful.
Second) An Investor Takes Extra Steps to Avoid Losses
We have all had a time in our investing career where we see a company with the price up 100% within the given year. We then think “It will keep going up and never come down”. I will admit I am guilty of this early in my investing career.
The truth is, when we don’t care about the price as so much as the company underlying it, it no longer becomes an investment. It becomes a bet that the share price will become higher in the future instead of a calculated buy.
When you don’t take price into consideration it leaves no room for the margin of safety. Also meaning, you leave no room for yourself to be wrong.
Part of being an investor and not a speculator means you take deliberate steps to avoid major losses. One of these major steps is resisting to buy into the hot stocks of the year that might seem like good companies but are priced out of proportion.
Graham introduces the principle of maintaining a ‘Margin of safety’ while making your investments.
The margin of safety is an investing principle that requires an investor to only purchase securities when the market price is significantly lower than your estimate of intrinsic value. The difference between the market value and the estimation of intrinsic value is the margin of safety.
By taking the steps to not buy into a security until you have a large margin of safety you give yourself room for error. The margin of safety will help make this error much smaller than if you ignored it.
I have never met an investor that has never made a bad investment. We all have them. The thing that separates the survivors from the casualties is the amount of loss. Those who maintain a margin of safety will prove to survive.
Third) An Investor Aspires to Produce Adequate Not Extraordinary Performance
Being a successful investor means checking your ego at the door. Which can be the hardest thing to do. The prior 2 characteristics require hard work and self-control. This one, though, requires you to swallow your pride.
An intelligent investor would much rather have slow steady gains rather than extraordinary returns that occur only on occasion. Investing is a marathon, not a sprint. A tortoise and the hair kind of race.
Those who start out fast usually fall behind to those that paced themselves over the course of a race. Select the slower speed. It will put you ahead in the end.
Howard Marks, the co-founder, and co-chairman of Oaktree capital is a great example of someone who embodies this characteristic fully. He stated that his main goal for Oaktree is to perform. There is no desire to be the top performing hedge fund of the year, or even number two. Rather all he cares about is achieving strong constant returns.
Howard understands fully that it is better to consistently be above the bottom 10% than to be in the top 10% one year and the bottom the next.
What drives this thought process is that during any given year a fund manager can become lucky, pick the one stock that rises 200% and is the main driver of his performance. At the end of the day, was this just luck or was this an actual skill?
Most of the time it has a lot to do with luck. Then when the luck runs out, they are back at the bottom 10%. Temporary high returns do not prove anything.
Here is a strengthening example that was used in the Intelligent Investor (in full disclosure this an affiliate link)
Imagine there are two places 130 miles apart. If one goes the speed limit, 65 MPH, they can reach the destination in 2 hours. But if one decides to drive 130 MPH they can get there in one hour. If you do that and survive does that make you “right”? Should one be tempted to do it if they hear, the other bragging that it “worked”?
Chasing flashy high returns in the market is much the same: In short streaks, as long as your luck does not run out, will work. Over time, you will get killed.
(If you have never heard of Howard Marks I strongly recommend you go check out his memos, they are a great read for anyone who wants to become a better investor. Also, his book, The Most Important Thing (In full disclosure this is an affiliate link), is fantastic. I recommend that too.)
Related: Dissecting the Greats Warren Buffett
These 3 characteristics make up what an investor truly. He is a hard-working, patient person, that only desires adequate returns.
Embodying these 3 qualities are not easy. Precisely why there are a lot more people who lose money in the stock market than those who do. Being an investor is not easy by any means.
On the other hand, it is much easier to speculate.
It might be hard to tell but there are many differences between speculator and investor. We grow up in a world that puts anyone that owns stock into the “investor” category. This could not be farther from the truth.
A speculator is a charlatan (Fancy word huh? That SAT vocab paid off, it just means a fake). They pretend to be an investor when, in fact, they do not embody the characteristics that are the being of a true investor.
Speculators are the people in the car going 130 MPH to every destination. They might beat out investors in the short term, in the long term, however, they will be left behind.
As you go through the rest of this post I want you to keep in mind your own behavior. Does it resemble that of an investor or that of a speculator? I will be the first to admit I suffered from this thought for a majority of my investing career. It all comes with the process of learning to be a great investor though. I think we all have times like these. It is how we learn. So if you start to feel like you have been doing it all wrong, don’t worry. You’re are not alone.
The best part is that you can change your behavior to embody the characteristic of an investor rather than a speculator.
First) A Speculator Makes a lot of “Investments” Based on Little Knowledge
I put the word investments in quotes because when you buy stock with little information about the company it is more like a bet. With no homework done, any purchase of shares becomes a bet.
Here is an example: Let’s say someone sees that Nike (NKE) beat earnings for one quarter. You say to yourself “I like Nike and they beat expectations this quarter. I bet Nike will beat every quarter because they are everywhere!” Then you go and buy some stock.
This is the definition of a bet. There was no homework done. No analysis of the annual report, financial statement, and I bet if asked they couldn’t even tell us the CEO of the company.
Speculators, make a lot of decisions like this.
A big difference from what an investor might do. Even if the stock was a bit of a risky investment, a serious investor will still go and dig up any relevant information possible. Making sure they turn over every rock possible.
You are putting yourself in a vulnerable position when you purchase shares of a company with no background knowledge. There is no real difference than walking up to roulette table and putting money on black.
Investors will never take a stake of ownership in a company if they have no assessed all possible information. Speculators, on the other hand, will take a shot at anything that looks good.
Second) Margin of Safety is Like Timing the Market
Let me be clear, it is impossible to time the market. One can never know what truly is the bottom or the absolute top. However, investing all derives from what you pay. If you pay $200 for a TV and I get it for $100, who got the better return on investment.
The stock market doesn’t work as black and white as that example, but there is no company that is worth the investment at any price. A company can be very attractive at one price and not so much at another. It is all about the assessment of the company.
A speculator will look past the price and just buy. An investor will never look past what he is paying. A speculator will buy anything that looks good. An investor will wait for a company to fall right into his circle of competence and then pull the trigger.
Warren Buffett is a big advocate of developing your own circle of competence. He likes to refer to a Ted Williams example. I will do the same.
Ted Williams (who is the greatest baseball hitter to ever live) developed an understanding that if he waited for the pitches that where right in his sweet spot he would bat .400. (For a baseball player that is unheard of) If he chased pitches that where outside his zone he would bat .240. The trick was being patient enough to wait for that perfect pitch and swinging.
This relates to investing also. You have to develop your own system to be able to identify what a good investment looks like and then wait until companies fall into your lap. Wait for your fat pitch. The greatest part of investing is that you can sit and wait. Watching strike after strike goes by, all you have to do is hit one.
A speculator will not wait, he will chase any pitch that looks like a strike, batting .240. A successful investor will wait for the perfect pitch and bat .400. The investor who waits also leaves room for his margin of safety. When you wait for a company to meet all of your criteria which includes trading at a steep discount, you leave room for error which can make or break an investor.
Speculators will not pay attention to margin of safety exposing them self to a massive downside. In the market, there is no sure investment. Once the words “This can’t go down” leave your mouth you have already lost.
An investor plans for the downside and only buys when the downside is minimal and the price is well below the intrinsic value leaving a large margin of safety. Make it your goal to never pay full price for any assets. Every investment should be the purchase of a good business the market has priced wrong in the short term. This will save you from a lot of losses.
It is true a good company will reward shareholders for a long time, but if you get shares at a premium and I get them at a discount, who got the better deal? There are so many companies in the market, in my opinion, there is no company worth paying a huge premium for.
Warren Buffett relates buying stocks to buying socks. He is always looking for quality but if he would much rather buy socks at a bargain price than full price. The same goes for his investments.
Third) A Speculator Wants Big Returns Now
Speculators by nature are greedy. We all are from time to time. With speculators, it is the how can I make the most money the quickest. They are in the constant chase to find the next big thing. All looking around for what could be the next big thing.
Being on the lookout for what could be a great company in the future is always smart, but you have to be selective when you decide to purchase.
The problem with always chasing, you are never out front. You are always behind. With this will come a lot of purchases at premium prices and massive losses. Instead of desiring an adequate return, a speculator wants to be the biggest winner year after year. This might work out one year, but more often than not, they will end up towards the bottom.
We have to remember a speculator embodies all the characteristics listed above, which is the reason why they end up at the bottom. With no research, a little margin of safety, and the desire to get rich quick all in the head of a speculator you can be willing to bet that the majority of his “investments” will be duds. Then if he does hit one gold mine, is he really a skillful stock picker or was this just a matter of luck?
The latter would be more appropriate in this situation given the context. The speculator is the rabbit and the investor is the tortoise. In the end, we all know who comes out on top.
Instead of being satisfied with adequate returns, the desire for massive returns will only leave you broke and defeated.
The Kiss of Death
By know, you can tell there is a massive difference between an investor and a speculator. Above all though, there is one thing that can truly be the kiss of death for someone. It is to think they are truly investing when in fact they are speculating.
Once a speculator begins to believe that they are investing they will convince themselves that they know what they are doing. This will lead to a lot of loss of money.
Someone who confuses the two terms is someone that is losing money on multiple accounts. Speculators have multiple losses because they take no steps in order to prevent them. Investors, however, make calculated decisions that prevent such exposure to massive losses.
It is imperative that you understand the difference between the two and are to identify the behavior in your own actions.
A speculator has a lot in common with veteran’s gamblers. They are willing to take a chance to hit the big winner even though it means they will have a lot of losses occur in the process. In the end, though, the house always wins. There is room for both
A single human can embody both an investor and a speculators mindset. A strong example of someone who did was Peter Lynch. While managing the Magellan fund Lynch would stack his portfolio with good investments then put a few speculation picks in there also.
He noted that the solid investments provided the portfolio with the stable returns. The speculation picks were the ones that helped him create the massive returns annually.
The crucial element here is the ability to identify the difference between the two. Make sure that when you are making investments that what they are. The same goes for speculations.
There is nothing wrong with taking a little risk, just make sure it is not the majority of your portfolio. I would recommend you only allow yourself to have a maximum 10% of your portfolio in speculative picks. The other 90% should be in solid investments.
As long as you can identify the difference between the two and also allocate the appropriate amount of capital to each then there is nothing wrong with making a few speculation picks.
We now know the true definition of what it is like to be an investor. Make it a point to become the best INVESTOR possible. It requires little talent to be a successful speculator so do not settle.
Be thorough in your analysis, wait for your fat pitch, and strive to achieve adequate returns. Embody these three things and the process of becoming a successful investor will approach you at a much quicker rate than going out and learning for yourself.
If you want to make a few speculation picks there is no harm in doing so. Just make sure you follow the rules. 1) Never use more than 10% of your capital for speculation and 2) never in a million years convince yourself that your speculations are actually investments.
Follow this outline and you will become a great investor.
Warren Buffett is a great example. He has built Berkshire Hathaway on all these simple rules and look at his success. I am not saying you will end up with him but there is no reason you can not follow the same criteria. It’s simple and effective.
We all have the ability to be successful investors. We just need to make sure that ‘investing, is what we are doing.
Peace and Love,
I would love to hear what you have to say about this article. Let me know in the comments below!