Intelligent Investor Chapter 1 Summary : Investment vs Speculation


Investment vs Speculation : Results to be expected by the Intelligent Investor

Investment vs Speculation:

An investment operation is one which, upon thorough analysis(company and it's underlying business based on established standards) promises safety(deliberately protect) of principal and an adequate(not extraordinary) return. Operations not meeting these requirements are speculative.

  • Reckless investors is an oxymoron.
  • Speculators go by emotional conviction that some stock is bound to go up "somehow".
  • However, there's a speculative factor inherent in all stocks - for example, investing in new untested companies like Amazon. This is intelligent speculation that is different from blind investing when you are just speculating thinking that you are investing or speculating seriously without any knowledge or risking more money in speculation.
  • If you want to speculate, keep a very small portion of money separate for this purpose and don't mix it with your actual investment portfolio.

Results to be expected by the Defensive investor:

  • 50-50 division of stock and bonds in portfolio. 25<Bonds in portfolio<75. Stocks to 25 when market is dangerously high and 75 when they are at very low prices.Keep adjusting with every 5% variation of these percentages in portfolio.
  • Future of securities is unpredictable - for example, 
    • Bonds performed better than stocks in 1964 even with high inflation. In general, in case of inflation or raise of highly profitable businesses in market or even because of speculative rise, stocks will go up. Only bonds that depend on CPI(Customer Price Index) provide protection against inflation.
    • S&P 500 performed better than DJIA 30 from 1960-70 - which shows that assorted mix of 500 stocks performed better than 30 large tyrants.
  • It's better for defensive investor to confine himself for important companies with long record of profits and good financial condition. Better to go for shares of a well established investment fund instead of creating his own portfolio with dollar cost averaging.

Results to be expected by the Aggressive investor:

  • Trading in the market(violates safety of principal and satisfactory return): buying stock that's performing better than market average when it's advancing and selling when it goes down. Short selling: selling borrowed stocks from stock exchange and buying them after subsequent decline in price - profits from difference in sold price and buying price.
  • Short term selectivity: Stocks that are about to perform well because of some favorable development in business.
  • Long term selectivity: Expected high earning power in future sometimes because of past growth.
  • He can be wrong(his own fallacy) or the market already reflects his forecasting(his competition).
  • Making correct predictions unlike experts is highly unlikely.
  • So only sound investing policies that aren't popular will help- options might be 
    • undervalued issues because of lack of interest or unjustified prejudice.
    • special situations like payouts in liquidations, merger/acquisitions(careful-not all go through ultimately).
    • bargain issues - issues that are selling less than net current assets/working capital. Such sub-working capital issues are rare to find.

Commentary:

All of human unhappiness comes from one single thing; not knowing how to remain at rest in a room.

  • Exchanges and stock brokers make money when you trade whether you do or not. They are just like casinos. House always prevails in the end. So obviously, investment will be downplayed by them.
  • Investor calculates stock worth based on underlying business using established standards of value and speculator calculates underlying business worth based on the market price of stock.
  • Think if you would be comfortable investing in a stock without knowing daily quotes.
  • Not just temporarily right because of some luck, you got to be sustainably and reliably right.
  • With so much advertising on trading, investing has become a national video game drowning in data, with no knowledge. Knows price of everything, but value of nothing.
  • Half baked opinions, dopey ideas and mechanical formulas are speculative and temporarily cause a surge in stock prices.
  • Formulas that actually work like January effect get famous to the point that it's followed by everyone resulting in diminishing or no returns after brokerage expenses. 
    • Jan effect: Small stocks produce more gains when bought in second half of December and held through January. Reasons: Investors sell stocks to account for losses in tax. Professionals don't want to buy small under-performing stocks at the end of the year so that their holdings list doesn't look bad.
  • Allot only 10% of your wealth to speculation.
~

See Intelligent Investor Summary for other chapters summary.

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