In investing, it can be difficult to distinguish between investing and speculating. Both investors and speculators aim to make a profit by putting money to work in the financial markets. In the seminal work Security Analysis (1934), legendary value investor Benjamin Graham and co-author David Dodd attempted to more precisely define the difference between investing and speculating: “An investment operation is one which, upon thorough analysis, promises safety of principle and a satisfactory return. Operations not meeting these requirements are speculative.” Later Graham became concerned that the term “investor” was being applied to virtually anyone and everyone who participated in the stock market. He blamed this on the “easy language of Wall Street [in which] everyone who buys or sells a security has become an investor, regardless of what he buys, or for what purpose, or at what price, or whether for cash or on margin.”
An important factor in determining whether one is an investor or a speculator is how long they own a security. All market activity can be viewed as lying on a continuum. As we move from left to right, we can see stock market buy-sell decisions that occur in microseconds, minutes, hours, days, weeks, months, years and decades. While the exact point of separation is uncertain, the general belief is that the closer the activity is to the spectrum’s left side, the more likely it is to be speculation. Accordingly, the further it is to the right, the more it is thought to be investing. In the opinion of Vanguard’s John Bogle, investment means long-term ownership; speculation is represented by short-term trading.
While the duration of ownership is a factor, we think there is more to the story. In our view, investing also includes thorough analysis, while speculation is more akin to guessing. Investors are also more likely to take the view frequently expressed by Warren Buffett: To an investor the stock is a business; to a speculator it is a ticker symbol. Another important distinction is that speculation can be viewed as buying something with the notion of selling it to someone else as soon as you realize a favorable price. Investing, on the other hand, implies a willingness to own something for an extended period without being concerned about the short run or temporary impairments of capital.
At BWFA, we favor investment over speculation. We perform fundamental research with the purpose of understanding how a company generates cash, how it allocates its capital, how it got to where it is and where it may go in the future. We make an assessment of management’s capabilities. Most importantly we estimate its value, and look to acquire securities that are trading at a discount to fair value, not a premium. We also look for stocks that we can hold for at least three-to-five years. Given the market’s strong performance over the past few years, we believe applying these factors as part of our investment process is more essential today than ever.