Security Analysis Series: Chapter 4 Summary

“Distinctions Between Investment and Speculation”

Chapter Summary

  • The definition of investment is: “Upon thorough analysis, [an investment] promises safety of principal an a satisfactory return. Operations not meeting these requirements are speculative.” (pg 106).
    It is also: “justified on both qualitative and quantitative grounds.” (pg 107).

    • “Thorough analysis” refers to the study of facts towards safety and value;
    • “Safety” refers to protection against loss under normal/reasonable circumstances;
    • “Satisfactory return” refers to appreciation of principal.
  • Graham rejects more classical definitions of “investment”, such as “putting money in a business”, or anything involved in the field of finance, so as to allow a differentiation between speculation and investment. (pg 100).
  • Graham rejects the many classical differences between investment and speculation, such as safety vs. risk, short-term vs. long-term, income vs. profit, and outright purchases vs. purchases on the margin. (pg 102-105).
    • A fascinating theoretical case is given where an investment can be made in the short-term on margin, netting a guaranteed profit of $100 per 3 months. This flies in the face of traditional thinking on investing vs. speculating. (pg 108).
  • Graham points on that while speculation is largely based on the whims of future events, investment is subject to the same treatment of future uncertainties. However, intelligent investing involves guarding against the future, as opposed to profiting from it. (pg 109).
  • Intelligent vs. unintelligent speculation involves taking a risk that is justified by logical pros and cons, as compared to a risky, uninformed decision that is not justified. (pg 110).

 

Chapter Analysis and Thoughts

  • The difference between intelligent speculation and investment seems negligible. Everything involves some degree of risk; why is it that one decision that is backed with the support of logic is considered speculation, likely because it is far more risky, while a different, less risky decision that is also backed by logic is to be considered investment?
  • There seems to be a certain degree of arbitrariness to Graham’s philosophy. There are certainly grey areas. For example, what qualifies a decision as being informed, or backed by logic? At what level of risk does investment turn to speculation? What amount of protection is sufficient for an investment to be considered “safe”?
    • But perhaps it is important to keep in mind that value-investing philosophy doesn’t need to be precise and definitive in itself. We can readily operate and select investments from within the spheres of his definitions, even if there are no strict borders to those spheres. One will likely know intuitively when he is investing, and when he is gambling; there is no need to press Graham for more specificity.
  • Graham’s idea of “guarding against the future”, as opposed to looking to capitalize on it, is very interesting. It is difficult for me to reconcile this protective outlook with the fact that intrinsic value must necessarily be related to future cash flows. It illuminates his more cautious nature, and I’m not entirely certain if that caution is a part of the value-investing canon, or if it is his personal preference.
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