Difference between Investment and Speculation

Hello friends, in today’s article we see the difference between Investment and Speculation from chapter 4 of the security analysis book. so let’s see the Benjamin Graham point of view.

The Previous Chapter 3: Sources of Information

Difference between Investment and Speculation
What People think about It:-Difference between Investment and Speculation

Difference Investment and speculation

Bonds and stocks

so people say, ” Invest in bonds is an investment, and invest in stocks is called speculation.”

Outright purchase and purchase on margin( taking loan and buy security)

Some people say, ” We buy the outright purchases that investment and speculation when you purchase on margin ( means taking borrowed money and buy the stocks).

People say, ” Investment is permanent holdings and Speculation is for a quick return.”

other people say, ” Investment is for income and speculation is for profits”

Investment is in safe securities and speculation in risky issues. (Difference between Investment and Speculation)

so authors say, ” this all is bullshit whatever above peoples think.”

So Author starts with the first point and say,

” If you buy bonds that secure but companies earning is not sufficient, so those interest payment not fully paid by the companies, so this is also the speculation.”

so go on to the second point from the above table i.e. Outright Purchases and purchases on Margin

If you want to purchase security and this security is shit, so then this is not a good opportunity so whatever you buy on outright purchases, this also speculation.

or

If you get the wonderful stocks and you get the maximum discount and margin of safety but you buy on purchase on margin this is also Investment and this maybe becomes a good investment.

Temporary and permanent points

This is only the intention of purchase so If someone says, ” I buy this security and keep it so what is the benefit of that if they keep that security. so you have a purpose in buying that whatever your purpose i.e. Profits or income.

So in this, not any temporary or permanent,  If they reach at purpose in a short time or long term time, this doesn’t matter, the matter is that purpose is accomplished, whatever the time frame.

Income and Profits

Suppose you get the return whatever is 10, 20%

from where it comes, it doesn’t matter

they come in form of income or profits this all depends on your fundamental circumstance, which means you need every month money for maintaining your lifestyle or you need profits for long terms.

So we can’t say, ” income is investment and speculation is profits”

because of the above fundamental circumstances. (Difference between Investment and Speculation)

Safety and risky point

so safety and risky is dependent on the different points of view of people.

So if one man puts money on a racehorse and he thinks they will win the racing then in his point of view they think it’s a good investment and safe money.

so some people think in 1929, investors think to put money stocks is a safe investment and they think this stock has never gone down because now a new era is beginning and the stock goes high.

so whatever they pay the price, they are justifiable for that stocks in 1929.

This depends on the perspective to perspective so we can’t separate the investment and speculation.

So all this statement neglect by the author and they give his own point of view of definition of Investment and Speculation.

Definition of  Investment:

An investment operation is one which upon thorough analysis, promises safety of the principle and a satisfactory return.

If operators not meeting these requirements are speculations.

Thorough Analysis means studying the facts while applying standards of safety and value.

Safety of Principles means, Your principles are not going anywhere in normal circumstances.

Like lite situation happen in the market, except the stream events like recession, depression, etc so then there is no safety in this situation on investment principle, this told by the Benjamin Graham

Satisfactory Returns may be in any form like capital appreciation, dividends returns, or interest payments.

Lastly, investment operation called an investment instead of securities operation as investment operation.

Because any type of securities is an investment or any type of security is speculation. so this only depends on how much price you pay. (Difference between Investment and Speculation)

the author also define another form of Investment

An investment operation is one that can be justified on both qualitative and quantitative grounds.

after this author gives  Examples of Speculation.

In Dec 1934, General Electrics stocks were sold at 12 3/4 dollar and paid 6% on $10 pay.

It has one difficulty was they are callable on any dividend date at $11.

So the author says, ” Buying these preferred stocks at 12 3/4 is speculating and we put the 10% of our principal.

so how this happen explain below

Suppose if the issue is called on the very first date i.e. 15 April 1935, then you will get the $11 as call price plus a Dividend.

so how much dividends? for this
Annual dividend = 6% of $10 = $0.6

so for 4 month dividend = 0.6/3 = 0.2.

 

so, you will get $11 as call price and dividend is 0.2 means $11.02 which could result in a loss of 12%.

so now you think, this is a very simple calculation, so who do like this stupidity.

so, guys, everyone wants to become rich in the stock market and no one wants to do work for that that why we all do stupid things.

So the author says, ” buying these preferred stocks, you are doing speculations.”

You were wagering that issue would not be called for some years to come, therefore it is speculation.

so the author gives the Example of Investment:

In real-time, the same stocks of General Electrics, the issue was called that every month at $11 per share on 15 April 1935. so from this announcement. (Difference between Investment and Speculation)

The price promptly decreased to $11 so the author says, ” this is the investment opportunity.”

So let’s see how?

Now you have the opportunity for profitable short-term investment on margin investors buying.

Suppose, you buy the $11 stocks at on 15 Jan 1935 and you get the $10 per share borrowed money at 2% per annum interest.

so you buy the 1000 shares.

at $11  so net money = $11,000

On April, 15, 1935, you get the $11 plus dividend = $11,150

so this time you have to call the price and get dividends of $150. ( $0.6 per annum and 3 month dividend is 0.15 multiply by 1000 = $150)

so gross profits = $150

so you invest $11,000 and you get the $11,150, but on this, you have to pay borrowed money whatever their interest rates.

so for 3 month interest rat 2% per annum on $10,000 = $50

your net profits were = $100

so you invest $1000 and you take $10,000 as a loan (borrowed money).

The net profit of $100 on $1000 investment, in 3 months is equivalent to = 10% * 4

= 40% Annual return

so this type of return is very much best for an annual year.

Peoples say, that ” investment depends on the past and speculation is depends on the future.”

So after this example, the author gives the four types of investment

Types of  Investment:-(Difference between Investment and Speculation)

1) Business Investment: Your money put in any business

2) financial Investment: Your money put in any securities like bonds, stocks, etc.

3) sheltered Investment: In this, you buy those securities that have minimum risk and they have the first claim on company asset.

4) Analysis Investment: Analysis investment is that investment operation that going through the analysis and they give the promise statement about principle safety and also adequate returns.

So this is the list of types of investment, so this is not an exotic investment list, and about them not other any investment is not like that. and this put randomly without any relations. (Difference between Investment and Speculation)

Types of Speculation:

1) Intelligent Speculation

2) Unintelligent Speculation

1) Intelligent Speculation: Those are intelligent speculation, you only get those risks, you are justifiable on that because you do good studies and whatever your prose and cause on your decision.

So this called Intelligent Speculation

2) Unintelligent Speculation:

In this, you take the risk, without reading that situation you just doing this, because you think these stocks going high.

Because you listen this is a popular company and lots of people talk about this company so this is all are bullshit.

Those are stocks price, and you are paying for that stocks, so we can divide them into two components.

Investment and Speculative components of Price:

e.g. In 1939, General Electric stocks $38

so analyst judgement says that the investment of that stocks price is $25.

and other remains $13 is that speculation price.

so they represent the stocks market appraisal and long term prospects may be good and peoples bias is that this company is very good and they include the other factor of specular component.

So any investor/buyers pay more than the $25, then they have to recognise, they are paying for speculative possible so the author doesn’t say that this is wrong thinking or right thinking.

they have to just recognise that they are paying for speculation price also and they have to remember this fact then only your mind is set

If you think this is justifiable to pay more than the $25 then, this is Bullshit Think.

and your brain is not set for investing.

lastly, the author gives the relationship between intrinsic value, investment value and speculative value

Relation: Intrinsic value, Investment Value and Speculative Value:

So those are intrinsic value they can include in the speculative value also, but only for Intelligent Speculation.

So Intrinsic value has two components

  1. Investment Value
  2. Intelligent speculation value

If stocks price is equal to Intrinsic value and If they have more than then they include the unintelligent Speculation Value.

so this is all about the Difference between Investment and Speculation from the Security analysis book, chapter 4.

One Up On Wall Street: Chapter 13

Hello friends, in today’s article we see the different chapter 13 of one up on wall street. In this chapter, you get the quantitative part of one up on wall street book. So from this chapter 13, you get which term is important in the balance sheet for looking at investment. so let’s begin.

Previous Chapter 12:

One Up On Wall Street: Chapter 13

Some famous Numbers:-One Up On Wall Street: Chapter 13

so come in direct point let start with Percentage of sale

1. Percentage of Sales:-One Up On Wall Street: Chapter 13

  • In a company you have to see which product is selling very fast, as well as the quality of sale, is increasing, means you have to found the product that product sale is maximum. So you have to see the how the percentage of the sale that represent of company. (One Up On Wall Street: Chapter 13)
  • To see the sale account and how much account of profit that product is given.

2. P/E ratio:-One Up On Wall Street: Chapter 13

  • so let see the famous ratio that is the P/E ratio. So while looking for the P/E ratio. and then don’t only look at the P/E ratio look also at the company growth, which means earning in growth and compare with them.
  • If the P/E ratio and company growth are equal that means the company is fairly priced.
  • So here Peter Lynch talks about the PEG ratio. If the PEG ratio is 0.5 then that company is very good for investment. (One Up On Wall Street: Chapter 13)
  • If the PEG ratio is less than one then the company is good for investment, and if the PEG ratio is more than one then that the company stock is overrated.
  • If that PEG ratio is more than two then don’t buy the company stock. So let’s calculate the PEG ratio
  • The PEG ratio =  (P/E ratio)/EPS Growth
  • So author gives the other things about considering the P/E ratio. (One Up On Wall Street: Chapter 13)
  • The dividend yield is added with the long term and that sum is divided by the P/E ratio. If you get the ratio is more than 2 then is a good investment and if you got 1.5 ratios then it is also ok.
  • But if you got the ratio is minimum than 1 then don’t buy that the company stock.

3. Cash position:-One Up On Wall Street: Chapter 13

  • If the company has maximum cash on the balance sheet then that company is very strong. In the previous chapter, we see the how-to calculate cash per share.
  • So the author gives the example of a ford company, In company, the stock price is increased from $4 dollar to $ 38, and wall street investors think this stock is overpriced. so let’s see what happen
  • But in the company, $16.3 of net cash is present at that time, which means if you buy that stock you get the $16.3 cash per share is completely free. (One Up On Wall Street: Chapter 13)
  • So do calculations, : $38 – $16.3 = $21.7, so P/E ratio is calculate on $21.7 price not on $38 price. so the P/E ratio is about $3.1, so the P/E ratio is 3 which means is a very good P/E ratio.
  • Ford company also has another insurance subsidiary name is FORD CREDIT.
  • and his subsidiary earning per share is $1.66, and the same similar company that P/E ratio is 10. If we calculate share price, in that time market trade is about $16.6 in market. (One Up On Wall Street: Chapter 13)
  • So interesting things is that ford stick is $38 and net cash $16.3 and if their subsidiary trade is $16.6, so you have to do the simple calculation: = $38 – $16.3 – $16.6 =$5.
  • So you have to buy the ford company at $5, which means that earning per share is 7, and you give $5 so you get the $2 free.
  • So some company looks like ford but they have the above stuff inside on balance sheet, just we have to think like a businessman. (One Up On Wall Street: Chapter 13)
  • So author also gives another company example for comparison, let’s see the company name is Boin
  • it has more cash and their shares price is about $42, and net cash is about $27. so make calculation and you get = $42 – $27 = $15.
  • so hence no difference in both above company. So ford’s company type of opportunity does not come again and again. so sometimes maximum cash also not affect the company’s goodness, and also if the company has maximum debt or NOSO(Number of shares outstanding) that time also not affect the company having maximum cash. (One Up On Wall Street: Chapter 13)

4. Debt factors:-One Up On Wall Street: Chapter 13

  • debt factor is the most important factor for identifying the value of the company. So you have to look at the company how much debt or equity.
  • If 75% are equity and 25% debt, then this company is a good company.
  • If 90% are equity and 10% debt then this company is a very good company.
  • If 80% are debt and 20% equity then this company has the weakest balance sheet. So in this situation, you have to focus on the turnaround company, as special attention.
  • If the debt is maximum then the company can’t become a turnaround company. You have to see in the company which type of debt are they carrying. (One Up On Wall Street: Chapter 13)
  • one is bank debt and another is funded debt. If they have bank debt, then the bank sees your performance and they realize you can’t do better then they liquidate your company and take their money from it.
  • Funded debt is the type of debt in which there is no power to liquidate your company, which means you can get the time to recover your company as a turnaround company.
  • If you select a company then see which type of debt is present on them.
  • Peter Lynch gives the example of Crysler company, This company becomes the turnaround because they have government-guaranteed debt that is helpful to recover the company. If they have the bank debt Crysler company also can’t recover itself. (One Up On Wall Street: Chapter 13)

5. Dividends:-One Up On Wall Street: Chapter 13

  • Peter lynch give the example to understand the term of dividends, so let’s see
  • If any company stock price is $20 and giving a $2 dividend, then this stock giving a 10% dividend yield.
  • If its stock price is down to $10 and they also give $2 at this time also, means its dividend yield is 20%.
  • So this stock maximum people buy because this stock comes in the floor means this stock never go down by 10%. So if the dividend price is $2 means the dividend yield is high so people can’t go this stock is down.
  • If you buy stock for dividends, then you have to see the history of the company. In history, you have to look for 20 to 30 years. (One Up On Wall Street: Chapter 13)
  • In this period if the company misses any dividend. so this is very important because if you buy slow growers and they miss dividends, then this stock does not become double in number. so you are found in a trap. so always check for dividend yield. (One Up On Wall Street: Chapter 13)

6. Book Value:

  • In book value, you can’t buy the company because the stock is less than book value, so don’t need to buy the company stock. Because book value can be overstated.
  • It may be happening if the asset value is not that much seen on the balance sheet. If you buy any stock on book value then check the real value of the asset at this time and confirm that the value is the same as to see on the balance sheet. (One Up On Wall Street: Chapter 13)
  • If you do not see this then your strategy of investment is 100% fail.

7. Hidden Asset:

  • In the company, sometimes see are understated on the balance sheet. Sometimes parent company is very cheap than the subsidiary. so focus on also his opportunity.
  • Many times happen with a foreign company and their subsidiary, so the parent company is cheap than our domestic company.
  • So careful of any hidden asset, and also see any tax law carry forward point, this is also a hidden asset. Because you don’t need to pay tax in future.

8. Cash Flow:

  • Peter Lynch says, ” stock price $20 and annual cash flow is $4, means 20% return on cash. If you get the stock like that the stock price is $20 and cash flow $10, which means you get a 50% return on cash for this stock.
  • For this stock peter lynch say, sell your house and take the loan for investment purposes, because this stock is minimum in number. (One Up On Wall Street: Chapter 13)

9. Inventories:

  • If the company increases inventories, so this is a bad sign, and also if inventory increases as fast as sales then this is the worst sign for the company.
  • and also you see the companies inventory is placed at the corner of the parking lot, so that also a bad time. This company can become a turnaround, so for this, you have to wait for this but not necessary for this company if the company happens. (One Up On Wall Street: Chapter 13)

10. Pension plans:

  • If you looking for a turnaround then also look, in the company, there is also any pension plan.
  • If there is a pension plan that comes underfunded, means that the pension obligation is more than the pension asset, so this is the cause of concern. (One Up On Wall Street: Chapter 13)
  • To solve it first then you can invest in the company.

11. Growth Rate:

  • If you get a business that increases the price of the product is continuously and people also buy that company stock and they don’t lose market share also.
  • Most of the time this type of product is present in cigarettes, liquor, drugs, etc, so this is a good investment but one cause is that you have to focus.
  • When someone is died because of a product and they do complain against the company and in between that one person wins then, the company has to pay the maximum money for his penalty. so this risk comes in this company. (One Up On Wall Street: Chapter 13)
  • In growth rate author say if any company has a 20% growth rate and its P/E ratio is also 20, and another company has a 10% growth rate and a P/E ratio is 10. so let’s what is a difference in that.
  • 20% growth rate company is good than the 10% growth rate, let’s see how.
  • If a 20% growth rate increase in earing after 10 years the earning rate is 6.19, and if the P/E ratio comes 20 to 10, still company stock price stays 61.9. (One Up On Wall Street: Chapter 13)
  • and another company that growth rate of 10 increase in 10 years, the earning is growing like 2.50 time, and if their P/E ratio stays 10 then the company stock price is 25.9.
  • So this is the huge difference between the 20% growth rate and 10% growth rate.

12. Bottom line:

  • Profit after tax is called the bottom line or also called net income.
  • So different industries have different bottom lines.
  • If Company is in the same industry and the profit before tax company to each other and if the company profit margin is increased by 2% so their earnings are increased by 20%. so this is a big factor.
  • If that company’s profit margin is high they have maximum chances of survival in bad condition because some little losses increase or profit margin is minimum then they are going down. But when this company comes in recovery, this company become the double or triple also, means if 2% becomes 4% 6%. (One Up On Wall Street: Chapter 13)

Remember:

If you want to hold stock for a good or bad time for the long term, then choose the high-profit margin stock. But you want to see a turnaround then look for a low-profit margin so this gives a good return.