What’s the difference between investing and gambling?

Tim Price looks at the difference between investment and speculation – and where value investing comes into the picture.

“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

Thus did Benjamin Graham, the godfather of value investing, distinguish between the “business” of investing and the“‘game” of speculation.

All investing is value investing

In his attempt to define the difference between investment and speculation, we don’t think Graham was casting moral judgments upon speculators, so much as simply trying to codify the nature of capital allocation and define some of the ground rules.

We have no problem with shorter-term speculation either. Indeed we incorporate it within our bespoke managed account service in the form of systematic trend-following managers.

We would argue that there are, in essence, only really two ways of attempting to secure enhanced returns versus the market itself with any reasonable chance of success. One is “value investing”, which we would define briefly as “obtaining superior cash flows cheaply”.

The other is “momentum investing”. That is, exploiting the various price trends manifest in markets, but doing so without any concern as to underlying valuation during the process (albeit incorporating a defined algorithmic approach and a selection of standardised rules in the context of price evolution, position sizing and risk management).

Pretty much everything else, we would argue, comes down to gambling.

That said, according to much of the financial media, “value investing” has been dead for years. So perhaps we should define, or redefine, our terms. As Joel Greenblatt puts it: “All investing is value investing. The rest is speculation.”

Fund management practitioners, especially after having garnered a few billion by way of assets, start to hawk adjectives around: “growth”, “value”, and so on. This enables them to market even more types of funds and garner even more assets.

But the only essential distinction then comes down to what Graham called a “margin of safety”: the characteristic that a listed share, for example, possesses when it is bought for less than the underlying business is intrinsically worth.

The one characteristic that value investors need above all others

As discretionary investment managers, we seek to protect and grow the irreplaceable capital of our clients using the broadest range of diverse investments available to us.

Because of the secular distortion of capital markets and valuations inflicted by clueless inflationists at the world’s central banks, we consciously focus on “margin of safety” because we do not wish to incur the significant drawdowns that inevitably come from overpaying for poor quality investments.

We complement these holdings of “value” shares (ie, superior cash flows bought at a discount, ideally being generated by companies with little or no attendant debt) with real assets (notably the monetary metals, gold and silver, and related companies with the same attributes of superior cash-flow generation and no debt).

We diversify further with systematic trend-following funds that can be confidently predicted to possess little or no outright price correlation with the world’s stock or bond markets.

The value stocks are a claim on the real economy and on human ingenuity. The real assets are a hedge of sorts against politicians. The uncorrelated funds are a hedge against our own overconfidence.

In reading the output of the mainstream media (never a good idea), one might be forgiven for concluding that, over recent years, speculators chasing growth stocks have made out like bandits while value managers have been haemorrhaging capital through their eyeballs.

The reality is that any value managers worthy of the name have simply made less money than they might have done by owning stocks such as Facebook, Amazon, Netflix and Tesla.

We have been content with the returns of our own equity portfolio, and we haven’t bought stocks in companies that we consider either wildly overpriced, fraudulent or, in some notorious instances, probably both.

The “wrinkle” with legitimate value investing is that, as Keynes correctly observed, markets can remain irrational longer than market participants can remain solvent. The solution, we humbly suggest, is to combine a defensive posture with patience.

As the value manager Peter Cundill once observed: “The most important attribute for success in value investing is patience, patience, and more patience. The majority of investors do not possess this characteristic.”

• Tim Price is manager of the VT Price Value Portfolio (pricevaluepartners.com) and author of Investing Through the Looking Glass: a Rational Guide to Irrational Financial Markets.

Recommended

Julian Brigden: markets are at a huge inflexion point
Investment strategy

Julian Brigden: markets are at a huge inflexion point

Merryn talks to Julian Brigden of Macro Intelligence 2 Partners about the unwinding of the US stockmarket's super-bubble, and the risks and opportunit…
25 Jan 2022
Has growth investing had its day? Don’t be so sure
Growth investing

Has growth investing had its day? Don’t be so sure

Markets – and “jam tomorrow” growth stocks in particular – continue to crash, with some analysts forecasting a 50% drop or more. But, says Max King, a…
25 Jan 2022
A cheap investment trust with a good record
Investment trusts

A cheap investment trust with a good record

This cheap investment trust’s yield of almost 9% may look too good to be true, but should be sustainable, says Max King.
25 Jan 2022
Tax return deadline extended – but don't forget to file
Income tax

Tax return deadline extended – but don't forget to file

HMRC is being slightly more lenient about tax returns this year, but falling behind will still incur hefty fines.
25 Jan 2022

Most Popular

Shareholder capitalism: why we must return power to listed companies’ ultimate owners
Investment strategy

Shareholder capitalism: why we must return power to listed companies’ ultimate owners

Under our system of shareholder capitalism it's not fund managers, it‘s the individual investors – the company's ultimate owners – who should be telli…
24 Jan 2022
Three innovative Asian stocks to buy now
Share tips

Three innovative Asian stocks to buy now

Professional investor Fay Ren of the Cerno Pacific Fund highlights three of her favourite Asian stocks to buy now
24 Jan 2022
Ask for a pay rise – everyone else is
Inflation

Ask for a pay rise – everyone else is

As inflation bites and the labour market remains tight, many of the nation's employees are asking for a pay rise. Merryn Somerset Webb explains why yo…
17 Jan 2022