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

Just how powerful is artificial intelligence becoming?
Tech stocks

Just how powerful is artificial intelligence becoming?

An uncannily human response from an artificial intelligence program sparked a minor panic last month. But just how powerful are machines getting – and…
2 Jul 2022
Persimmon yields 12.3%, but can you trust the company to deliver?
Share tips

Persimmon yields 12.3%, but can you trust the company to deliver?

With a dividend yield of 12.3%, Persimmon looks like a highly attractive prospect for income investors. But that sort of yield can also indicate compa…
1 Jul 2022
The MoneyWeek Podcast: nuggets of positivity in an extended bear market
Investment strategy

The MoneyWeek Podcast: nuggets of positivity in an extended bear market

Merryn and John talk about he need for higher wages and lower house prices, and why the fact that this is the least dramatic bear market they’ve ever …
1 Jul 2022
Here are the best savings accounts on the market now
Savings

Here are the best savings accounts on the market now

With inflation at more than 9%, your savings are not going to keep pace with the rising cost of living. But you can at least slow the rate at which yo…
1 Jul 2022

Most Popular

UK house prices are definitely cooling off – but are they heading for a fall?
House prices

UK house prices are definitely cooling off – but are they heading for a fall?

UK house prices hit a fresh high in June, but as interest rates start to rise, the market is cooling John Stepek assesses just how much of an effect h…
30 Jun 2022
The ten highest dividend yields in the FTSE 100
Income investing

The ten highest dividend yields in the FTSE 100

Rupert Hargreaves looks at the FTSE 100’s top yielding stocks for income investors to consider.
22 Jun 2022
The ten highest dividend yields on Aim
Income investing

The ten highest dividend yields on Aim

Rupert Hargreaves picks the highest-paying dividend stocks on Aim, London’s junior market for small and medium-sized growth companies.
29 Jun 2022