Value Investing

Investor ≠ Speculator

More often than not, investment and speculation are used interchangeably and are considered to be synonymous to each other. It has been an age old argument whether investors are the same as speculators. Let us analyse it and throw some light on what each of them actually are!

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Investors Are The Same As Speculators

It has been a misconception that any person who owns any stock is an investor. This, however, is not true. The fundamental difference lies in the intent and in the process of accumulating the stocks. An investor is a person who studies and carefully analyses a company, decides its worth and will buy its stock only if he believes, based on fundamental analysis, that the stock is at a discount to its intrinsic value.

On the other hand, speculator is a person who buys the shares of a company that is trending and has high volume, irrespective of its intrinsic value. A speculator does not undertake the process of careful analysis and buys the stock of a company only on the basis of chance and emotions of the market. Therefore, the fundamental difference between investment and speculation ensures that investment is rather safer. Speculation may bring in short-term profits, but it rarely provides any long-term returns.

This has been clearly explained by Benjamin Graham in his book “The Intelligent Investor”, first published in 1949. Benjamin Graham writes,

We must prevent our readers from accepting the common jargon which applies the term "investor" to anybody and everybody in the stock market. In our last edition we cited the following headline of a front-page article of our leading financial journal in June 1962:

SMALL INVESTORS BEARISH, THEY ARE SELLING ODD-LOTS SHORT

In October 1970 the same journal had an editorial critical of what it called "reckless investors," who this time were rushing in on the buying side.

These quotations well illustrate the confusion that has been dominant for many years in the use of the words investment and speculation. Think of our suggested definition of investment given above, and compare it with the sale of a few shares of stock by an inexperienced member of the public, who does not even own what he is selling, and has some largely emotional conviction that he will be able to buy them back at a much lower price. (It is not irrelevant to point out that when the 1962 article appeared the market had already experienced a decline of major size, and was now getting ready for an even greater upswing. It was about as poor a time as possible for selling short.) In a more general sense, the later-used phrase "reckless investors" could be regarded as a laughable contradiction in terms—something like "spendthrift misers" -- were this misuse of language not so mischievous.

Benjamin Graham provides the clarity that investment is done with the intent of certain returns in the future, speculation is about earning short-term profits without the blanket of security. Speculation is considered quite reckless and risky.

The newspaper employed the word "investor" in these instances because, in the easy language of Wall Street, 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. Compare this with the attitude of the public toward common stocks in 1948, when over 90% of those queried expressed themselves as opposed to the purchase of common stocks. About half gave as their reason "not safe, a gamble," and about half, the reason "not familiar with." It is indeed ironical (though not surprising) that common-stock purchases of all kinds were quite generally regarded as highly speculative or risky at a time when they were selling on a most attractive basis, and due soon to begin their greatest advance in history; conversely the very fact they had advanced to what were undoubtedly dangerous levels as judged by past experience later transformed them into "investments," and the entire stock-buying public into “investors.”"

Therefore, according to Benjamin Graham as well, investment and speculation must not be confused with each other. Both actions come with different intents and different outcomes. The intent behind investment is stability, security and long-term returns, while speculation is done with an intent of quick gains and no future consideration. Also, the effect of speculation and investment on the markets is poles apart. Investment helps to even out the market in the long run, while speculation takes the prices to the extremes.

This is to be noted and remembered that if everyone who owned stock was an investor, the market would have behaved way more rationally than how it does. The irrationality and the fluctuations in the market are mainly caused by the speculators. If it were for the investors, any undervalues stock would be bought, taking its price up to the optimum levels; and every undervalued stock would be sold, taking its price down to the average. It is because of the presence of the speculators that the volatility is created in the market. They buy and sell securities based on market sentiments and emotions, and it may lead to undervalued stocks being sold and overvalued stocks being bought.

So, it is critical to know that investors and speculators are not the same. Fundamentals matter to the investors and they don’t to the speculators. To be precise, both investors and speculators are needed in the market, but they must not be confused to be one and the same.