Investment operation and speculation
Benjamin Graham one of the gurus of investing famously said:
“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
Many of us say we “invest” in the stock market. Or we have “invested” in a NCD issue (non-convertible debenture). If we went by Graham’s definition the number of people who truly “invest” would be a fraction of the total number. This is because most of these “investments” are not backed by thorough analysis. Let us break down the definition.
Thorough analysis
For example if it were a stock of a company, an investor should be ready to dig deeper in the following areas:
- Understanding of the business area the company works in
- Competition
- Strengths and weaknesses of the company
- Potential for future
- What value one sees in the company
- What price one is ready to pay
If it were a bond or debenture issue, an investor must examine the following:
- Cash flows that give the ability to repay principal
- Ability to service the borrowing by paying interest regularly
Safety of principal
I had written a previous article about Return Of Capital. What Graham says is that the basic amount that you invest should be recovered. He speaks about return of capital it before he talks of return on capital. In search of high returns on capital one may enter into an investment in which one loses the principal amount of investment too.
Satisfactory return
Graham does not fix the return as a number or percentage. It may be 7% or it may be 20%. He has left it to the discretion of the investor. For example, from past records, an investor may expect a return of 10-12% from well chosen blue-chip companies in the stock market. A savvy investor who has greater expertise and is able to search for undiscovered gems in the stock market may expect 20% or more. T0 each his own. But the important thing is that you should have an expected return based on facts about the company and your analysis.
Speculation example 1
Can investment in the equity shares of Larsen and Toubro be speculative? Sure! Just because the company has a good long-term track record and is a leader in its space does not mean that an investment in its equity shares might be good. Why? Because you make an investment at a certain price. At the peak share price in November 2007 when L&T reached Rs. 4411/- its price-earning multiple was above 50! Contrast that with a long-term P/E multiple for the Nifty index of around 15.
It was a clear case of overpaying for a good company. At such a price there was no safety in the investment. It needed a greater fool to buy your shares at an even higher price.
Speculation example 2
Fixed deposits (FD) are considered the safest investment option by many in India. Read these headlines.
8 cooperative banks go belly up
Maharashtra’s apex co-operative bank in financial turmoil
Are your fixed deposits safe in a shaky co-operative bank? Is that extra 1-2% interest rate they give on FDs worth it when the basic principal amount in fixed deposit may go under? This too is speculation if your analysis is incomplete and you are unaware of the risk involved.
Is speculation bad?
Speculation in itself is not bad as long as the speculator is completely aware of the risks involved in the activity and is ready for possible adverse consequences.
Summary
Be aware of whether you are an investor or speculator in the activity you undertake. You might speculate in an activity and invest in another activity.
If you want to be an investor, next time you put down any amount of money in a FD, debenture issue. mutual funds. stock market, ULIP, endowment plan, pension plan or real estate, do the following:
- Conduct a thorough analysis.
- Read the brochure or investment related material carefully.
- If you are dealing with an agent or advisor, ask them questions.
- Check with friends.
- Visit the Internet and make use of resources to understand better.
- Make sure you have covered all the points that Graham spoke of and then invest
Ganesh prasad says
A SEBI registered financial advisory company from Indore gave me a promise to give in writing a commited profit earning through their F&O calls of 4lakh in a month time for whcih they took 70k as fees from me. Later they have not given me the mail of agreement form of commitment. They said if complained to sebi they will collect the details as the calls are recorded.
Later he forced me to pay more fees assuring that a sure shot call is there and will recover that in next day only, but it did not happen. Now he tells agreement form will come in a week time and do not worry by then you would have made your profit.
Its one month now they have not fulfilled their promise but through their calls have earned around 70000 still the fee amount is not yet earned and now hes putting pressure to take up another scheme by paying another Rs1.2 lakh assuring within this month they will get me profit of 15lakh or no good calls will come up.
I have all the telephonic discussions recorded with me and the receipt of the payment done to them, can i complaint to sebi on this or any other alternative (like filing a criminal case or so)
Please suggest