The Intelligent Investor

The book my colleagues bought me a month ago is one of those which trigger the perennial question “who am I”? It may seem at least weird that a book about managing your personal finances can make you ponder upon a part of your identity, but this particular one definitely does it.

So who am I as a market participant? On the market there are two major groups of participants: investors and speculators. Usually market commentators call everyone who trades in securities an investor, which is a palpable insult to all true investors. Those two terms must not be used interchangeably, as their meanings are worlds apart. In short, an investor is someone who seeks out profitable companies, analyses their financial statements, the way they are run, industries in which they operate, estimates their fundamental values and puts his money into companies he picks out for a long period of time. Hence, an investor feels and acts like a co-owner of a company. A speculator in turn seeks quick profit, doesn’t care much about fundamentals of companies he buys and sells, falls back on various sets of rules that, as he believes, will enable him to reap profits. His only goal is to earn as much as possible in a possibly short period of time. Money never sleeps…

So who am I? Both. Impossible? I bought some stocks a few months ago and still hold them, but I also trade in stocks on a daily basis. I have to plead for some time now I have been faring better as an investor than as a speculator. Whenever buying companies for a long time I sought out those markedly undervalued and settled on middle-term investments in them. The strategy proved right and bore robust fruits. Most of my profits actually come from proper investments. How about speculation then? Here I have to confess I made an error almost everyone makes just before starting to run through money on a stock exchange. My over-confidence led me astray. I thought nothing bad would happen to me and eventually I sank around 1,000 PLN in risky, volatile stocks. It was still wiser than lending it to the ex-classmate, but has taught me a lesson of humility, a very precious one.

Speculation means risk – the odds to reap a quick profit are lower than to cover a position with a loss. Why is it more probable to incur a loss even if we assume stock prices follow a random walk? The answer lies in transaction costs. At my brokerage firm fee for a transaction is 0.39% of its amount. Hence, to let me break even, a price of a security has to go up by over 0.78%, if I buy a stock for 100.00 PLN and sell it for 100.50 PLN I lose. I even dread to tot up how much I have spent this year on brokerage fees. The sum is unfolded when the tax report (necessary to fill in the tax return on which traders report their capital gains on security trading) from my brokerage firm is delivered to me.

I think my colleagues had discerned all perils and traps of speculation and gave me that book to dissuade me from trading strategies which sooner or later would do me out of money.

Has reading the book changed my investment “mindset”? It was a kind of eye-opener, but I remain critical about some theses set there.

Firstly, I began to look at myself as at a co-owner of companies I invest in (or even just trade in). Those are not just securities which I buy to sell later at a higher price. I own a minuscule part of a company so I should have a stake in it.

Secondly, it changed my perception of investment horizon. As a young person I still find it hard to imagine that I could freeze money for thirty years in stocks. Alright, it might not be the best choice to buy stocks and sell them after a few days, but my plans have never reached beyond five years…

I remain wary of long-term investments. OK, I may stay on the market (provided my portfolio is made up mostly of blue-chips) during the whole bull market, but I feel it is wiser to sell stocks when the next bear market is imminent. It is not a stupid strategy, because everyone buys then and pays over the odds for stocks. Benjamin Graham has a recipe for bear and bull markets – you should always buy stocks for the same amount of money every month. If market prices are high, you buy fewer stocks, if they are low, you buy more and in the long run you will rake in profits. Surely an ideal recipe would be to buy in the dead of bear market, but who can grasp the moment when it cannot be worse?

I see two major drawbacks of the book. It was first released in 1949, then had several updates with the last one dated 1970. The Polish edition (unfortunately they would have to spend more and take some extra effort to get the paperback in English) includes commentaries made in 2003, after the burst of dot-com bubble which triggered the worst (until then) bear market in post-war history of NYSE. But… it has not been updated in the ongoing financial crisis in which the bear market wiped out profits from the whole previous bull market. From mid-2007 to March 2009 the peak-to-trough decline of S&P 500 was 57%. On Warsaw Stock Exchange indices fell by 67%. Was there any investor not put to a very tough test? The bear market of 2007 – 2009 was unprecedented in its scale, some economists predict an even more severe meltdown around 2015. In the light of the recent events, the book seems a bit outdated, even despite the fact its author rode out the Great Depression and came burnt and bruised, but stronger out of it.

The second downside is that it is relevant to developed American capital market. Warsaw Stock Exchange is not yet twenty years old, Poland remains and will remain for some time an emerging market, it is not possible to find companies listed on WSE that meet all investment criteria set out by Mr Graham. Polish stock market is totally different from the American one, so it ought to be handled in a different way, although many principles outlined in the book will always apply.

The book condemns speculation, but doesn’t get with the times. Today speculation is far is easier. When everyone has access to online brokerage accounts and transaction fees are much lower (in Graham’s times they stood at 4%, today they are below 0.5%), cost-effectiveness of such actions is higher, but it is hard to determine whether the risk has also gone down.

Finally, the author advises the readers to keep away from short-selling. This makes another difference between investors and speculators. Only the latter indulge in and profit from “betting against the stocks”, but I do not denounce it. Short selling after all only improves market efficiency because it allows market participants to bring the market value of a security down towards its fundamental value. Of course going short entails a far greater risk than taking only long positions, but hang on. The risk is what stock market is also about!