|
|
 |
|
|
Join the Discussion
|
"My employer gives me the option of having money
taken out of my paycheck and putting it in an
investment. Is this a good idea?"
Read More...
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Investor
vs. Speculator
Over the course of the past several decades, the term "investor" has been used
for anyone who owns a share of stock. It is important that you understand this
is not the case. When a person buys a stock, they are doing it as one of two
people: either an investor or a speculator.
What's the difference? An investor is someone who carefully analyses a company,
decides exactly what it is worth, and will not buy the stock unless it is
trading at a substantial discount to its intrinsic value. They are able to say,
for example, that "Company 'X' is trading for $48 per share, but it is worth
$62 per share." They make their investment decisions based on factual data
and do not allow their emotions to get involved. A speculator is a person who
buys a stock for any other reason. Often, they will buy shares in a company
because they are "in play" (which is another way of saying a stock is
experiencing higher than normal volume and its shares may be being accumulated
or sold by institutions). They buy stock not on the basis of careful analysis,
but on the chance it will rise from any cause other than a recognition of its
underlying fundamentals. Speculation itself is not necessarily a vice, but its
participants must be absolutely willing to accept the fact that they are risking
their principal. While it can be profitable in the short term (especially
during bull markets), it very rarely provides a lifetime of sustainable income
or returns. It should be left only to those who can afford to lose everything
they are putting up for stake.
How do these two different types of activity affect stock price? The speculator
will drive prices to extremes, while the investor (who generally sells when the
speculator buys and buys when the speculator sells) evens out the market, so
over the long run, stock prices reflect the underlying value of the companies.
If everyone who bought common stocks were an investor, the market as a whole
would behave far more rationally than it does. Stocks would be bought and sold
based on the value of the business. Wild price fluctuations would occur far
less frequently because as soon as a security appeared to be undervalued,
investors would buy it, driving the price up to more reasonable levels. When a
company became overpriced, it would promptly be sold. Speculators on the other
hand, are the ones who help create the volatility the value investor loves.
Since they buy securities based sometimes on little more than a whim, they are
apt to sell for the same reason. This leads to stocks becoming dramatically
overvalued when everyone is interested and unjustifiably undervalued when they
fall out of vogue. This manic-depressive behavior creates the opportunity for
us to pick up companies that are selling for far less than they are worth.
This leads to a fundamental belief among value investors that although the stock
market may, in the short-term, wildly depart from the fundamentals of a
business, in the long-run the fundamentals are all that matter. This is the
basis behind the famous Ben Graham quote "In the short-term the market is a
voting machine, in the long-term, a weighing one." Sadly, some reject this
basic principle of the stock market. Several months ago, I received an email
from a reader who asserted that "the economic fundamentals of a company have no
relation to the stock price." This is completely false. My response was a
simple message that read "If fundamentals don't matter, what if Coca-Cola never
sold another bottle of Coke? How long do you think the stock price would stay
at its current level?" When put in this light, the folly of the "fundamentals
don't matter" becomes evident. The next time someone preaches this, simply ask
"what happens to the stock if the company can't make its payments and defaults
on its loans?" When they answer "it goes bankrupt", simply smile and walk
away. Fundamentals do matter.
Unfortunately, countless investors believe the myth this gentleman does. The
perfect example of this is the dot-com boom of the late 1990's. Companies that
generated no profit and had very little, if any, book value were selling at
astronomical levels. "Surely this would prove that fundamentals mean nothing,"
some would argue. On the contrary, it proves our point entirely. Only a few
short years after the initial stock market bonanza, the economic realities of
these companies came back to haunt them. Most fell 90% or more from their
highs, with many more going bankrupt, ultimately worth less than the paper their
stock certificates were printed on.
Next page > The Commodity
Nature of Stocks >
1,
2,
3, 4,
5,
6,
7,
8, or
9 |
| 