Reflections on Investing Versus Speculating
By: J. William Waltman, Jr., CFP®, CPA
As the new year begins, many investment professionals write about what they believe the coming year will bring for the financial markets. While this attempt at divining the future may be fun, it is not terribly helpful for investors. Rather than engaging in fortune telling, we thought a more productive use of time would be to reflect on the profound differences between investing and speculating.
The world we live in today is filled with noise. An almost endless cacophony of competing voices from cable news to social media. An environment constantly trying to steal away the quiet space and time needed to reflect on enduring first principles. But one must reflect or otherwise run the risk of being swept away by the zeitgeist of the day.
After recently reading the excellent book The Warren Buffett Way, written by Robert G. Hagstrom, it prompted me to once again reflect on the concept of investing versus speculating. These two terms are commonly thought about in daily conversations, seemingly interchangeably and lacking in terms of distinction. But words are very important because when properly used they should convey the essence of the matter being discussed or written about. Speculating is the antithesis of investing. Investing is about owning durable businesses (not stock prices) and participating in their growing cash flow through time. Speculating typically involves predicting the path of the stock market and/or price pattern of a stock. Speculators, whether they acknowledge themselves as such or not, are often trying to determine if NOW is the right time to invest. Will there be a recession next year? What about the upcoming election? Will the price of my “stock” be higher next year? Many consume themselves with these questions, which are completely rational if one is a speculator, but a distraction and a waste of time if an investor.
The following are excerpts from The Warren Buffett Way that illustrate these key ideas.
Much of modern finance is based upon Modern Portfolio Theory (MPT), the central belief of which is that a portfolio’s overall risk and return is more important than the risk and return of an individual investment. MPT assumes investors are risk averse and that given the choice of two portfolios with the same expected return, an individual will always prefer the less risky one. In MPT the whole becomes more important than the individual parts. It puts investors’ emotional well-being ahead of investment returns, which are given second place on the priority list. Thus, the primary objective becomes an exercise in managing a portfolio of PRICES rather than a portfolio of BUSINESSES. Under this line of thinking, the risk of the portfolio depends on the price variance of its holdings with no mention of the financial risk to the value of the underlying companies.
Business-driven investing, as espoused by Warren Buffett, defines risk differently. For Buffett, risk is the possibility of harm to the intrinsic value of a business, not the ongoing short-term price movements of the market. In business-driven investing the guiding principle is the economic return of the businesses you own. The objective being NOT to build a portfolio of low volatility and low covariance but to invest in individual businesses that generate high economic returns, each unto themselves. MPT adherents believe variance, or price volatility, is almighty. And this focus on price volatility leads many investors to succumb to the temptation of becoming speculators. Benjamin Graham once warned that the greatest danger an investor faces is not so much speculation, but acquiring speculative habits without realizing they have done so.
MPT was founded by well-meaning academics who believed stock price volatility was the demon that must be defeated. Everything else, including portfolio management and its subsequent investment returns, is submissive to this goal. Conversely, business-driven investors are the insiders, the practitioners who own businesses or at least think of stocks as business ownership. Their charge is not to defeat stock market volatility but to outwit it to enhance their investment return. We can say with certainty that business-driven investing is the philosophical antithesis of MPT.
The bedrock to becoming a successful investor is purposeful detachment from the stock market. The market zone is a carnival full of different actors playing different games with different time horizons. Whenever they are in the market zone, it is imperative that business-driven investors not allow themselves to be pulled into the vortex of short-term noise. They must never lose sight of this truth: They are managing a portfolio of value-creating companies, all of them compounding their intrinsic value over time (Hagstrom).
PYA Waltman strives to be a business-driven investor that seeks to compound our clients’ capital over the long term. This often requires more patience and less activity. While many successful investors have written about the benefits of this formula, many choose not to employ it as they cannot resist the temptation to “be in game” making trades. I guess Warren Buffett was correct when he replied to the question as to why more investors don’t copy his approach… “No one wants to get rich slowly.”
The noise of the market can be tempting, but true investors understand that it’s the intrinsic value of the businesses they own that matter most. By staying disciplined and avoiding the pitfalls of speculative thinking, we can navigate the market with a clear vision and stay focused on what truly drives long-term returns. Remember, the market’s short-term fluctuations are just that—short-term. It’s the underlying businesses that compound their value over time.
Source: Hagstrom, Robert G. The Warren Buffett Way
The opinions expressed are those of PYAW’s Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed. This material is for informational use only and should not be considered investment advice. The information discussed herein is not a recommendation to buy or sell a particular security or to invest in any particular sector.
PYA Waltman Capital, LLC (“PYAW”) is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about PYAW’s investment advisory services can be found in its Form ADV Part 2, which is available upon request. PYA-25-06
