TJS Partners, Inc.

Mark Twain said there are two times in a man’s life when he should not speculate:  when he can’t afford it and when he can.

“Investors” believe that over the longer term security prices tend to reflect the fundamental developments and underlying cash flows of the business or assets.  Investors expect to realize a gain through (1) profits distributed as dividends, used to repurchase shares (another form of returning value to owners) or accumulated and reflected in a higher share price, (2) share prices to eventually reflect an increase in the multiple of future earnings that investors are willing to pay, and/or (3) a closing of the gap between share price and underlying business value.

“Speculators” on the other hand, buy and sell securities based on whether they believe the price will next rise or fall based upon the behavior of other market participants. They regard securities as intangible pieces of paper to be swapped back and forth, ignorant of, or regardless of, the fundamental developments of the underlying business.  Speculators are obsessed with predicting (guessing, really) the direction of prices.

The vast majority of capital market activity is speculation.   Over 70% of daily U.S. stock trading activity is computer driven, high frequency or program day trading.  It’s all basically speculating.

Investing is serious business, not entertainment.  Participate in the financial markets as an investor, not as a speculator, and understand the critical difference.

Investments depend upon their underlying economic characteristics in determining their outcome (success or failure) e.g., a business makes a product or provides a service for sale to a customer; an office building, shopping center or multi-family apartment has tenants who pay rent; farmland produces crops; timberland is eventually harvested and sold – even if long after it was originally planted.

Speculations, on the other hand, only throw off cash from their eventual sale to “the next buyer” (who is also dependent upon finding yet another buyer).  So goes the circular reasoning of buying what has recently gone up, is in fashion, or offers the owner social status or cache.  Their value is solely dependent upon supply and demand.  As Seth Klarman has observed, “you need to know the difference between Pepsico and Picasso….  Stocks and bonds go up and down in price, as do Monets and Mickle Mantle rookie cards, but there should be no confusion as to which are true investments.  Collectibles, such as art, antiques, rare coins and baseball cards, are not investments, but speculations.”

Wall Street seems to roll out a new crop of speculations every 5 years or so.  Between 1988 and 2008 there was no fewer than 4 speculative bubbles:  Junk bonds, Biotech stocks, Internet stocks, and housing prices (and their financially engineered mortgage surrogates).   And it is highly probably that the present and future cycles will prove no different.   

Read the 2011 Berkshire Hathaway (Warren Buffett’s) letter to shareholders, particularly the section “The Basic Choices for Investors and the One We Strongly Prefer.”  (I can mail or email you a copy.)  It is a compelling case for how risk is widely misunderstood and it sounds a loud timely caution about today’s “risk free” investments in government and fixed income securities.