indianotes

At dinner tables and WhatsApp groups in India, everyone is suddenly an investor. It doesn’t matter whether they’re flipping IPOs, or day-trading, or punting on F&O, or buying and holding. If you ask them what they do, the answer will be, “I am investing”.

Nobody says “I’m speculating”, just like nobody says “I’m on a diet”!

There is nothing wrong with speculation, if that’s what you want to do – but calling it investing is simply, fooling yourself.

The essential difference is that speculators focus on price, while investors look at value.

Let me try to explain this.

Speculators buy stocks in the belief that the stock price will go up. The speculator does not care about the underlying value of the asset, simply that the price moves in the correct direction in a selected time period. Whether the company makes profits or not, does not matter. All information – economy, tariffs, wars, earnings, and everything else is already baked into the price.

Most believe that price action can be predicted (with decent win rates) by studying past trends and patterns. They use simple and complex tools, and lately, algorithms and AI to guide their trading. Others believe in chasing hot trends or tips.

Still others base their strategy on astrology!

It’s not for me to say what works, or whether it works, as my blood pressure doesn’t allow me to trade. However, like every field of human endeavour, some will be more talented and hard-working and do better than others. Some may have better algorithms (at least for a while).  Others may simply be better at reading signals. Or just lucky!

The investor, on the other hand, is focused on the value of the underlying asset. Is the company worth x or y? Once they figure this out, they buy or sell stocks based on their discount or premium to this intrinsic value.

Estimating the value of a company is extremely hard, and despite the zillions of text-books on the subject, as much an art as a science.  One has to understand the industry, the company’s business model, competitive position, management competency, technology, IP, growth prospects – and then put a value on all of this.

And no two analysts or investors will agree on what this is!

Which is why great investors suggest buying at a sufficient discount. Whatever your estimate is, buy only at a good discount to that.

This usually works, but involves hard work. You will actually have to read boring annual reports, and try to decipher the jargon and numbers. Even though many valuation short-cuts like P/E, P/S, P/B, EV/EBITDA, etc. exist to make life simpler, you still have to take a call on future earnings that determine tomorrow’s value.

Also, time periods are long, often much longer than anticipated. Just because you think the valuation is cheap doesn’t mean the market will agree. It may stay cheap for a long time. Besides, a multitude of factors can and do affect near-term performance, and market perceptions of value.

Value investors, therefore, have to think in years, not minutes, hours, days, weeks or months. So there is no instant gratification, unlike in short-term trading. Investors need conviction to hang on, even if the market goes the wrong way and everybody else is chasing the latest hot theme.

It’s much easier (and more exciting) to play with some cheap software that tells you what to do, or rely on tips from friends, or Telegram chats, or dubious subscription services. You might also make money. This is fine, it’s your money. But remember that it’s speculation, not investing.

Recently, a new term “momentum investing” has caught fancy. This is where recent price trends are extrapolated into the near future – the logic being that rising prices attract more investors speculators who will push the price up some more. Even mutual funds today are floating “momentum” funds.

Such methods can and do work in certain periods, especially in unidirectional markets (like we’ve seen post COVID). And maybe some people have figured out how to beat the system consistently. But for the vast majority, speculation is the implicit belief in the greater fool theory – that some greater fool (than me) will buy this at a higher price tomorrow, regardless of its real value.

To reiterate, it’s a free world, and there is no single way to make money in the stock market. However, don’t be the guy in the WhatsApp group who calls day-trading “long-term wealth creation”.

So what are you, an investor, or a speculator, or someone who still isn’t sure?