The Difference Between Stock Market Investors and Speculators

The following is an excerpt from Seth Klarman’s ‘Margin of Safety.’I got around to reading this book based on the recommendations of one of the readers of this blog.Thank you Andy!I think the following is a nice way of making a distinction between stock market investment and speculation.BTW the book is pretty nice and I will blog more about it as and when I come across more interesting stuff.

To investors stocks represent fractional ownership of underlying businesses and bonds are loans to those businesses.Investors make buy and sell decisions on the basis of the current prices of securities compared with the perceived values of those securities. They transact when they think they know something that others don’t know, don’t care about, or prefer to ignore. They buy securities that appear to offer attractive return for the risk incurred and sell when the return no longer justifies the risk.Investors believe that over the long run security prices tend to reflect fundamental developments involving the underlying businesses. Investors in a stock thus expect to profit in at least one of three possible ways: from free cash flow generated by the underlying business, which eventually will be reflected in a higher share price or distributed as dividends; from an increase in the multiple that investors are willing to pay for the underlying business as reflected in a higher share price; or by a narrowing of the gap between share price and underlying business value.Speculators, by contrast, buy and sell securities based on whether they believe those securities will next rise or fall inprice. Their judgment regarding future price movements is based, not on fundamentals, but on a prediction of the behavior of others. They regard securities as pieces of paper to be swapped back and forth and are generally ignorant of or indifferentto investment fundamentals. They buy securities because they “act” well and sell when they don’t. Indeed, even if it were certain that the world would end tomorrow, it is likely that some speculators would continue to trade securities based on what they thought the market would do today.Speculators are obsessed with predicting-guessing-the direction of stock prices. Every morning on cable television,every afternoon on the stock market report, every weekend in Barron’s,every week in dozens of market newsletters, andwhenever businesspeople get together, there is rampant conjecture on where the market is heading. Many speculators attempt to predict the market direction by using technical analysis-past stock price fluctuations-as a guide. Technical analysis is based on the presumption that past share price meanderings,rather than underlying business value, hold the key to future stock prices. In reality, no one knows what the market will do;trying to predict it is a waste of time, and investing based upon that prediction is a speculative undertaking.