Investing, speculating and gambling – or why I would never INVEST in Greece and China
It is always interesting to see what other “value investors” are doing. Stefan at simple value investing for instance likes Greek stocks, the German Value fund investor Discover (just as an example) in their Squad Value Fund hold “German Chinese” stocks like Kinghero and Vtion.
In both cases, this is branded as “value investing” or “deep value investing”. As we all know, value investing itself is already a quite wide area or I would rather say it is in danger to become a “stretched brand”. But for this question what is avlue investing goes much deeper.
What is investing ? And how do we differentiate this for example from terms which are sometimes used for the same activity like speculating, trading and gambling ?
Investing
Investing as an activity normally implies several important aspects:
– it is longer term oriented
– fundamental development usually plays the major role, either in the form of valueing the underlying assets or estimating future profits
– the sale of the investment at a higher price to someone else is only one possibility to realise value, over time “value will prevail” either through dividends, share buybacks etc.
This holds true for both, value and growth investing, stocks and bonds.
Speculation or Trading
– the term speculation or trading is mostly used for shorter time horizons
– it usually implies that one can sell the purchased position at a later time for more money
– fundamental issues play a lesser role, news flow and short term behaviour of other investors are more important
Gambling or betting
– gambling has ussually the “worst reputation” among the described activities and normally relates to non-financial instruments
– it implies to “bet” a certain amount of money with one resulting cashflow which is either zero or a certain amount above the initial bet
– the “underlying” is usually a certain event (wheel spin, horse race, football match)
– although the “odds” sometimes depend on the behaviour of others (sports betting), the payout then usually only depends on the event itself
I think so far there is nothing new in my short theoretical essay.
However most people who are active in some of those areas (or in all of them) are forgetting a very important point: All described activities depend on certain underlying assumptions which should insure that one actually can realise the profit.
The underlying assumption for gambling are relatively clear:
You should not loose your receipt and the bookie (or the casino) has to pay out the quoted amount. So they should not be able to run away with your betting money. Most people know this and this is also why betting in dark street corners at night with a bunch of gusy you do not know might not be a good idea or “negative expected value”.
Other than that, betting is a relatively “fair” and transparent way of risking money, there are few other “strings” attached.
For “speculation” and trading interestingly a lot more implicit assumptions have to hold to realise potential profits
– markets have to be open and liquid
– your counterpart to the trade should be solvent
– your assets should not suddenly dissappear for unknown
– “a priory” you only know the size of your bet, you don’t know the probability of winning or the amoutn you will win (or loose)
In normal times this is not a problem, but as we have seen in 2007/2008, if such issues come up, they ussually appear at the same time. So you could have had the best risk management as a trader, but if you had an account at Lehman London, which had lent out your securities to someone else you were screwed.
Underlying assumptions investing
Interestingly, investing is the activity which relies on the most comprehensive implicitly assumed rules- Those general rules are ussually taken for granted, but let’s look explitly what we are assuming:
A) Underlying assumptions stock and bond investing
If you buy a stock, you are assuming that you get a (small) part of the business and a corresponding part of the current assets and future profits. You are also assuming that you are protected by law and the corresponding institutions that not suddenly the CEO decides to take all the money and run. Or that creditors take out the money or or or…
Those imlicit laws are not only race track or casino rules but very complex company, civil, international etc. laws which have to be safeguarded by a varity of institutions (courts, lawmakers, international courts, police, stock exchange supervision etc.) to provide a more or less “level playing field”.
So what the hell does this have this to do with investing in Greece and German-Chinese stocks ?
Simple example: Greek Government bonds under Greek law
Many people thought that Greek Government bonds were an investment and would be a safe as long as Greece does not become insolvent. As we all know now, the Greek Government just changed the underlying Greek law and could introduce a nice hair cut for certain bondholders why others got away unharmed (Greece actually repaid a UK law bond just recently).
So we know now that Greek bonds under Greek law were actually not an investment but a speculation on Greece not applying this possibility to get way with just paying less. To have known this course of action before was almost impossible.
Application on Greek stocks
The same applies for Greek stocks. Most of the Greek stocks are cooperations under Greek law. As we have seen with the bonds, the Greek Government has full authority on how to interpret and change Greek laws. So in theory they can (like the Argentinians did) say that all profitable Greek companies should be Government owned without compensation if they wish. Or they can exchange all cash from those corporations in worthless Drachma etc etc.
So we are in a situation, where “normal” rules or the rules we implicitly assume do not apply any more. All the nice historical studies (O’S etc.) which value inevstors love, are from the US, a country which hasn’t seen true large scale nationalization or redenomination of currency for at least a hundred years.
So yes, a Greek stock with a P/E of 3 could turn out to be a good speculation but it is definitely not a investment or a value investment. There is no margin of safety because the Government can just take away everything if they want or if they are desperate.
“German-Chinese stocks”
On German listed Chines stocks, we have basically the same issue:
First and foremost: China is still a communist country, where private ownership is only tolerated and capital controls are in existence and enforced. So the Chinese Government (in contrast to the Greek Govenrment) doesn’t even need to change the rules, they just need to apply them or continue to aplly them so that a German investor never sees a single EUR.
I can travel to China and look at the new shiny factory every 4 weeks, but if for some reasons the Chinese Governement just decides that exchanging Yuan into FX is not applicalbe and moiney should not leave the conutry (which they can do at any time), then the “intrinsic value” of my Chinese stock is zero. Maybe one could try to sue them in The Hagues but ggod luck with that.
Another issue on the individual company level is the legal aspect. I am not saysing that every Chinese CEO of a foreign listed company is crook, but the fact that there is no legal action possible against a fraudulent foreign listed Chinese managrment should serve as a big warning sign.
Yes, Kinghero, Vtion and the others look cheap. They start to pay little dividends and do some stock repurchases. But if those guys just dissappear with the money, nothing happens to them.
Of course you can have frauds in other companiws as well (Thielert is a good example) and nothing happens. Even in the US, frauds are common place and not veryone goes to prison, however those who get caught can serve up to 230 years in prison like Allen Stanford. However, in most cases this is not systemically.
Of course Kinghero and Vtion could be good speculations, but they are definitely no investments nor “value investments”.
So if you have read so far you might think: Why is this important, I don’t care how I or someone else makes their profits, be it investment or speculation.
Howver in my opinion, this ASPECT is maybe one of the best long term risk indicators for investment portfolios.
In the short term, all share prices fluctuate, but in the long term, in many cases excess speculation will lead to permanent loss of capital. Good expamles are “legendary value investors” Bill Miller and Bruce Berkowitz who thought that “cheap banking stocks” are a value investment. As they found out the hard way, implictly assumed rules for regulated entities can be changed realtively quickly and any entity with 20 times leverage will never be a value investment.
Summary:
For many capital market participants, the differentiation between speculation and investing seems to be academic. In the long run, excesss speculation increases the risk of permanent capital losses DRAMATICALLY. There are speculative aspects in many investments, but to have long term success and enjoy the power of compounding, one should try to limit speculation to a relatively small amount.
P.S.: The oldest finance joke goes as follows: What is an investment ? Answer: A speculation gone wrong.
P.S. 2: I did not write a lot about bets. “Financial bets” with a clear pay off profile are in my opinion much more interesting than a “speculation”. Examples are certain distressed debt situations or other “special” situation where the pay out does not depend on someone else buying the position at a higher price. However, the rules have to be clear and should not change within the game…..
value and opportunity 
I quite enjoy your blog and old posts, but every now and then some of the generalizations are weirdly off. I suspect that you may have changed your views on this slightly since 2012, but my immediate reaction (said in good spirit) below.
One cannot simply apply general wide-sweeping rules to a socioeconomic discipline like investing. In physics, that can be done, but not in finance. That’s poor investigative journalism (which constitutes a good portion of the investing task) and poor advice for would-be investors (who no doubt read this blog).
If it’s inevitable that China’s output overtakes the US’ (a superior per capita standard of living will be harder to achieve), then surely a lot that growth will be reflected in industry. And some truly marvelous technologies will eventually start to be innovated (50 years of a maniacal determination to become as good as German/Japanese engineering and/or US tech innovation should not be underestimated).
Case in point: BYD and it’s lithium battery which will timeshift power as more and more of humankind realizes, without even needing to get into a silly political/ideological debate, how dumb it is to waste scarce hydrocarbons and how smart it would be to harness the pure fusion energy of the Sun? Well, BYD won’t be discovered from the comfort of one’s living room or office and it certainly will not be if one is screening in/out pre-conceived ideas about value…
“So yes, a Greek stock with a P/E of 3 could turn out to be a good speculation but it is definitely not a investment or a value investment. There is no margin of safety because the Government can just take away everything if they want or if they are desperate.”
-he said and then bought russian company
Good observation đ
And yes, that was clearly a mistake. I also thought that I know more than others which was wrong. Sistema and Sberbank were clearly no value investments.
interesting Bloomberg Article on a hedge fund dedicated towards Grrek opportunities:
http://www.bloomberg.com/news/2012-06-20/lonely-hedge-fund-bullish-on-greece-tries-to-woo-investors.html
Interesting.
ne,war Follie Follie
Ist es Paragon Shipping ?
http://www.ft.com/intl/cms/s/0/a2123114-a690-11e1-aef2-00144feabdc0.html
Newedge to leave Greek stock market
By Gregory Meyer and Dan McCrum in New York
Newedge, a leading broker, is abandoning the Greek stock market in a sign of mounting concern over the countryâs future in the eurozone.
The broker has told clients that it will process only sell orders, and stop extending margin loans for existing positions in Greek securities, according to a memo obtained by the Financial Times.
The changes come amid fears Greece will leave the single currency after elections next month.
A list of securities subject to the new restrictions include foreign-listed shares and American depositary receipts for Greek companies including Alpha Bank, Coca-Cola Hellenic Bottling and Paragon Shipping, a New York-listed shipowner that is headquartered in Greece.
….
Michael Bodouroglou, chief executive of Paragon Shipping, called the decision âill-advisedâ. He said the companyâs assets took the form of ships sailing between places such as Brazil and China, and its income was denominated in dollars. Clients include multinational companies such as Cargill, he pointed out.
âGreek shipping is not a Greek business; it is an international business,â Mr Bodouroglou said.
…
The company is Folli Follie. They have a chinese subsidiary in Hongkong.
balance sheet and income for 2010: http://www.follifolliegroup.com/files/EN%20SUBs.pdf
The figures are better for 2011 but they don’t have a separate report.
In 2011 a chinese investor Fosun invested in the group, which means for me the Chinese part of Folli Follie is real and worth something:
http://www.fosun.com/En.php/Philosophy/Index/ID/10
Now i have to mention the negative points:
-no dividend
-capex increase 2012: much in greece, some in china –> negative free cashflow 2012
-debt should rise in 2012
-the subsidiaries in greece could theoretically make losses and the family owner may not liquidate even a loss making subisidary, this could eat up the earnings from China
regarding the special situation with greece:
The only risks for my greek stock is
-expropriation by the government
I have valued all assets in Greece with zero. All profits and revenues in Greece = zero.
The assets/revenues/profits abroad justify a valuation higher then current market capitalization. The irony: main abroad assets are in China đ
If the greek government wants EU subsidies, they have to accept EU laws. (This has nothing to do with the euro.)
The business is family owned. This means the main shareholders are greek. This leads to lower propability of expropriation in my opinion. Without the family the state should not be able to run the business, because they for example don’t have the connections in china which are vital for the business (Guanxi). This is no commodity business. They pay taxes.
upside: gain >100%
downside: loss 100% (I don’t know if the government could get hold of the assets not residing within greece)
regarding the general situation:
Even in Germany you can be hit by the legislator (atomic power plants, subsidies, …). Western governments in general would not expropriate, but
1) raise taxes
2) forbid certain business areas to operate
3) subsidize competitors
Hi Martin,
you mention a good point: All highly regulated businesses even in western countries are “at risk”. But normally, changes should follow some genral rules and then you can “handicap” the outcomes.
Now you made me curious: A Greek stock with Chinese assets, this sounds like a Dream combination. Which stock is it ?
MMI
Maybe one additional comment: I remember having the same discussion about bank stocks in 2007/2008 where people said they are cheap (5 P/E, 10% dividend yields etc.). Now it is common knowledge that “value doesn’t work with financials”. It wasn’t back then.
The same will happen in my opinion with Greek and China stocks. At some point in time it will be common knowledga that “value” in the long run only works in markets with clear established rules. If the rules are being changed, value doesn’t work.
Good article mmi!
But I only partly agree with you. In my view, Value Investing (or lets just call it Investing) means, you buy something and justify the price you pay by the value it has because of possible future cash flows. Speculation on the contrary means, you buy something in the hope, that you can sell it to other people for a higher price in the future.
The value of EVERY Investment could be Zero. You can never be absolutely certain. In my opinion, every Investment is a bet, that some future developments of the fundamentals and surrounding conditions (for example taxes, protection of ownership …) will lie inside a certain range.
A speculation is a bet, too. But not on fundamentals, but on future prices, other people are willing to pay.
So back to Investments: based on the probability of negative things, that could happen and cause the value of your Investment to fall below the price you paid, an Investment is more or less secure. So to make an Investment relatively secure, you must do one thing: pay a price, where the chance is as low as possible, that the value of the asset you buy is below that.
And now some thoughts on greek stocks: how big is the risk, that good greek companies like the 3 I bought (Opap, Jumbo and Autohellas) are worth less than the current price, that is about 2,5 and 3 times last earnings? It is clear, that these companies are worth much more than the current price, if earnings don’t fall dramatically for decades (some years of low earnings don’t change the value of a company much, except if there are really high losses). So what could cause a reduction of the earnings of these companies to much much lower levels than today for a long time to come? And how big are the chances for that? Following things could happen:
1) Because of the economic downturn a company could go bankrupt. Maybe not unlikely for some greek companies. But not so likely for the stocks I mentioned, because of strong financial position
2) (Re)Introducing the Drachma and a dramatic permanent reduction of exchange rates, adjusted for different inflation rates. Even when that happens, you have a huge margin of safety. And especially for Autohellas the risk here is not that great in my opinion, because of assets (cars) that should have a certain value in euros anyway. Furthermore I don’t think that exchange rates are likely to go far out of bounds for long time periods, because of Purchasing Power Parities
3) An expropriation by the government
So the risk in healthy greek stocks lies essentially in 3).
How likely is it, that the government takes away your stocks? Thats a good question. But I think: although that might happen case by case, it is unlikely, that this will happen in large style. So it may be a good idea to buy not only one stock. Note, that a large style expropriation is not impossible at all. Nothing is impossible. But in my opinion greek stocks are not so risky investments, than it could seem at first glance.
One thing I forgot to mention, my conclusion:
Greek stocks as well as chinese stocks are Investments in my view, if you justify the price you pay by future earnings, cashflows, dividends, liquidation proceeds or similar things.
If they are good or bad investments, risky or secure investments, you must decide for yourself.
Stefan, thanks for your comments.
Great that you disagree, otherwise it would be boring….
Regarding bets: For a “good bet” you have to be able to “handicap” the bet, this means you have to have the ability to put probabilities on the outcomes.
The current greek sitaution, especially for stocks, I think it is objectively not possible to find probablities on the outcaome (EUR yes /no, nationalisation yes/no).
You are correct that every investment could turn out a zero, but “margin of safety” means that this probability has to be very very very low. You can achieve this either by buying “safe situations” (buffet style) or by diversifying risky situations (Graham & Schloss style).
30% in Greek stocks in my opinion is “worst of”, I.e. a non-diversified risky situation portfolio. There is no “margin of Safety” for this.
But in the end, veryone has to decide himself how to invest…..
P.S.: Just as a side remark: OPAP has a local government monopoly which allows it to earn outsized profits, without the license they are worth nothing. If the far left wins the elections, I am willing to bet against OPAP.
Interesting Video about China Fraud School
janHendrik,
this is a very good question which I am asking myself at the moment.
“too big to fail” is not a value strategy as we all know now…
mmi
great post. i am curious what your decision process is ex-ante (i.e. before it becomes obvious that the Greek government has no trouble stealing our money).
when does italy stop being an investment and start being a speculation?
Appreciate your thoughts.
#derivatus,
as far as I know, they have their own money in the fund. I am realtively sure that this is a small “speculation” for them.
#valuematze,
a bet in my opinion implies that the rules are not going to be changed during the game. For Chinese stocks I am not sure about the rules. If it is a bet, then it is the dark corner “hĂŒtchenspieler” bet.
Of course you can make those bets / Speculations, it is nothing “bad”. But you shouldn’t call them value investment.
Other than that I highly appreciate their approach.
“Of course you can make those bets / Speculations, it is nothing âbadâ. But you shouldnât call them value investment.”
– I wonder why you think that. Munger once said that “all good investment strategies are value investing.”
Buying a portfolio of assymmetrical cash flow distributions at distressed prices can be a good strategy IMHO.
JanHendrik,
Munger is very very clever. However, there are other clever investors like Ed Thorpe etc. who have demonstrated that you can make great long term profit with systemtac financial betting.
MMI
The Discover Managers are honest people in my view. I think they would rather loose half their clients than half of the clients money.
With respect to the chinese investments I am sure that they are aware of these risk and take these positions as “good priced bets” rather than “value investments”.
Hi, wirklich guter Beitrag. Spricht mir genau aus dem Kopf. Ich komm gerad von der Via Value Conference in MĂŒnchen. Und die wirklich guten (wie z.b. Jean-Marie Eveillard) sehen dass laut Ihren Reden genauso. Er meinte, selbst hervorragende GeschĂ€ftszahlen und Gewinne der Vergangenheit sind nichts wert. Ganz im Gegenteil! Um so eher kommt jemand (der Staat) auf die Idee sich dort zu bedienen.
Maybe Squad has a asymetrical payoff. If they win they will get a lot of good reputation
and/or inflows into their funds.
If they loose they loose not their own money.
Great post. Describes exactly my opinion of responsible investing. I am a little bit amazed about the courage of Squad. But I like them anyway.