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 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.
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.
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…..