This article was first published on May 5, 2014
For most value investors, speculation by itself may have a negative connotation. Benjamin Graham once stated, “An investment operation is one which, on through analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative”.
What is speculation?
Even Benjamin Graham himself, felt that the above was a brief reference to speculation. There are many classifications of speculative operations but almost all have something in common – All speculative operations are concerned with changes with price.
Speculation can be split into 2 general genres:
1) Price changes:
If one buys in anticipation of the “January effect” chiefly because of the belief that security prices would increase in January more than other months, it would be a speculative operation premised upon an opinion of prices changes without any particular reference to value.
2) Changes in value expected to give rise to changes in price:
In the event that one buys a company undergoing reorganisation on the premise that the plan changes for the best, his rationale would be on an expected change in value
Is speculation everywhere?
Broadly, any operation based on expected change in price could potentially be labelled as speculative.
At any point in time, any security could be either over, fairly or under-valued. This could be attributed to the concept of a speculative component inherent in market quotations. A security’s market price may reflect in part both an investment value and a speculative element.
Recently, Blumont Group Ltd (SGX: A33) has become a poster child on the speculative element present in market quotations. From Blumont’s FY2012 Annual Report, it was evident that the bulk of their accounting profits resulted from fair value gains from Singapore Listed Securities.
From their latest quarter ending Jun 30, 2013, assuming there wasn’t a significant change in holdings, financial assets at fair value made up approximately 84% of assets. Taking market price at ≈ S$1.40 on Jul 30, 2013 (Not its peak), it traded at over 20x P/B. For an investment holding entity vested primarily in listed securities, one could buy it off the open market instead of paying over 20x for them.
An argument for the huge speculative element would be the potential profits from their core operations. But after discounting fair value gains, paying a P/E ratio of over 100x may be regarded by some as an unintelligent speculation.
The crux of the matter would be the existence of a distinction between intelligent and unintelligent speculation.
What is intelligent speculation?
Intelligent speculation is an operation where the mathematical possibilities based on quantitative and qualitative factors aren’t against the speculation, meaning to say that the expected return would still be positive.
Value In Action
At the end of the day, investing may be defined as a systematic repeatable process that stacks the odds in your favour. We have to acknowledge that in a broad sense, there is a speculative element present in market prices and have to be aware of how to deal with it intelligently.
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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Cheong Mun Hong’s personal capacity and do not in any way represent those of his employer and other related entities. Cheong Mun Hong doesn’t own shares in any companies mentioned above.