Tuesday, November 28, 2006

From Warren Buffett to Benjamin Graham on Speculation.

John Hussman of the Hussman Fund has done an excellent job of building on Warren Buffett's talk at the Columbia Business School.

Hussman's relates a couple of passages from Buffett's mentor, Benjamin Graham. Graham and Dodd are the foundation of understanding every investor needs to build on.

Of particular interest here are two passage's Hussman pulls out of Ben Graham's work.

"I should greatly welcome an effort by security analysts to deal intelligently with speculative operations. To my mind the prerequisite here is for the quantitative approach, which is based on the calculation of the probabilities in each case, and a conclusion that the odds are strongly in favor of the operation's success. It is not necessary that this calculation be completely dependable in each instance, and certainly not mathematically precise, but only that it be made with a fair degree of knowledge and skill. The law of averages will take care of minor errors and of the many individual disappointments which are inherent in speculation by its very definition."

Elsewhere, he warned, "but there are many ways in which speculation may be unintelligent. Of these the foremost are: (1) speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and (3) risking more money in speculation than you can afford to lose."

Graham defined investment differently than I do, in essence he thought of investment as an almost sure thing. His idea of buying a business for under its value based on historical performance is diametrically opposed to the modern use where you pay someone to speculate for you based on a guess of future value.

Salesmen love the newer version. If they can convince you to trust them to gamble with your money, they will call you wise and conservative. I define investment as a subset of speculation, if you reread the Graham quotes above you can understand what I mean.

The key to success in speculation is many small losses more than offset by a few huge gains. To achieve this you will have to follow two speculation rules:

  • Keep losses small

  • Let profits grow

In any case you will be well served by reading John Hussman's article. He starts with Buffett, goes to Graham, and then gives a nice shot of Hussman to finish it off.



Anonymous Anonymous said...

Many people are watching the Dow Jones as if it is their very life. Most people in fact are not invested in the stock market and from my experience it is like pouring your money into a big hole. How do you think the people on Wall street get so rich? They take the suckers money and laugh all the way to the bank.

1:59 PM  

Warren buffett is a student of ben graham.

1:39 PM  

Post a Comment

<< Home