A Socratic Rancher 6-14-10
June 14, 2010
Just as there are many breeds of cattle, there are many breeds of investors. When I started investing, I decided to study the breeds, just as a rancher might study the characteristics of various breeds to see which might suit his or her operation best. The taxonomy of investors offered below is not as obvious as the difference between a Charlois and Angus, and some of you may think, with some justification, that all stock market investors are a three-way cross of Jersey, Longhorn, and Scottish Highland: capable of cream, but likely to gore you, with eyes hiding behind a wall of hair.
Value investor. The value investor sees the basic concept behind investing in stocks is for the investor to own an undivided interest in a company that the investor believes has good management and contributes something of value to the world. This may be naive, but it allows different people to have different perceptions of what constitutes value. Warren Buffet is an outstanding example of a value investor. He is a long-term player, takes positions based on the business performance of the company, and is an aging student of fundamentals.
A value investor wants to know price-to-earnings ratios, revenue, debt, quality of management, and company ethics. Generally, a value investor is a long-term player, but not necessarily. Values change, and a value investor maintains an adaptable outlook.
Legacy investor. The difference between a value and legacy investor is time and origin. A legacy investor may have inherited stock from family, or been in on the ground floor of a small company that merged, or was acquired by, a larger company. For example, my father invented the Water Pik, and his small company, AquaTec, was eventually bought by Teledyne. My father gave me some of the original AquaTec stock when I was a kid, and I held it, as a legacy investor, when it became Teledyne. But when Teledyne began to do things that didn’t square with my estimate of value, I sold the stock and invested in a stock that I thought had more value.
Speculator. Though speculators take a lot of cussing, they do provide liquidity in the market for value investors who are responding to changing values. Generally, a speculator is looking at a short-term situation, or a rapid growth potential, and seeking to profit from it. But time, as we know, is relative, so one investor’s long term might be another’s short term, and visa-versa. A speculator might even claim to be speculating on value.
Also, a speculator, for purposes of this taxonomy, could be said to be investing money he or she can afford to lose, whereas value investors are placing their savings and retirement funds into stock positions, and it may be money they do not consider dispensable.
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Trader. Generally, a trader makes investment decisions based on price, not value. As discussed in prior columns, there are now many traders in the market operating high -peed computer trading programs based on statistical arbitrages and complex stochastic variables.
I chose to be a value investor with money I did not consider dispensable. It has been a wild ride at times, but my ox has not been gored: value companies have held their value, and paid dividends throughout the turbulence. Nevertheless, looking at the volatility, and extraordinary volume, of stock trading in recent years, and even over the last couple decades, it is clear that the market is becoming more and more dominated by speculators and traders. This raises a legitimate question about market efficiency.
We all understand that our stock market in the U.S. is neither a “free market” nor a “controlled market,” but no market can function properly if price does not equate to, or at least closely approximate, value over a reasonable period of time. Next column, I will discuss both the theory and possible destination of market efficiency.