SoPAR, So Good

I didn't get rich by buying books on finance. Actually, I didn't get rich, but let's leave that minor point aside. Until now I've never bought a book on money or investing, although in true thrifty style I have read one or two that others have bought. For Xmas Mrs. G presented me with a Kindle. Such a gift immediately presents the frugalite with a problem: there's no point in having one unless you buy books for it (notwithstanding that some older books are free). I do buy books, of course, but not that many these days, having quite a backlog to work through. However, I have finally cracked with regard to finance, and just a few days before Monevator published his reading list.

I bought The Intelligent Investor by Benjamin Graham. This famous tome was first published in 1949 and the last edition was published in 1973, three years before the author died. The edition I bought was the £7.10 Kindle version from 2003 which is the 1973 version together with an extensive chapter by chapter commentary by Jason Zweig with a preface and appendices by Warren Buffett, who worked for Graham in the 1950s. Zweig's contribution covers mainly the lessons relearned in the dotcom bubble and he has no difficulty in applying Graham's advice and strictures to that era.

I think of myself mainly as an investor rather than a speculator. So, what's the difference? Graham's definition (which actually goes back to his earlier book Security Analysis , co-written with David Dodd in 1934) is as follows:

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.

From this I extract the key words Safety of Principal / Adequate Return or SoPAR, for short. My interpretation of "safety" here is not that the principal should never fall (it is not guaranteed), but that in the long run there should be at increasing opportunities (not necessarily taken) to sell without loss in real terms. In a similar way, "adequate" does not mean a rigid percentage figure, but it does imply a dependable, though possibly varying, income stream which is broadly in line with average investment returns.

With the SoPAR principle in mind, I thought I'd retrospectively classify my share porfolio into investments and speculations and see what proportions I came up with. If a stock pays no dividend or has cut it in response to adverse investment or trading conditions I class it as a speculative. Similarly, if its share price has taken a protracted tumble. Subjectively, I thought the allocation would be around 20% speculation, 80% investment. The actual figures are: speculations 9.8%, investments 90.2%. All well and good, it seems, at first glance. However, that is to ignore the historical reality. On tracking down the individual purchases, these apparently conservative figures reflect the bitter reality that the speculative shares were around 20% of the portfolio when first bought.

Of course, the distinction between invesmtent and speculation is not in all cases clear cut. To some extent I am classifying post hoc. In some cases, I thought I was buying an investment but, wouldn't you just know it, it turned out to be one of those damned speculations after all. In fact, in most cases, I did not really think in terms of an investment/speculation divide. With hindsight, I now realise that I bought many companies over the years without due diligence. These weren't investments that turned sour, these were lazy, stupid purchases. However, I've also had lucky escapes.

Had I been asked what I thought I was doing, for example, when I bought GEC in the early 1990s, I would have replied that I was making an investment in a dull electrical conglomerate. I collected my dividends and watched the share price hover around £3 for a few years. I guess it was an investment all right. Towards the end of the 90s I sold out after a very modest price gain. The old behemoth was too boring and wasn't going anywhere, I thought, and we needed some cash at that point. I was both right and wrong. As I was selling, speculators were buying into the company. Soon, it changed its name to Marconi (a old subsidiary) and began selling off the bits that made household appliances, industrial switchgear and avionics. The newly named company devoted itself to the Internet and telecomms and went on a debt-fulled spending spree. This was "new paradigm" corporate economics where the only way was up. In the Summer of 2000, the share price reached £12.50. A couple of years later it was a few pence. It was probably the biggest destruction of value in UK corporate history. In a few short years it went from being an investment, to a speculation, to a dud, and there was nothing that existing shareholders could do about it except to get out in time, as I did by accident. I have a nasty feeling that, had I still been on board for the big rises, emotion would have clouded my judgment and I would have held on in grim disbelief while the shares tanked.

I've taken to the Graham/Zweig approach, so I suppose it reinforces my own experiences and prejudices. Buffett says that you either get value-investing quickly or you don't, which is probably fair enough. However, getting it is one thing, disciplining yourself not to deviate is another, as Graham knew full well. I am resolved now to spend more time researching company fundamentals and trying to assess value. With Graham's quietly insistent prose and Zweig's punchy comments to guide me, I shall try to put into practice the SoPAR principle.