The Speculative Investing Fallacy
Can one invest in stocks?
The question may seem dumb, especially when the popular opinion today is that one can invest in crypto, gold, art, collectibles, and pretty much anything else that trades, but here is what one respected figure thought about common stocks a century ago:
Common stocks, as such, are not superior to bonds as long-term investments, because primarily they are not investments at all. They are speculations.
The quote comes from Investment and Speculation by Lawrence Chamberlain and William W. Hay, published by Henry Holt in 1931. Characterizing all common stock purchases as speculation is one position. Let’s file that position away for right now.
This wasn’t Chamberlain's first book, nor was it a new position. He published The Principles of Bond Investment in 1911. His disdain for stocks was already palpable:
Since stocks are the typical speculative paper and bonds the typical investment security, it is manifestly unfair to measure them both by the investment standard to the predetermined disparagement of stocks.
He continued:
But on the other hand stocks, as a class, are so generally thought of as investments, and the distinction between investment and speculation is so inadequately recognized, that a contrast of stocks with bonds as channels for pure investment may be worthwhile, even if the conclusion is foregone.
It is possible that Chamberlain adopted the extreme position that common stocks are never investments because he felt the other extreme doesn’t make sense: all common stock purchases are investments. Let’s also file that away and we will come back to it.
There is, of course, a middle-of-the-road position between these two extremes: some common stock purchases are investments and others are not. While we don’t have three hands, let’s file this one away too, and we will come back to it.
In the 1920s and 1930s, there were a bunch of thinkers who adopted this middle position. Enter Edgar Lawrence Smith, for example, who wrote Common Stocks as Long Term Investments. Even just judging by the title, it feels like a rebuttal to Chamberlain’s The Principles of Bond Investment (1911), doesn’t it? In any event, Chamberlain’s Investment and Speculation (1931) that we referenced earlier was arguably rebutting the rebuttal. At least one commentator thought that it was a response to Edgar Lawrence Smith’s work:
After the devastating 1929 Wall Street Crash, “the tenor of the times was captured in 1931 by a book written by Lawrence Chamberlain and William Hay entitled Investment and Speculation. Implicitly attacking Edgar Smith’s 1924 work Common Stocks as Long Term Investments, which had provided an intellectual basis for the 1920s boom,” here Chamberlain and Hay emphatically argued that “in fact common stocks are not investments; that they are speculations.”
Sandwiched between the two Chamberlain books, Edgar Lawrence Smith forcefully argued the position that investing is about buying cash flows at a reasonable price (cheap apple trees, anyone)? He said:
Well--let us see how it would work out if our fathers had invested solely in common stocks, not with the thought of immediate speculative gain, a thought that it is unfortunately most difficult to eliminate from the choice of common stocks, but with the sober-minded purpose of providing:
Constancy of income.
Safety of Principal.
So, are common stocks investments? Let’s visualize the three positions we filed away:
Chamberlain was spot on when he said: “The distinction between investment and speculation is so inadequately recognized.” The irony is he didn’t properly recognize it, either. In rejecting the idea that buying a stock is always an investment, he went too far in the other direction and concluded that stocks are never investments. It’s not the third door.
The first door isn’t correct, either. Stock purchases can be investing, but only if the price is right, meaning it’s sufficiently less than the estimated value of the stock.
So, the second door it is. Edgar Lawrence Smith was right (the answer was “sometimes”) but the world needed another decade for an evangelist named Benjamin Graham to advocate more effectively for that message. In Part II, we discuss how Graham communicated his message to the masses, ever so eloquently, ensuring that the correct opinion also became the popular opinion.
