Changing the Game

Nowhere does history indulge in repetition so often or so uniformly as in Wall Street. When you read contemporary accounts of booms or panics, the one thing that strikes you most forcibly is how little either stock speculation or stock speculators today differ from yesterday. The game does not change and neither does human nature

Ewdin Lefevre, Reminiscences of a Stock Operator (1923)

Since the first trading of joint-stock companies at the Forum in Rome during the reign of the Roman Empire speculators have preyed upon the biases which are part of our human nature.  Our nature is to believe recent events can be projected into the future.  We listen to story tellers proclaiming they know the difference between anomalies and trends.   We believe better outcomes are possible if we follow the advice of someone more recognizable, someone with a complicated theory or someone who has a more privileged position in society.  Speculators will have you believe they have special insight or information only available through them and for a fee they can give you an exclusive opportunity to wealth.  Speculators will tell you it is different this time and to ignore what is reasonable and rational.

Fred Schweb, a Wall Street wit, declared that difference between investment and speculation is that the first aim of investment was the preservation of capital while the primary aim of speculation was the enhancement of fortune. The goal of this blog is to help the reader recognize the difference between speculation and investment.

Listen to the following statement: “Speculators are full of instability, insanity, pride and foolishness.  They will sell without knowing the motive; the will buy without reason…the expectation of an event creates a much deeper impression upon the exchange than the event itself.”   Was this said on CNBC? Fox News? Bloomberg?  No, this quote goes back to the first description of stock market activity in Western Europe by Joseph Penso de la Vega in Amsterdam in 1688!  Its 2017, not much has changed!

Fast forward to 2014 following Yelp’s third quarter 2014 earnings report.  “We had a great quarter,” said Yelp CEO Jeremy Stoppelman.  “We see a large opportunity internationally and we continue to roll out the Yelp playbook in new markets as we plant the seeds for future growth.” Goldman Sachs analyst Heath P. Terry stated, “We continue to believe Yelp remains extremely well positioned to benefit from growth in mobile usage and local ad dollars shifting online.”  At the time Yelp was trading at in the low 60’s off from a high in the low 80’s.  Today Yelp trades in the low 30’s.  How many investors followed the story of the speculators and lost their savings?

If these investors would have broken through the story and looked at the fundamentals, they would have seen the truth:


Yelp 2014 Fundamentals
Price to Earnings 3412x
Price to Book 9.18X
Price to Operating Cash Flow 104.8X
Price to Sales 14.91X
Approximately 10% Year over Year increase in shares outstanding

Self-Interested story-tellers appeal to our human nature to follow someone recognizable and of high privilege.   Statements like, “we see large opportunity”, appeal to our sense of great fortune, while “we continue to believe”, appeal to our need to project most recent and recognizable events into the future.  The problem is that these statements are subjective and we never question their foundation.  A rational investor would have taken one look at the high valuations of this stock and dismissed any value.

The fundamentals of investing are quite simple, if you pay more for a dollar of revenue you will do worse than if you pay less for a dollar of revenue.  The same principal applies to earnings, dividends and equity.  These are the fundamentals of investing.  These truths have rung true since the beginnings of the markets.

In his book “What Works on Wall Street,” James O’Shaunessy presented a number of simple and transparent fundamental strategies that have outperformed the market over time and allowed the investor to achieve excess returns.  So why do so few fund managers outperform the market.   Successful investing requires, at a minimum, a structured decision-making process that can be easily defined and a stated investment philosophy that is consistently applied.

Its now time to ask yourself a few questions:

  • Does my investment manager have a strategy or are we speculating and buying into the hype?
  • Does my investment manager have the discipline required to stick to our strategy?
  • Is my investment manager helping me tune out the noise and instead looking at fundamentals that drive returns?
  • Could I be doing better?

From the first recorded stock market located in Rome at the Forum during the time of the Roman Empire to today in New York speculation has resulted in folly while disciplined fundamental investing has reaped rewards. Speculators look to impress you with complicated theories and hypothesis, overwhelm you with subjective statements and appealing to our need to have something luxurious and exclusive.   Their real goal is to transfer your wealth into their wealth.  Beware of human nature to make emotional decisions and have the confidence to rely on time tested fundamental strategies to grow your wealth.