A Correct Basis For Speculating
We maintain that there is only one basis upon which successful
speculation can be carried on continually; that is, never to buy a
security unless it is selling at a price below that which is warranted
by assets, earning power, and prospective future earning power.
There are many influences that affect the movements of stock prices,
which are referred to in subsequent chapters. All of these should be
d and understood, but they should be used as secondary factors in
relation to the value of the stock in which you are trading.
If the market price of any stock is far below its intrinsic value and
there is no reason why the future should bring about a change in this
value that will decrease it, then you may be certain that important
influences are working against the market price of the stock for the
time being. In the course of time the market price will go up towards
the real value. This matter will be more fully explained in subsequent
You always should keep in mind the fact that when you buy a stock at a
higher price than its intrinsic value, you are taking a risk. The stock
may have great future possibilities, but it is risky to buy stocks when
present assets and earnings do not warrant their market prices, no
matter how attractive prospective future earnings may appear. However,
the possibilities of profit sometimes are so great that one is justified
in taking this risk.
It is our belief that the majority of traders buy stocks because they
are active in the market and somebody said they were a good buy, even
though the real values may not be nearly as much as the market prices.
As an example of this kind of trading, we want to call your attention to
a news item that appeared in a New York paper. It stated that on April
1st, some brokers in Detroit, as an April Fool joke, gave out a tip to
buy A. F. P., meaning April Fool Preferred, but when asked what it
meant, replied "American Fire Protection." Of course, there was no such
stock, but there was active trading in it until the joke was discovered.
Evidently it is not necessary to list a stock on the Detroit Stock
Exchange in order to trade in it.
This story may or may not be true, but we believe the statement that
people trade in stocks they do not know anything about is true. You
should be careful not to buy a stock merely because somebody says it is
a good thing to buy, unless the person making the statement is in the
business of giving information on stocks, because it may be only a rumor
with no substantial basis. Of course, if many people act on the rumor,
there will be active trading in the stock, and it is frequently for that
purpose that such rumors are started.