Investing in Shares Vs. Speculation in Shares

Graham defines an investment operations as "one in which, upon thorough analysis promises safety of principle and an adequate return." adding that "operations not reaching these requirements are speculative." Graham himself admits thats some speculation is unavoidable upon purchasing shares as a risk is always inherrited by a buyer.

For Example 

Stock XYZ trades at £1 per share and has delivered earnings averaging 23 pence per share over the last decade- likely an undervalued share and therefore a "buying" oppurtunity. The buyer would be spectulating that such results will continue if he buys- however he has minimized the element of speculation through research (It is unlikely that a company will suddenly make an enourmous loss after continous profits for ten years).

Further research would further lessen the degree of speculation, for example an analysis of the company's financial strength. Furthermore, an investor could assess some "brokers forecasts" to gain a ball park figure of future earnings.

N.B Graham was critical of "Brokers forecasts" for good reason as they often vary widely from reality. However they can help an investor gain confidence that the company in question has a reasonable financial future- ie that brokers believe it will continue to make money at similar levels in the future. Be very wary of predictions of massive, unprecednted growth- instead look at the forecast in line with past earnings and check that the values seem realistic.

Unnacceptable Speculation

A classic example of this would be to buy shares of companies that are in a certain field, simply because it is where the "growth of the future" is supposed to come from. To give an example, you might speculate that renewable energy is the best area for the future and so buy lots of shares in "green" companies. This is a dangerous strategy for two reasons: 
You can safely assume that if you have come to this conclusion, lots of other people have too- and the share price will hence be vastly overvalued- offering neither "safety of principle" or "an adequate return" 
Just because your company is in a "hot" sector this is no indication it will beome a market leader. For example in the race for internet stocks in 2000, there were probably a thousand failure companies for every google success story- the odds of you picking the success story as well as putting a decent amount of money into it are minute.

Example

To illustrate my point let us analyse a company in the renewable energy sector, Clipper Windpower.

The power of speculation over share prices- Cisco systems in the boom of the internet stocks in 1999, followed by its demise after the bubble burst