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Stocks and Horse Racing

Posted on June 3, 2006

Is there a connection between betting at the horse track and the stock market? Benjamin Graham, the father of fundamental investment analysis and one of the most influential investors of all time, seemed to think so. Below are some interesting quotes from lecture ten of The Rediscovered Benjamin Graham, a compendium of transcripts from his lectures given to security analysts in, I believe, 1946. The full transcripts are  available over at Wiley.com.

Graham comments that, "Intelligent speculation presupposes at least that the mathematical
possibilities are not against the speculation, basing the measurement
of these odds on experience and the careful weighing of relevant facts…If the probabilities, as measured by our mathematical test, are
definitely in favor of the speculation, then we can transform these
separate intelligent speculations into investment by the simple device
of diversification. That, I think, is a clue to the most successful and
rewarding treatment of speculation in Wall Street. The idea, in fine,
is simply to get the odds on your side by processes of skillful,
experienced calculation.

Graham later continues, "If we are allowed to commit some misdemeanor by making some mild
comparisons between Wall Street and horse-racing, the thought might
occur to some of us that the intelligent operator in Wall Street would
try to follow the technique of the bookmaker rather than the technique
of the man who bets on the horses. Further, if we assume that a very
considerable amount of Wall Street activity must inevitably have
elements of chance in it, then the sound idea would be to measure these
chances as accurately as you can, and play the game in the direction of
having the odds on your side."

Finally, Graham advises, "To my mind the prerequisite here is for the quantitative approach,
which is based on the calculation of the probabilities in each case,
and a conclusion that the odds are strongly in favor of the operation’s
success…It is a great mistake to believe that a speculation has been unwise
if you lose money at it. That sounds like an obvious conclusion, but
actually it is not true at all. A speculation is unwise only if it is
made on insufficient study and by poor judgment. I recall to those of
you who are bridge players the emphasis that the bridge experts place
on playing a hand right rather than on playing it successfully.
Because, as you know, if you play it right you are going to make money
and if you play it wrong you lose money — in the long run…
In some cases the thing will work out badly. But that is
simply part of the game. If it was bound to work out rightly, it
wouldn’t be a speculation at all, and there wouldn’t be the
opportunities of profit that inhere in sound speculation. It seems to
me that is axiomatic."

If you would like to read this whole lecture, please click here.

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