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The Real Intelligent Investor

May 18, 2013

Drama. The fellows of Wall Street describe whole markets, as well as the investors themselves and their customers, as being in the flip-flop state of Risk-On or Risk-Off, and the current market is described as Risk-On, meaning that investors have demonstrated an “appetite” for risk, and the evidence is a buoyant stock market (up in the double digits this year, for all but the Toronto market) and a tepid bond market in which a lot of money seems to be leaving and heading for the stock market; last year’s market (2012) and the 2008 market are described as Risk-Off and (oddly enough, because it really is an”odd” notion) a “flight to safety” (for more on that, please see our Posts, The New Wave Markets and Risk-On/Risk-Off, both in May 2013; and for re-cap of 2012 and what they said, What’s a girl to do?, June 2012).

Their preferred understanding of “risk”, and the only workable understanding that they have in common with each other and with their customers and programmed traders who are running billions of dollars on a “wire”, is summarized by “The Risk/Reward Equation” (please see our Post, Adventure Investing in the Stock Market, August 2012) and there are also many “value” investors who use a “disciplined” approach, but they can only get “random” or unpredictable results in an “undisciplined” market – “value” investors (who don’t own or control the whole company) are, in effect, using “rifle-shots” in a “shot-gun market” with “gunslingers” (the hedge funds) who have a lot of money and can really move prices, but not necessarily “value”. Please see our Post, The Active Investor (DOA), November 2012, for some caution on that.

However, our understanding of “risk” is quite different from theirs; for us, “investment risk” is the possibility that we might not obtain a non-negative real rate of return, and that has nothing to do with either value investing or volatility, and we will also show that it has nothing to do with Risk-On or Risk-Off, other than as a beneficiary.

If the risk is on for us (Risk-On), then we are using our money to buy “risk” which means that we are using our money to buy (and hold) stocks and bonds, and we expect that our money as stocks and bonds is “as good as cash” and “better than money” (in our pocket), and in the case of stocks, we are only buying and holding stocks that are trading at or above the price of risk; and the selling discipline is in force which assures “as good as cash” – 100% capital safety and 100% liquidity.

To be “better than money”, however, other investors must be willing to buy those stocks from us at higher real prices. We are always in a Risk-Off position (and a Risk-On position, at the same time) because there is no capital risk – we’re always as good as cash – and there is no other risk but a possible failure to obtain a rate of return above the rate of inflation, which is hopefully remedied by investors who are willing to buy our stocks at “higher prices” helped by a buoyant market in which they bought stocks at “value prices”, if they weren’t too late, and at any price if they still have more money to invest in Risk-On.

Moreover, “investment risk” (as we define it) has nothing to do with the “earnings” of companies which affect only “price risk”, and that, usually only for a short time; and we can show, systematically, that “earnings don’t matter” and do not raise or lower investment risk when the risk is to obtain a non-negative real rate of return (please see our Post, Earnings Don’t Matter, April 2013, for ways to test that); that is also easy to see in a thought experiment: if an investor decides to sell their stock because of a bad earnings report, then they can only sell it if there’s another investor who is willing to buy it; and if there’s a run of sellers for the same reason, then the stock will command a lower price, and the buyer is the winner and the seller is the loser. We might think that the seller will win in the long term – whatever that is – but we only buy stocks that are “as good as cash” and “better than money” and, therefore, trading at or above the price of risk, regardless of any other factor, and if we can get them at “lower prices”, so much the better.

So, that’s the market from our point of view. As long as the market is Risk-On, we can expect that investors will buy an interest in the stocks (B) that we already own, and push prices higher; when the market turns to Risk-Off and goes to cash or bonds – and with Wall Street’s help, it will, because Wall Street makes the market but is not in the market in the same way as “retail investors”, which is everybody but the investment banks – our price protection kicks in and we make a lot of money because we don’t have to sell the stocks at lower prices but we can cash in and put the stock at a higher than market price, or sell the puts, as it suits us.

Because Risk-On and Risk-Off have a different meaning and consequence for us than the “value” investors and volatility players who are subject to The Risk/Reward Equation and all the mechanics of Wall Street, they will, eventually, turn to Risk-Off and “take profits” or drop the stock on earnings or find some new anxiety that will cause many of them to sell, at which point the margin accounts could also be called and further increase seller distress, and further increase selling, no matter what the price. Ipso facto “Risk-Off” in 2012, 2008, 2002, 1998, and 1987, most recently, some of which are only remembered for the color “black”.

The Intelligent Investor

The classic books on investing are The Intelligent Investor (1949) and the earlier, Security Analysis (1934), by Benjamin Graham and David Dodd, and they have seeded generations of investors and created a widespread interest in investing as something that almost anyone can do; and anyone who has an interest in investing in the stock or bond market will be more comfortable if they understand the terms and meaning of the balance sheet, income statement, cash flow statement, and the financial ratios and discounted cash flow in various flavors. We should not buy, for example, a company (or its stock) that is only capable of making losses and cannot meet its payroll or pay its suppliers or service its debt, unless we know how to fix that.

But they don’t explain why a stock price has the price that it has, and the market for stocks and bonds is much more diverse and mechanized now than it was before the pandemic of the Capital Assets Pricing Model (CAPM), Modern Portfolio Theory (MPT) and the Black & Scholes Option Pricing Model, and the advent of programmed trading to take advantage of those calculations.

Moreover, Graham & Dodd, and generations of investors, equate “investment” with the “value” of something, when, in fact, the only way to think about an investment (and to cast it in mathematics and economics) is not to think about the “thing” that we’re buying, in all its diversity, but to think that an investment is just and only the purchase of risk and it is only the “risk” that we are buying; and the “risk” is the possibility that we might not get our money back and a hopeful return above the rate of inflation.

The Price of Risk

The calculated Risk Price (SF) is a provably effective estimate of the “price of risk” which is “the least stock price at which the company is likeable” (Goetze 2009) and “likeability” is determined by the demonstrated factors of “risk aversion” – we want to keep our money and obtain a hopeful return above the rate of inflation – and the properties of portfolios of such stocks.

Stock prices that are less than the price of risk can be said to be “bargain prices” but with the risk attached that the company might never get a higher price other than that due to ambient volatility or “surprise”; on the other hand, investors who are willing to pay the “full price” above the price of risk, and buy and hold the stock at those prices, must also be confident, and have reason to believe, that the company will produce those values, absent new information.

Please see our Posts, The Price of Risk, August 2012 and The Nash Equilibrium & Its Stock Price, October 2012, for more information on the theory.

To see what else “risk averse” investing can do for us, please see our recent Posts, The Wall Street Put, April 2013, and earlier Posts such as The Dow Transports, March 2013, or The Risk Adjusted Dow, March 2013, or The Canada Pension Bond, February 2013, and for a more colorful description of investment risk and the application of the “price of risk” to mergers & acquisitions, please see our Post, Bystanders & Collateral Damage, April 2013.


We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to


Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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