Sunday, 6 September 2015

Investing vs Speculating

There's a fine line that we have to thread between investing and speculating, so I think that's important to know on roughly which side of the line we are staying on. As we have come to know, investing is something that brings about good returns in the long run while speculating focuses on short-term gains and bears a much higher risk of losing principle. Anyway, so in this post I'll be covering the differences between the two.

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Investing looks at the company, speculation looks at the market sentiment

Investing involves investing in companies that are able to generate good returns for the money over the long run. Usually investing looks at the financial statements of the company, the management, its economic moats, etc to get a good idea of how well the company will grow and paying a reasonable price for that. Speculation on the other hand is not based on such fundamentals and focuses more on the "speculative value" or perceived value of the company above the investment value of the share.

Investing provides a reasonable chance for gain, speculation does not

This links back to the previous point, investing has its roots in the quality of the company and the investment price, while speculation looks at market sentiment, which can result in an impairment of principal if market sentiment is read wrongly. While investing also bears a certain element of risk, this is usually a calculated risk, while trying to read market sentiments makes no guarantee as to any gains.

I think these two yardsticks are the ones that divide investing and speculating. But I think there may also be some differences between investing and speculating that are quite misleading as well. Some of them are

Investing is investing in good companies while speculation is putting money in poor companies

This is not necessarily true. Paying a high price for a good company, maybe a blue-chip even, does not meet the two criteria of investing mentioned above as it is not likely to provide a gain in the long run and buying it is just hoping that someone else will pay an even more ridiculous price than the one you paid for it, which is speculating. Poor companies that may not have a lot of good investment characteristics can also make good investments, at the right price.

Investing is long-term while speculation is short-term

The idea of this is flawed as speculation can be long-term, for example, buying into oil companies now expecting that they will go up in maybe a few years time, without properly analyzing the companies. Investing can also be short-term, buying into a good company with a value higher than the price and hoping to book a profit in the short-term when the price difference is met, which still provides a reasonable chance for gain and looks at the company.

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  1. Hi JST,

    Properly analyzing into companies is subjective, because it depends on your analysis and market may not correlates to your analysis. And the information retail investor gets from analysis is different. Buffett, not only analyse a company, he go to the company and talk to them and know the industry well.

    So sometimes, it pays when younger to spend also time in developing human capital to learn about the real business, people and industry.

    To look at a bigger picture, learning how to manage our emotions is important. This can only be done via experiences, reading... again, in fact, career and personal life still can provide u a rather good platform to do that.

    1. Hi Rolf,

      Being able to walk the ground and actually go to the company's offices, shops and talk to their people is definitely useful and will give us a much better insight into the company and its inner workings. Talking with its customers and other industry professionals is also helpful.

      Companies that we encounter in our jobs and personal life can be more convenient to analyze this way since we encounter them regularly. We just need to open our eyes and look out for them.

      But I think that analyzing a company, while subjective, has some general ground rules that the company earns a good and sustainable profit, has a healthy balance sheet not overloaded with debt or receivables, etc. While the market turbulence in the short term may lead to losses, in the long run, the company should rebound ever stronger and deliver the expected returns (or if circumstances change then we should cut loss quickly)