Investing versus Speculation

It’s tough to make predictions, especially about the future. – Yogi Berra

You hear it all the time. “I don’t speculate, I invest.” The term speculate has a negative connotation. It implies you are gambling. That what you are doing is no different than going to the casino or the racetrack. Investing, however, that’s what Warren Buffett does, and we all know how successful he has been.

But what is the real difference between the two concepts? Warren Buffett implies that investing turns on analyzing businesses and buying them for less than they are truly worth. Upon analyzing a business, which most people do not know how to do, you conclude that the ‘true’ value of that company is say $100 per share. If the company’s current stock price is $50 per share, you would be “investing” when you purchase the stock at $50.

Now if you buy stock in a company currently trading at $100 per share (at or close to the highest price it has ever traded), and after you’ve done your analysis, you believe the stock will climb to $150, a price higher than it has ever traded at, you are speculating.

Both processes involve analysis. Both processes support the notion you are buying a stock at a price less than what it is really worth. Yet one is investing and the other is speculating. Does this make any sense?

I don’t think so. At the end of the day you are speculating either way. In the first example your analysis says at the rate this company is growing it is worth $100, but trading at $50. A great deal. However, all the research in the world does not mean the company is really worth $100 per share. Even if the company is worth $100 there is no guarantee the stock price will rise to that figure.

In order to conclude the company is worth a certain amount, you have to make certain assumptions about what will happen in the future. These assumptions include the company’s growth will continue at the same rate, that the people buying the company’s products won’t change their preferences, that the overall economy with keep doing what it has or will get better, etc. The same analysis applies in both situations mentioned.

Because investing or speculating always deals with the future, and no one has a crystal ball that tells you exactly what with happen in the future, you are speculating either way. Analyzing fundamentals on a ‘value’ stock and holding it for the long term does not make you any less a speculator than looking at the charts and fundamentals of a ‘growth’ stock and concluding it will go higher.

So invest in whatever way you are most comfortable, but remember, in the end we are all dealing with an unknown future and we speculate about what will happen.