Written by Andrew Roth
Speculating, Investing, and Everything In Between
"Something is only worth what someone else will pay for it.”
This sentiment took a little while for me to digest when it was first explained. Contrary to what you may have heard, value isn’t in the eye of the beholder, but in the eye of the buyer. This topic came to me while I was thinking about the differences between speculation and investing, and the grey area between.
The easiest way to think about an “investment” is as a capital outlay expected to make a future profit over time. Investing in a public utility stock is a straightforward example of buying stock for a future, predictable dividend. Buying bonds is also a good example—lending money to a company or municipality in exchange for future payments. Extending outside of the markets, maybe a small business invests in new machine tools. Those tools will allow them to manufacture new products which will be sold for profit.
The idea of speculation is a little harder to define. Speculation revolves around buying something with the hopes that in the future you will be able to sell that “thing” for a profit, sometimes absent of any productive value. A mint Wayne Gretzky rookie hockey card recently sold at auction for $1.29 million. Is the card worth that much money? It’s hard for me to say, other than the buyer is hopeful they can re-sell it in the future for even more. The collectibles market is a unique one, as it gains more prominence in the media and among ultra-high net worth investors looking to diversify their assets away from traditional securities, real-estate, or other “alternative” strategies.
While we’re all for diversification, history is paved with stories large and small about speculative investing imploding as sentiments change. Look at recent claims of a bubble in the world of high-end artwork. Remember the Beanie Baby craze of the mid-1990s? Ask the Dutch about their peculiar 17th century fascination with Tulips.
Where the worlds of “investing” and “speculation” collide is in the stock market. The modern capital system can be credited with facilitating so many human advances in the last century. While it has funded much human progress, it has also created a cauldron that can quickly distort value and lead undisciplined investors chasing profit and instead finding disaster.
The dot-com boom of the late 1990s is an example of euphoria and speculation commanding a huge swath of the market. The internet was undoubtedly the future, and any company with “dot-com” in the name could print money by selling their shares to a public with an insatiable appetite. Cash flow and fundamentals were irrelevant. While some people made fortunes, some people were wiped out when the music stopped.
This article isn’t meant to be a specific warning. It’s inevitable that companies will seem overvalued and a few companies will bring to market concepts so revolutionary that there is no reasonable peer comparison (see electric car manufacturers with stock trading above one thousand times price-to-earnings and my comment about human advancement above). This article is instead a call to occasionally look around and ask yourself if you’re being caught in the right kind of tides? Rising tides do raise all ships—but tidal waves can spell disaster.
One might say that fighting this phenomenon is the wrong approach, that there is still opportunity in certain stock or sectors even if they might be “overvalued.” After all, what is value anyway? Some professional money managers tend to agree. There is a whole discipline of “momentum” investing dedicated to these types of ideas—buying based on trends instead of underlying fundamentals.
The last calendar year brought these topics to the forefront as 2020 saw incredible volatility as markets rebounded from spring lows to year-end all-time highs, and retail investors fueled a rally in such a concentrated section of the market that diversified investors looked around wondering if they were missing out on the fun.
The underlying message here is that we believe in diversification of assets and of management styles, because trends and fads can be over at any moment— even while economic conditions remain strong. As certain assets become more expensive, others appear increasingly attractive. Momentum, growth, and value styles all have roles in a diversified portfolio because they will all have their days in the sun. Regardless of your assessment of value, the adage of “buy low and sell high” is still a good long-term strategy.