Investing vs. Gambling

Everyone who purchases stock does so with the expectation that the price will go up and that shares purchased today will be worth more in the future. Everyone who purchases stock exchanges their cash for equity in the company that issued the shares. And, everyone who purchases stock is taking a risk. However, only some of the people who purchase stock are actually investing. The rest are just gambling. Don’t get me wrong, sometimes investments go bad and gambles pay off (and vice versa), so I’m not turning my nose up at the latter. But I want my readers to understand the difference and to think about what that difference could mean for their investment strategy. 

While the transaction of investing in the market looks exactly the same as the transaction of gambling in the market, there are clear differences in the two acts evidenced by what leads up to the transaction and the strategy behind it (or lack thereof). I’ll give an example:

Subject A works as a checker at a grocery store and overhears a shopper in her line tell another shopper that he realized a 500% return in two months on HJK stock. The checker writes down the name of the stock, excited that she may be on to the next big money maker. When she gets home, she pulls up the internet and begins to research HJK stock.  She checks a reputable financial reporting website and, lo and behold, she is able to confirm that there was an overall 500% increase in the stock’s price in the last two months. She then visits the HJK website and reads everything on it – she wants to know as much about this company as she can. Subject A knows that past performance does not guarantee future performance, but she is comfortable taking calculated risks. Satisfied with what she’s learned from the company’s website, she does a broader search to determine if what the company has claimed is supported and whether the current and future market for what they are selling is strong. She takes her time, and over the next week, she convinces herself that stock in HJK company is a good buy, and she purchases 100 shares.

Subject B, who was standing in Subject A’s checkout line behind the chatty shopper and who also overheard about HJK’s massive stock returns, arrived at the same conclusion as Subject A to purchase 100 shares of HJK stock. However, the road to that conclusion was very different. Immediately upon hearing that the stock price had soared 500% in such a short amount of time, Subject B searched, “Did HJK stock increase 500% in two months” online. Anecdotal search results overwhelmingly confirmed that not only did the price increase fivefold in the last two months, but it had been increasing for the last year and some people made enough money from selling it to retire early. Beyond convinced, he logs into his online investment account and executes a purchase, hoping to get in and out while the money is flowing.

This may go without saying, but Subject A invested in HJK; Subject B gambled on HJK.  Here’s a different example:

Buyer Q has been watching the news and reading reports about Hot Shot company and how it’s revolutionizing the industry. The company is creating demand for its product and is a household brand. But, looking at it’s financial statements, Buyer Q sees that Hot Shot has not turned a profit since it started seven years ago. Revenues have increased, but so have expenses. The company has been investing in R&D, which could explain why there are no profits and is not uncommon for new companies. But, further inspection shows that their customer acquisition costs are higher than their customer lifetime value. Also, the cost to make the product is 1.5 times the current price, which the company has kept low in order to compete. It’s unclear whether their customer base will buy the product at a price that will cover costs and leave room for a profit since comparable products are sold for less.  Buyer Q also sees no evidence through any publication that Hot Shot has a plan to become profitable. However, based on all the hype and his belief in the product Buyer Q purchases 1000 shares. He is taking a gamble because his analysis of the company does not indicate that Hot Shot is investable at this time. Had he determined that Hot Shot has a sustainable business model and a viable plan to become profitable, that same 1000 share purchase would be an investment. 

Some may argue that investing is gambling, since both come down to taking risk and expecting a reward. While, I’ll concede that there is a fine line between the two, there is at least one major difference: To invest is to take a supported risk and to gamble to take an unsupported risk. As a financial advisor, it is my duty to warn clients against putting money into a company based on emotion or anything other than the support of careful and thorough analysis. I know it’s tempting to just jump on the bandwagon when everyone is singing the praises of a stock that you know nothing about other than its price is soaring. But you have to remember, sometimes a rise in a stock’s value is just a self-fulfilling prophecy - certain people tout it as valuable, so certain other people run out and buy it and the value rises (due to demand), “confirming” its value and this creates more praises and more demand. And, the problem is that eventually the euphoria will fade and people will realize there isn’t support for the currently inflated price and the price will likely plummet…..Then certain people will buy more shares because it’s “on sale”, the price will rise, certain people will tout as valuable and the cycle of up and down price movements (volatility) will continue until fundamental analysis supports the stock’s price and it levels out. So be careful out here in these (Wall)streets. I’m not telling you what to do with your money (this is not advice nor is it meant to establish a client/advisor relationship), but I think you should at least  be aware that there is a difference and depending on your goals and overall investment strategy, one approach may more suitable for you than the other.

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