Speculative investments

Written by Dhirendra Kumar | Updated: Jan 27 2008, 06:31am hrs
Oh my God! Speculation! The stock market is nothing but speculation, often hisses my friend, who is a leftist intellectual. And after he reads this he will be transformed into an angry and irritated leftist intellectual who will have to be placated over some liquid refreshments. But thats okay because this whole routine is something weve been doing for many years now.

However, that doesnt quite change the fact he firmly believes in this speculation business. That the stock market is nothing but speculation is an article of faith in some circles. The strange thing is that this belief extends to circles far wider than my friends. Large swathes of media, political and official circles believe this. Even though the so-called investing community doesnt seem aware of this, this view permeates much of the general attitude in our country about stock investing. The curious thing is that few people are at all clear about the definition of speculation. What exactly is this speculation that stock investors are accused of and how is it different from non-speculation

The dictionary lists the following words among the synonyms of speculation: conjecture, rumour, gossip, assumption, guesswork, hearsay and supposition. Its clear that the word has a bad reputation, but that doesnt help us figure out what is speculation and what is investment. One definition thats surprisingly common is that speculation is engagement in business transactions involving considerable risk but offering the chance of large gains, esp. trading in commodities, stocks, etc., in the hope of profit from changes in the market price.

Unfortunately, this is a somewhat circular idea that isnt much use unless one can define what is considerable risk. In any case, at the end of the day, all investment hopes to profit from changes in market price so thats not much of a distinguishing factor.

In my view, the difference between an investment and speculation boils down to not what an investor does but to what he wants and what his level of knowledge is. Think about it. Someone tells you that X stock is going to go up and you go ahead and buy it without any further thought. By comparison, someone else could know everything about X, its prospects, the industry, its peers and come to the conclusion that its a good buy. Clearly, the very same action, depending on how much an investor knows, could be intensely speculative or could be a carefully considered investment.

Speculation really is a state of mind, but unfortunately its one which generally has poor self-awareness. Are you, in this sense, a speculator Here are a few checkpoints. The more of these you answer yes to, the closer you are to being a speculator:

a) You never try to balance risk between different investments.

b) You buy stocks of companies without a clear idea of how their businesses work.

c) You choose which new issues to invest in based on the ads of those new issues.

d) You buy stocks because theyve gone up.

e) You sell stocks because theyve gone down.

f) You think a stock with a lower price is cheaper than one with a higher price.

g) You think the previous checkpoint is a mistake.

h) You answered yes to most of these checkpoints and yet you are sure you are an investor and not a speculator.

The author is CEO, Value Research