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On the difference between speculation and investing! December 4, 2008

Posted by shaferfinancial in Uncategorized.
Tags: , , , ,

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I have given the idea of investing versus speculation much thought lately because I have done some reading on speculative bubbles.  It seems to me that the difference is pretty clear.  Investing requires analysis.  It requires thought and use of metrics.   I have posted on stock and real estate investing over the last couple of months.  It seems to me that if you are passive in your approach, allowing others to make the buy and sell decisions on your investments, then you are speculating whether you realize it or not.  One of the key ideas on speculative bubbles is that people bid up the price of assets beyond what the intrinsic value of the cash flow is, hoping that “a greater fool” will show up to purchase the asset at an even greater price.  In Japan in the 1980s for example the p/e ratio of their stock market went above 80 and the value of their real estate went so high as to be higher than the collective value of all US real estate, a country that dwarves Japan’s size!  Using this criteria we see that the real estate valuations of 2003-2006 were definitely a bubble, while the stock valuations of last year weren’t.  What we have in the stock market now is a loss of confidence going forward built on the sub-prime/credit/derivatives fiasco.  I have no crystal ball, but what that means to me is that real estate probably will not return to those double digit appreciation days anytime in my life time (they don’t need to in order to be a strong investment) and likely will languish at current valuations for a few years while the foreclosures and oversupply are worked through.  While the stock market will bounce back relatively soon and dramatically to represent the true value of the cash flow they produce.  With the last reported earning per share p/e ratio in the area of 12 (S & P 500) and estimates that it will fall below 10 this quarter I think it is fair to assume a generally undervalued stock market.  Now when this turns and why I have no idea but an investor really doesn’t care.

If you do your fundamental analysis, using the proper metrics, then you are an investor and can invest with confidence.  If you rely on Wall Street or the mass media to tell you, then you are speculating.  Eventually, speculators’ luck runs out and they get burned bad.  While investors might take a hit every once and a while, but keep on ticking as they build wealth.



Choose to become an educated investor and you will find yourself in much better position than those who think Wall Street will do it for them!



1. Joe - December 5, 2008

An “investment” is the word people use for a “speculation” that succeeds.

2. shaferfinancial - December 5, 2008

Thanks Joe 🙂

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