Investing or Gambling, What’s The Difference?
Peter Lynch once said, “When people discover they are no good as baseball or hockey, they put away their bats and their skates and they take up amateur golf or stamp collecting or gardening. But when people discover they are no good at picking stocks, they are likely to continue to do it anyway.”
In traditional sports, it’s easy to measure if you are good based on batting average, goals scored, or other statistics. In the stock market, some investors seem to believe their next great stock idea will be the big winner that makes up for all of their losers. The question every investor needs to answer is…are you investing or gambling?
What is Investing?
According to one definition, investing is, “the act of committing money or capital to an endeavor with the expectation of obtaining additional income or profit.” What this definition lacks is the real difference between investing and gambling…research. Unfortunately, there is a huge crowd of amateur investors that ignore Peter Lynch’s sound advice, “a share is not a lottery ticket…it’s part ownership of a business.”
Many “investors” think investing in the stock market is like walking into a casino. They throw money at a stock, or a basket of stocks, based on a rumor, tip, or something they believe. They do very little research (if any) into each company, and many times, they lose just like at a casino. For the amount of “investing” they are doing, they may as well have gone to Atlantic City and bet on number 13 at the roulette wheel.
While gambling involves random chance, investing requires some research. Lest anyone get intimidated, this type of research doesn’t require a PhD, and in some cases can be done in a short amount of time. If you are interested in a company, the first place many real investors should go is the company’s most recent quarterly report. Beyond this, analyzing things like the company’s last annual report, balance sheet, cash flow statement, and income statement can be instructive.
More thorough research, might involve reading the company’s last few conference call transcripts, and even calling the company to ask questions. Finally, the investor might look at some valuation comparisons of the stock compared to its industry peers, or historical norms. Unlike pulling the handle on a slot machine, in the stock market, a little bit of research can increase your chances of making money significantly.
Timing is Everything…or is it?
An additional hurdle that many investors must try to overcome is the idea that some people are born market timers. The truth is, there is no such thing as an investor who is consistently great at timing the market. Investors do their research, and attempt to pay a fair valuation based on their assumptions. Real investors ignore the market and focus on the company.
A few case studies are instructive, to show how an investor can either make or lose a lot of money by trying to time the market. First, let’s say you believed in October 2011, that Netflix (NASDAQ: NFLX) was going to be the king of online video. The stock was valued at a split-adjusted price of around $12 a share. You decided to invest $10,000, and purchased 832 shares. Today, that $10,000 investment is worth more than $80,000, or an annual rate of return of just under 70%.
However, let’s say you decided to buy into Netflix a bit earlier in July 2011. With the same conviction as the first investor, you bought shares when they were at $42.16. Just a year later, you get nervous because you’re losing money. Rather than focusing on the company, you abandon your investment a year later at $8.42 a share, a negative 34% annual rate of return.
The difference between the investor who made a huge profit in Netflix, and the one who suffered significant losses was patience and conviction. Netflix’s financial and operating profile didn’t change, the stock market simply mispriced the opportunity in 2012.
In the second scenario, an investor decided that Keurig Green Mountain (NASDAQ: GMCR) would change the coffee industry forever. In October 2011, the company’s stock was around $71 a share, and this investor chose to buy $10,000 worth. That same investor has been on a wild ride over the last few years, and has witnessed their investment decline to about $7,800. With an annual rate of return of negative 6%, the company has some challenges and the market seems to be pricing these issues accordingly.
That being said, an investor in December 2010, might have thought that Green Mountain was a great company as well. With the stock at $32.50 a share, the investor decided to buy. Just nine months later, Green Mountain’s stock was riding high at $108, and the short-term investor sells out with an annual rate of return of nearly 400%. This investor might believe that Green Mountain is one of the best investments they ever made.
The point is, in the short-term, a stock can move up or down without correlation to the strength of the business. Over the long-term, investors might experience volatility, as stocks move based on supply and demand – not necessarily intrinsic value.
The bottom line is, if you’re a gambler you’re probably better off taking some of your money and having fun in Las Vegas. Hopefully you’ll have enough left to take your serious money, and put it in the hands of a qualified financial advisor.
However, if you’re interested in becoming a better investor, do some research into the company or companies you are interested in. When you’ve decided to put your money to work, make sure you keep up with the story and buy or sell based on the strength of the business. Sometimes, the difference between gambling and investing is a little bit of research, and the stomach to stick to your playbook.
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