All Things Financial Planning Blog

Are You an Investor or Speculator?

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A Worthwhile Financial Market DiagnosisHow can you tell if you are you an investor or a speculator? Many casual investors buy stocks and assume they are investing, but in reality, they are actually speculating. True investing entails conducting a thorough analysis of a company, determining whether the current price is justified, deciding whether the stock would be a good addition to your portfolio, and repeating the process periodically; speculation is simply buying a stock because you think it’s a good company or you heard a good tip, but you really don’t know how the company makes money, who its competitors are, or in some cases, even what it does. Most people would say they are an investor, but unless you are employing the fundamental analysis discussed below, you may actually be a speculator.

Top-Down

Suppose you believe that the new Affordable Care Act will benefit pharmaceutical companies and you want to capitalize on that potential gain. In a top-down approach, you would first generate a list of all the publicly traded pharmaceutical companies. Then you would compare them among each other using that industry’s metric. If any of the companies are non-US companies, then you need to translate the company’s currency to the US dollar for an equal comparison. Some common comparison metrics include: profit margins, sales, market capitalization, market penetration, debt/equity, etc. In addition, each industry has its own unique metric. For example, airlines use (revenues per passenger miles) and hotels use (average daily rate). Once you have identified the best stock within your filtered list, then you can determine whether the stock price is cheap or expensive versus its competitors.

Bottom-Up

Suppose you are an avid Facebook user and want to invest in the stock. In a bottom-up approach, you would first obtain financial information for Facebook to understand how it makes money. What are its income sources: advertising, selling products, partnerships? How much of their income comes from each source? Who are its competitors and what do their numbers look like? Keep in mind, just because a company makes a ton of money, it still doesn’t make it a good investment. Facebook made $5 billion in 2012 while Microsoft made $74 billion in 2012, yet Facebook stock trades at almost 143 times the value of Microsoft.

Research Reports

Some investors prefer to rely on research reports prepared by prominent analysts at investment banks. One of the many lessons the recent financial crisis taught us is that investment banks have countless conflicts of interest. There is no shortage of headlines where an investment bank issued research reports where they also did investment banking for the company in question. Unless the research is truly independent and neither the analyst nor their firms have a vested interest in the companies they cover, their assessment of a company is tainted by their firm’s relationship with the company being reviewed.

As you can see, researching individual stocks is very labor intensive whether you use the top-down or bottom-up approach. The analysis doesn’t stop when you buy the stock, you must continue to monitor the company (not just the stock price) to ensure it still meets your criteria. It’s ok to invest in stocks, but investors must recognize that unless they conduct ongoing and thorough analysis, they are merely gambling.

Ara OghoorianAra Oghoorian, CFP®, CFA
Founder and President
ACap Asset Management
Los Angeles, CA

Author: Ara Oghoorian, CFA, CFP®

Ara Oghoorian, CFA, CFP®, is the founder and president of ACap Asset Management, Inc., a boutique wealth management firm located in Los Angeles, CA. ACap provides comprehensive investment management and financial planning services with a niche in advising physicians and medical professionals. Ara began his professional career 20 years ago at Wells Fargo Bank in Huntington Beach, CA piloting new supermarket banks. He then moved to San Francisco to obtain a degree in finance and worked full time at the Federal Reserve Bank. Ara spent nearly nine years there as a bank examiner where he audited U.S. banks, bank holding companies, and foreign institutions from Japan, Hong Kong, China, Korea, Taiwan, Philippines, United Kingdom and France. In 2005, Ara accepted a prestigious position with the US Department of the Treasury as the resident advisor to the Ministry of Finance and Economy in the Republic of Armenia. He was responsible for advising the top officials of the Republic of Armenia on how to transition from a centralized audit function to a decentralized system. Upon his return to the US, Ara worked for a wealth management firm in the Washington DC area advising and managing the personal wealth of CEOs from Fortune 500 companies. Ara has spent his entire career in finance and as a result, he has a firm grasp of financial markets, economics, and their interactions. He is a member of the CFA Institute, CFA Society of Los Angeles, Financial Planning Association of Los Angeles, NAPFA, and Toastmasters International. In addition to his work in finance, Ara also sits on the board of the World Children’s Transplant Fund where he also chairs the annual Global Partners’ Dinner. Ara is a frequent speaker at local medical schools, medical societies, professional organizations, and private businesses. He has a degree in finance from San Francisco State University, is a Commissioned Bank Examiner through the Federal Reserve Board of Governors, holds the Chartered Financial Analyst (CFA) designation, Certified Financial Planner designation, and holds the Series 65 license. Ara currently lives in Los Angeles with his wife and two sons.

8 thoughts on “Are You an Investor or Speculator?

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