Investing Versus Speculating

Investment Perspective – May 2015

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

Experienced investors know the difference between speculation and investment, whereas less experienced investors sometimes struggle to tell the difference.

Investing in any number of new listings (Initial Public Offerings (IPO’s)) is a form of speculation because we don’t really know what we’re getting when we invest with some of those options.

For every investment that does well off the starting blocks from the list process, there are many more that don’t do so well.

The idea of investing, is to get our money back at the end of the day, plus a return on top. Further, it is the degree of certainty with which we go about that process, which is the real key to successful investing.

Many investors speculate because they see an opportunity to make big money quickly, or at least to make easy money without having to work for it. Of course, it is a free world and we can all choose.

There is a large amount of evidence, however, that suggests whilst, there are some who speculate successfully and have done well, there are lots who have tried it and failed.

At the same time, whilst there aren’t many, there some investors who have adopted a more methodical and disciplined approach and achieved significant success.

Although this comparison I am about to offer means little, it is interesting to note though that George Sorros, undoubtedly one of the world’s most successful investors, is a trader and a speculator whose wealth accumulation, if we use that as a measure, was well exceeded by none other than Warren Buffet, the value investor.

MindSET Over Money

The lure of easy money can be intoxicating.

For those who have had a bit of success speculating, the chances are they will encounter some failure at some point.

For boring and stable value investors, there are also some challenges. A lot of time and effort goes in to selecting the right options in which to invest and the payoff is not always immediate. It can take time.

LinkedIN As An Investment?

A number of my clients own Linked-In. This company is categorised at WISEplanning as The Interrupter. So called because it has changed the way executive recruitment is done around the world.

Individuals can access literally millions of individuals on LinkedIN free of charge. They can put their resumes up on the system and filter to find those who might be suitable candidates that they wish to employ.

The story surrounding Linked-In is quite compelling with the growth in numbers on the platform rapidly increasing from one year to the next.

Drill down a level and we can see significant growth in the turnover and revenues of LinkedIN over several years. This is compelling for investors who are happy to speculate.

Drill down yet another level, and we can see the underlying profit of LinkedIN over many years has also increased.

Look further and we see a business that uses capital well and also one that does have a compelling story around the way it has changed executive recruitment. Investors know that LinkedIN is now used by over 60% of Fortune 500 companies in the U.S. to help locate and recruit executives, but does so at a fraction of the usual cost.

For example, it is not uncommon for recruitment companies to charge around $40,000 or more to recruit a high level executive.

LinkedIN, on the other hand, charges around USD$4,000 for a similar service. One of the advantages that LinkedIN has is around 330,000,000 people on its network. No need to put ads in the paper to try and attract potential candidates!

Further, this company is a global organisation and from an investor’s perspective (looking for some certainty), LinkedIN has actually been making real money for many years.

Further, LinkedIN grew the business on the back of significant profits over many years, without the need to resort to using debt to help fund growth.

So, we have the makings of a real business with a competitive advantage, which is changing the way things are done not only in its little corner of the world, but rather the whole world.

Of course, there are no guarantees and we watched recently the share price decline sharply from a recent high of $269 down to a recent low of $198. That, of course, is price movement reflecting the market disappointment with Linked-In’s recent profit miss.

My clients and I will likely be using this profit miss, the resulting drop in the share price to either top up existing holdings or average down the original buy price if the current trading price is below what they originally purchased LinkedIN for (although I understand there are not many in that situation anyway).

“As the price declines, the value emerges”.

The Point Is…

The point here is that there is more to successful investing than a good sounding story and a rising share price.

Investing is not easy, however, keeping it fundamental for most of us keeps our capital secure and allows us to achieve solid gains over the long term, without too much worry or stress.

LinkedIN, whilst not for everybody and perhaps more suitable for those looking for above market returns than those who prefer a defensive approach, is nonetheless a sound business whose trading price is expensive based on the fundamentals but whose business model has helped it to carve out its own market niche with at least, at this stage, minimal competition.

Therefore, the competitive advantage for LinkedIN, whilst not impregnable, is strong and a difficult one for others to attack. The competitive advantage by the way is one of Warren Buffetts preferred tools for successful investing.

Also, it is worth mentioning that the market does not generally understand LinkedIN and the potential that is yet to be tapped. There are a number of premium services that are on the drawing board, which will be easy for Linked-In to be able to offer, thus monetising its not insignificant collective of 330,000,000 individuals.

So, the market remains overall a fan of Linked-In, but more recently the traders have dumped LinkedIN because it missed the most recent quarter’s profit estimate. This does impact on profit in the very near term, but has little impact on the underlying business economics long-term.

Experienced investors get this and are less inclined to be distracted by the noise of the rising or falling share price, particularly in the short-term. They know that the trading price is really just an entry or exit point.

Speculators, on the other hand, love it when the price rises strongly and hate it when the price declines. They see price and value as the same thing.

Successful investors, on the other hand, make their fortunes by relying on the underlying business economics and fundamentals – they also sleep well at night too!

Linked-In is not a specific recommendation for you necessarily, and please be aware that this information about LinkedIN should be considered as class advice of a general nature, rather than personalised advice for you specifically. Seek advice before taking action.