Investors Need to Know When They are Investing or Speculating

Investors without an investment strategy or a specific approach to selecting stocks have been known to jump on stock ideas they read online or hear from celebrity stock pundits. After all, these are trusted sources, and they’ve already done the research, right? Maybe, but what does that matter? As I suggested in my last blog post, if you don’t fully understand what you own, how it makes money, why it’s priced the way it is, and the other fundamentals that drive a company, it’s still speculation.

In general, when investors are drawn into the market based on a single approach, single measurement, or a single issue, it invariably ends badly. They may think they’re investing, finding some rationalization in an underlying news story, or the hyperbolic urging of a friend or colleague to make the leap. They have no investment strategy or approach, acting instead based purely on emotion. Yet, they’re shocked when they lose their money.

In recent months we’ve seen several examples of investors being drawn into a “stock event” that resulted in a few investors making a boatload of money while most investors, or speculators, lost their shirts. The infamous GameStop fiasco comes to mind. But another, lesser-known event is more illustrative of my main point.

How a Two-Word Tweet Changed Fortunes

Earlier this year, Elon Musk, CEO of Tesla, sent out a two-word tweet that sent investors into a tizzy. Musk is a brilliant guy, and he likes to remind his millions of Twitter followers how smart he is. He’s known for putting out very provocative tweets, even catching the ire of the Securities and Exchange Commission on a few occasions.

But, because of his obvious success and notoriety, many people take his word at face value. So, when he tweeted out two cryptic words, “Use Signal,” everyone thought he was endorsing an obscure medical device company called Signal Advances. The following Monday, share prices of Signal Advance surged more than 400% and 5,100% over the next two days.

At the end of the week, Musk clarified that his tweet referred to a messaging app called Signal that he was recommending as an alternative to WhatsApp. Signal is owned by Signal Foundation, a three-year-old nonprofit with no publicly traded stock.

By the end of that week, Signal Advance’s market capitalization had shot up to nearly $400 million. The last annual report it filed with the SEC showed the company had no revenue in 2016. Yet, even after the clarification on Friday, investors continued to buy up its shares, driving the price up another 885% on the following Monday. The stock, which was trading at $0.60 before the tweet and surged to more than $38 that week, now trades at around $1.60.

Thoughtless Investing, or Hope, is Not a Strategy

I think we can say with a high degree of certainty that many people lost a lot of money on that deal. While that may have been a surprise to them, it shouldn’t be to anyone who knows what it is to be a serious investor. It was the epitome of thoughtless investing—having no strategy, no approach, not even the curiosity to know something about the company before committing their money.

If it is speculative opportunities they’re looking for, that’s fine if they’re using money they can afford to lose. The problem is, many of these events are initiated by people who can afford to lose their money. Then, as the event unfolds and reaches a fever pitch—about the time when it has run its course—it manages to draw in the people who have less money to lose. When the initial speculators pull the plug, the stock price crashes quickly, and there’s no time for the others to get off the quickly sinking ship.

Investors need to know when they are investing and when they are speculating, with the understanding that, if they are speculating, they should be able, and willing, to lose their money. Taking your stock queues from the internet or a tweet is fine if you take the essential and measured steps of learning everything there is to know about the company and why it would make a great investment—one that can generate value over time. That takes you in the direction of more thoughtful investing.

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