Costly Addictions – V

Last week I wrote: “What an awful lot of people have developed a taste for is neither investing nor sophisticated speculation but gambling.”

A friend writes:

“Some readers, including me, might find it useful for you to elaborate on the difference. For example: After hearing that NATO was running out of cruise missiles in the Kosovo war, and reasoning that this type of war is likely to occur again in the future, I went out and bought stock (on-line, of course) in Raytheon, which makes cruise missiles. I did do some research in news archives first, which turned up some articles suggesting that Raytheon was a solid company and attractively priced, but did no quantitative analysis of my own. Am I investing, speculating or gambling? Does your answer depend on whether I intend to flip it for a quick profit (I bought at 60, it’s been in the low 70’s recently) or hold it for a few years (which is my actual intent)?”

I would say in this case you were investing.

Indeed, I thought of doing the same thing.

Of course, whether or not it was a good investment would turn on such things as, mainly, whether your expectations of rising sales/earnings were borne out and whether the stock market had not already fully discounted these improvements. (So far, you seem to be doing fine.)

But you were investing. Raytheon is hardly a wild speculation. And neither, sadly, is the defense industry. (Wouldn’t it be nice if war and weaponry were this way-out concept that might conceivably find a market but were a long shot?) Raytheon isn’t an underfunded start-up. Raytheon isn’t teetering on the edge of bankruptcy.

Nor were you buying some out-of-the-money options on Raytheon in advance of the bombing, speculating that the bombing would indeed begin (as it did) and that this would drive up the stock. In hindsight, that could have been a neat and successful speculation.

(Nor were you shorting Lockheed, knowing it’s not as well managed as Raytheon. Shorting a stock can be a smart speculation . . . buying Raytheon and shorting Lockheed might have been an interesting “hedge” . . . but shorting a stock is speculation, not investing.)

No, you were investing in the long-term success of a well-managed established company. You were not leveraging your risk with margin. You were not adding to your risk by imposing an expiration date on the transaction. (With an option, the stock not only has to go up, it has to go up before the option expires. An option is a bet, not an investment. You don’t own part of an enterprise, you’re merely betting on the direction of its stock price.)

With a long-term holding in Raytheon, you will even pocket some dividends. (Before they got so tiny in relation to stock prices, dividends used to be a very large part of the point of investing. And one day will be again.)

To repeat: there’s nothing wrong with speculating, if you can bear the risk and know what you’re doing. And there’s not even much wrong with gambling, if you recognize that it’s an expensive form of entertainment that can be addictive and wreck lives. But “playing the market” the way many Internet traders are playing it these days is, make no mistake, gambling. It can be addictive and will wreck some lives.

Faithful reader Anne Speck puts it this way: “Gambling is ultimately a zero-sum game. If I win, the house loses. Investing, on the other hand, is more like gardening. I take resources and set them aside. They grow and become more valuable. Then when I sell (or harvest) them, it’s a win-win thing. I get the value of the growth, and the buyer gets something healthy that — hopefully — will continue to grow for him (or her).”

I couldn’t have said it better.