Speculation is a term that is commonly used throughout the stock market, but just exactly what is speculation. The financial press frequently makes reference to speculative stocks as being any stock that is priced under $1 and at other times price under $5. The general implication is that the financial press considers a stock to be speculative when it’s priced under a certain limit.
At other times the financial press uses the term speculation to describe investors picking the market direction. Speculation is also sometimes used when referring to stocks outside of the S&P 500 and yet at other times speculation is simply used to describe a small company.
It’s no wonder why investors are totally confused with what speculation even really means.
To clear up the confusion, a distinction is first made between speculation and a speculative stock.
The term speculation is defined in the dictionary as “to form an opinion without having any definite evidence”.
With reference to the stock market, the term speculation refers to the decision made by a market participant. That decision was however based on information that is not guaranteed to be 100% accurate or complete. Thus the information was rationalized as to its reliability.
Speculation thus refers to an individual’s rationalized decision. Such a market participant is referred to as a speculator and is often called a speculative investor or a speculative trader.
Speculation refers to an investor’s decision that is based
on information that is not accurate or complete
A speculative stock on the other hand simply refers to a company whose future financial growth prospects are considered less likely to emerge based on its current financial history.
A Speculative stock is a company whose proposed
future growth is not supported by its historical growth
Companies can be broadly classified into two groups. The famous investor – Benjamin Graham considered a company which is fundamentally sound with realistic and proven growth to be of investment grade. Any company not considered to be of investment grade is considered to be a speculative stock.
Thus, speculation refers to an individual’s rationalized decision and a speculative stock refers to a company which is not of investment grade.
A distinction needs to be made between speculating on an increase in a company’s future valuation and speculating on the stock price movement.
There are two prices for any company. One is the stock price and the other is the fundamental valuation of the company. A market participant can speculate on either of these two prices.
Stock Price vs. Fundamental Valuation:
- When a market participant speculates on the price movement of a stock, they are referred to as speculative traders. Strictly speaking all trading is speculation since the trading decision is based on stock price history which by its very nature is extremely volatile and does not provide any definite evidence.
- When a market participant speculates on an increase in a company’s future valuation, they are referred to as being a speculative investor. This is the case whether the company is of investment grade or a speculative stock. In either case speculative investing is speculating on the future valuation of companies since there is no definite evidence. Investing (as opposed to speculation) is accepting the current proven growth which is the definite evidence.
Thus a speculative investor speculates on the future valuation of the company while a speculative trader speculates on the future stock price movement of the company.
An investor (as opposed to a speculative investor) simply accepts the current growth as being indicative of future growth.