The art of speculation

There really is a difference between speculating and investing. In my view to keep interest in the stock market you have to do both. While the majority of my investments are purely value based investing ideas, I do from time to time allocate a certain percentage of my portfolio to speculation. I do occasionally like to play the market like a slot machine, though granted, these risks are highly educated guesses and more than naught they work out great for me.

So why should you speculate? and most importantly how do you speculate with the odds in your favor? I will start off with the why because as many of you know, I am a rather successful value investor. The why is quite simply to score big on stocks that, because of a current trend in the market or because they will be bought; just explode. There are many reasons why a highly speculative stock can pay off handsomely if your guess is correct.

I speculate from time to time because I think it’s fun, it keeps me interested in the markets and just like playing a slot machine, the thrill of winning is amazing. Now there really is a difference between just buying anything hoping for the best and making educated guesses. So how do you make an educated guess that has a higher percentage of being right? You do your research.

1. Look for trends – Right now a big trend, as Jim cramer on Madmoney has pointed out consistently, is the Mobile internet tsuanami (or smartphones and the infastructure needed to make it work)


2. Look for the small fries in that industry who have a great story but maybe had a bad quarter or even year. This is usually the reason it is so cheap


3. In speculating I still do all the regular ground work, I look for undervalued securities, or securities with amazing stories or some kind of catalyst that will push it higher.


4. For speculation plays I like to look more for growth than undervalued. This is important for me as growth shows health. If the company is highly undervalued but no growth and is a really small company.. Well this usually spells disaster.

So how do we spot trends? How do we not spot them is the real question! Trends are everywhere if you keep your eyes open. Four years ago Crocs was the trend, had you got in early it would have paid off big. 10 years ago the internet was the trend. Today the trend is the mobile internet (Ipone, blackberry and all the infastructure needed to make it work), energy is a hot trend (coal, oil and soon natural gas), Green energy or green anything, china is a trend, south America, and most commodities (we can call trends bull markets).

How do we spot good spec stocks in a trend? How do we know which one to invest in and which one to stay away from? Personally I am terrible at market timing, so I go for the stocks that are already moving, that already have a newly lit fire under them. I figure out why the fire is lit, and if it has a possibility to continue. I look for growth in both revenue and cash flow and for future prospects. What will make this stock take off?

I stay clear from stocks that have a lot of debt and very little free cash flow, I don’t care how good the story is; if the cash flow is bad and they have a lot of debt, they will have a hard time doing anything. What is the reason the stock is so beaten down to begin with (if not a small company), is the problem fixed? What do the analyst say? You will usually have more luck if you bet against them. There are several reasons for this:

1. Most analyst rely too much on using macro-economics, beta, capm, technical analyst and popularity among other things to value a stock. This will not make you money.


2. Perhaps analyst work as analyst because they haven’t made any money as investors?


3. This is my favorite reason why: Only so many people can hate a stock or love a stock before the opposite has to happen. If all the sellers have sold, what more can happen?

With that said, have fun speculating but don’t get stupid. Keep the speculation side of your portfolio at less than 20% of your capital. There is no reason to risk all your capital on something that might not turn out as planned.