How to Master the Art of Intelligent Speculation

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club

It's been said that one good speculation is worth a lifetime of prudent investing.

I know this to be true from personal experience.

Three of my investments - each up more than hundredfold - have had a dramatic effect on my long-term returns and total net worth.

How do you identify an investment with the potential to go up severalfold?

There's a process. I call it "mastering the art of intelligent speculation."

Let's start by defining the terms investor, trader and speculator.

Investors measure their returns in years - or decades - and ignore short-term fluctuations. (Typical investment selections include blue chip stocks, index funds and high-grade bonds.)

Traders, on the other hand, measure their returns in weeks or months. They don't ignore short-term fluctuations. They seek to capitalize on them. (Typical trading vehicles are small cap and midcap stocks, hypergrowth stocks, and other high-beta equities.)

Speculators seek even higher short-term gains and are willing to risk more - potentially the entire investment - to achieve their goals. (This category includes options, futures, penny stocks and cryptocurrencies, for example.)

The three groups are not mutually exclusive, of course. In my experience, the best approach is to be a long-term investor who also trades regularly and speculates occasionally.

Intelligent speculators, in my view, combine the best qualities of each. They are short-term oriented and willing to risk more in the pursuit of much higher-than-average returns - but are also willing to hold longer term if it maximizes profits.

To better understand intelligent speculation, let's consider four things that it is not...

1. Timing the Market

If part of your speculation is based on a guess about what any market - stocks, bonds, currencies, metals, commodities - is about to do next, it is fundamentally flawed. I am a militant agnostic on this subject. (I don't know what the market will do next - and neither do you.)

Everything about the future that is known or highly probable is already discounted in stocks by rational, self-interested investors. (That's why academics call financial markets "efficient.")

What will move stocks tomorrow or next week is tomorrow's or next week's news. We can't know that now. And betting on the unknowable is gambling, not intelligent speculation.

2. Investing in things you don't understand

Warren Buffett missed the dramatic run-up in internet stocks two decades ago. He also sidestepped their complete meltdown. Why? Because he didn't understand them.

In Berkshire Hathaway's annual report 18 years ago, he said, "We have embraced the 21st century by entering such cutting-edge industries as brick, carpet, insulation and paint. Try to control your excitement."

If you are an expert on cryptocurrencies, blockchain, nano caps, angel investing or arbitrage, go knock yourself out. The rest of us can reasonably pass on these categories.

3. Getting stuck in illiquid securities

You wouldn't enter a building without clear, easy-to-find and well-marked exits. The same should be true in your portfolio. Always prefer securities that are easy and inexpensive to trade, have plenty of volume (i.e., high liquidity), and have no surrender penalties.

To me, intelligent speculation means giving a pass to hedge funds, annuities, art and collectibles, private equity, venture capital, and options that trade by appointment only.

You should be able to exit any speculation on a moment's notice and - especially in today's world of deep-discount brokers - at a cost of no more than a few dollars.

4. Overestimating the potential of low-priced stocks

It may seem reasonable to you - as it appears to be to so many investors - that it is easier for a $5 stock to go to $10 than it is for a $50 stock to go to $100.

I can assure you this is not the case. Plenty of research confirms this. Unfortunately, the same studies also show that it is a whole lot easier for a $5 stock to go to zero than it is for a $50 stock.

I could get into a long, technical explanation of why low-priced stocks do not outperform higher-priced ones, but let the following suffice...

Corporate officers and directors receive much of their compensation in the form of option grants. That means the better the stock performs, the higher their compensation. If a low-priced stock truly outperformed a higher-priced one, wouldn't they simply split the stock down to a few dollars a share and reap the rewards? They don't because it wouldn't.

The share price of a stock tells you nothing about its upside potential.

These are just a few examples of the wrong ways to go about speculating. In my next column, we'll look at the right ways.

Intelligent speculation is not an oxymoron. And following just a few important principles will dramatically impact your real-world returns.

Good investing,


Thoughts on this article? Leave a comment below.

Turbocharge Retirement With This Wisdom

Chief Income Strategist Marc Lichtenfeld just completed a media blitz for his new book You Don't Have to Drive an Uber in Retirement: How to Maintain Your Lifestyle without Getting a Job or Cutting Corners. No matter how much (or little) you've saved for retirement, Marc doesn't want you to ever worry about whether it's enough... or whether it's too late.

Alex recently called it "the best book on retirement and income investing" he's ever read - high praise coming from a four-time best-selling author himself. So today, I'm bringing you Apollo Global Management (NYSE: APO), one of Marc's "intelligent speculations" from The Oxford Income Letter's Retirement Catch-Up/High Yield Portfolio.

Apollo Global Management (NYSE: APO) has done extremely well for us.

The 7.6% yield is certainly nice. Even better, the stock's total return has been 64% since it was added just over a year ago.

That smokes the return of the S&P 500 during the same period.

Apollo Global Management is a value-oriented institutional investor in private equity, credit and real estate. It makes its money from management fees, as well as profits and income on its investments.

For example, in 2016, it bought home security company ADT (NYSE: ADT) and took it private. In January, it took ADT public in an IPO. Apollo still owns the majority of the company.

CEO Leon Black is a legendary investor. He recently told a conference audience that Apollo is on the hunt for larger companies - in the $10 billion to $20 billion range - that can offer double-digit compound annual growth.

It looks like he found one.

In December, it was announced that Voya Financial (Nasdaq: VOYA) will sell $54 billion worth of annuities to Athene, a new company created and controlled by Apollo Global Management and other partners.

Apollo will benefit not only from the increase in Athene's value but also through fees generated for helping to manage Athene's investments.

Apollo is a value-oriented investor, but its shares are a good value as well. It trades at just 11 times earnings, half that of its industry peers.

Apollo Global Management is a growth story. As its portfolios grow and it accumulates more assets, its earnings and dividend should increase as well.

But keep in mind that Apollo's dividend is not consistent. It pays shareholders based on its income during the quarter. That can vary widely depending on whether the company exits a big position or not.

Over the past year, Apollo has paid investors a total of $1.75 per share. Based on our entry price, that equals a 7.6% yield. Though, as I mentioned, you can't rely on previous quarters as a guide since the payout is partially dependent on profits that the company actually takes on its investments - not just the increase in value.

As long as you can handle a dividend that will vary from quarter to quarter, you should have Apollo Global Management in your Retirement Catch-Up/High Yield Portfolio.

- Donna DiVenuto-Ball with Marc Lichtenfeld

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