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Investing vs. Gambling: Entitlement & Predictability Thumbnail

Investing vs. Gambling: Entitlement & Predictability

People frequently refer to the stock market as a “casino”, as if they have zero influence over the financial result of their decision(s). However, there are at least two important differences between gambling on slot machines and investing in an actual business, or a collection (portfolio) of businesses: Entitlement and predictability.

We must be aware of our possible entitlements as business owners/stockholders. We must also know what we are likely to receive from such entitlements before we can determine whether it is wise to sacrifice resources such as money, time, energy, etc. to gain such shareholder entitlements. How can we predict whether a financial decision (or any decision in life) is wise without first knowing the likely result of our decision? We cannot. We are ignorant, relying mostly on luck. Hope may increase the chance of a positive result in some circumstances in life, but it has no belonging in the investment profession unless you are hoping for a financial disaster.

The risk of loss for an informed investor is considerably less than the risk of loss for a slot machine player. Although the informed investor is not guaranteed to be absolved of risk or granted gains, the odds of a positive result are significantly higher for the investor than the gambler. The slot machine player sits down at a screen, inserts currency, bows their head to wish to the gods, and pulls the lever. The investor analyzes, learns, and acts on well-thought judgments. The gambler hopes the universe magically aligns to satisfy their wishes. Unless a person is aware of the result that is most likely to occur from knowing all the necessary facts, relationships between facts, and the likely future facts - their decision is not guaranteed to be the wisest. Therefore, it is not deserving of the benefits provided by the wisest, most informed decision. 

The gambler and the investor both bear risk. However, the investor bears informed (calculated) risk, whereas the slot machine player bears uninformed (incalculable) risk. It is not that the investor is not exposed to risk. It is that the investor is able to access and frequently analyze influential information in financial reports and other sources to minimize their risk and maximize their chance of receiving an attractive reward for the money they risked for such entitlement. The slot machine player is only entitled to pull the lever with zero predictability about the result of their often-poor decision and zero security from no legal claim on assets. The investor, on the other hand, is entitled to the benefits and provided some security by partial ownership in a business (claim on company’s assets after paying all liabilities and future cash flows).

Besides the false assumption that the risk of loss in a casino is similar to the risk of loss in the stock market, it is forgotten that stocks represent partial ownership in businesses. Warren Buffett, one of the most successful investors in history, once said, “I am a better investor because I am a businessman, and a better businessman because I am an investor.” 

The stock market is essentially one unusually-large list of businesses for sale at prices that vary daily. For example, let us assume you are searching for the best private business investment in your local area. These businesses are not traded on a public exchange to provide a daily measurement of their values, but they are certainly not worthless simply because there is no public price. If there is a local grocery store with zero debt to any creditors, a consistent record of producing a little over $1,000,000 in cash per year for the past 17 years after all operating expenses and taxes, and no likelihood of any or many competitors entering the local market to steal a portion of the business, then the business must be worth at least a certain conservative amount of money because of the entitlement to the existing assets of the business and the future stream of predictable income. 

Every business has a reasonable economic value to its owner(s). Would you pay $100,000 for that grocery store if you knew it would provide a little more than $1,000,000 per year to you? I hope you would feel comfortable paying $100,000 for this business because many successful investors would gladly pay $7 million for the business. Is the grocery store worth $5 billion dollars? Absolutely not. Is the grocery store worth $7 million to $20 million? That seems reasonable when considering the historically-stable performance of the business providing a little over $1 million per year with zero debt (no bankruptcy risk). While every business has a REASONABLE VALUE to its owner(s), every business also has an OFFERING PRICE that may vary over time between cheap, reasonable, or extremely overpriced.

It would be intelligent to purchase the grocery store for $7 million, but extremely foolish to purchase it for $7 billion. Clearly, any business may be an excellent or poor investment depending on its offering price in the stock market. If you allow only the public market price of your business (or changes in the direction of the market price) to guide your decision on when to buy or sell some or all of your business without analyzing the financial condition, historical results of the business, and likely future results of the business, then you are a gambler instead of an investor. 

Once a person recognizes that the stock market exists to serve them in buying businesses at reasonable prices, and does NOT exist to inform them of the value of businesses - they become an investor. They take advantage of the stock market instead of letting the stock market take advantage of them.

There are both informed and ignorant people participating in the stock market. The skilled (informed) investors inform themselves of the financial condition, performance, threats, and expectations of the business to determine a reasonable value and an appropriate price to pay for the business. The rookie participants quickly read an article or hear about a stock in the cafeteria at work supposedly about to “explode” in price Maybe they see the PRICE of their business declining or see the PRICE of a business rapidly increasing. They may make uninformed emotional decisions that often cause devastating financial results.

While there is certainly risk of loss when investing in businesses - comparing a slot machine player who has zero entitlement to assets and zero predictability of the financial result to a true investor who has entitlement to assets and a predictable future stream of income is completely invalid. Let us be more concerned with and informed by reasoning, and less concerned with and informed by results. If we are more concerned and informed by facts and reasoning and less concerned and informed by emotions and results from unknown causes, then we are likely to find that the results take care of themselves. 

Next time you rely on the market price (or the direction of change in the market price) to inform your decision on whether to buy or sell a business or businesses remember this quote from Warren Buffet’s professor at Columbia University:

”You are not right or wrong because a thousand people agree or disagree with you - you are right because your facts and reasoning are right.”

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This commentary on this website reflects the personal opinions, viewpoints and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

Written by: Hunter Biggs

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