Sources of Income for Investors and Speculators

As far as I can see, there are two main types of income sources for investors, namely dividends and capital gains. However capital gains have two sub-categories. The first is the profits from undervaluation to fair valuation, which investors deserve to gain due to his/her own due diligence and analysis. The second category is from fair valuation to overvaluation, driven primarily by greedy speculators, which is icing on the cake.

The word dividend literally means benefit from an action or policy. There are no reasons why a company should not share profits with equity holders of the company. Equity holders are the ones who bear most of the risk. It is almost like a co-operation between shareholders and the founders of the company (in most cases for Chinese companies). If the company constantly takes advantage of shareholders be it by not paying any or paying too small an amount of dividends, or share dilution through rights issues, share options and whatnot, the relationship becomes non-mutual. The long term practice of these will create tension between two parties and both the equity holders and founders of the company will stand to lose. The company share price will most likely be below fair value in the long term due to lack of demand for holding onto low yielding assets. It would ruin the reputation of the company, hence the rippling effect on its customers, suppliers, and other parties.

While capital gains should not be treated as the bulk of the gains in the long term, but if timing happens to be on your side, capital gains will significantly outweigh dividends gained in the short term. The issue with capital gains is that they can go up indefinitely. As long as there is a story to sell, security firms, banks and everyone else will sell this story to greedy speculators. If the company has a reputable name coupled with a growth story, its stock price will see some serious overvaluation. However, these types of gains should not be expected at all. Your returns should do pretty well without the added bonus from greedy people. If you really come across one, take advantage of it while you can.

This is exactly what speculators do most, they don’t care about the valuation of a company, they don’t care about its fair value, they just buy into whatever that has a growth story. They just pocket the difference from fair valuation to overvaluation, or overvaluation to even more overvaluation – just the icing on the cake for investors. Now this is very risky business. They stand to lose big money if the story flops or they just timed it wrongly. They might do well in a good market, say from 2003 – 2009 (2007 was kind of a no brainer everything was super expensive, even for the smart speculators). In a range bound market, from 2010 to now, these story-buying speculators will do horribly.

While speculators are a different breed of people, a lot of so-called investors do not even know that they are speculating rather than investing. Speculation is so easy to commit that speculators fool themselves into believing they are investing. I try to treat speculation as a sin and avoid it as much as possible. Most speculators tend to ignore dividends, thinking that dividends will yield measly sums compared to multiple times growth in capital gains very quickly. They always seem to have to “hedge” their main bets against something in case something goes wrong. I say for investors our biggest forms of hedging are time and dividends. Time is always on our side, with dividends collected over the long term, our chances of losing in the long term is rather low unless we buy something really dud. Those who buy stocks based on earnings forecasts are outright speculators.

Lastly, I must say, proper investing is HARD, speculating is much easier. You can look at thousands of companies and not find one company worthy for your investments in bull market days. Speculation is a shortcut for proper investment. Most people love to take shortcuts in life, but how many shortcuts can there be that will yield similar results? By this fact, true investors will always, and always be the minority.


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