Strategist on reasons to bet on Coca-Cola and Hershey
Determining how many of us gamble in stocks is impossible, because it is impossible to get a consensus on what separates gambling from investing.
Both involve risking money on an uncertain outcome, but it’s the degree of uncertainty where the dividing line lies. More specifically, it comes down to the probability of profit – known in financial terms as earnings.
Gambling is definitely gambling
The statistical chance of long-term success from lottery tickets, casinos or online gambling sites is virtually nil because they are designed to favour the house. Odds of winning at a craps table are higher than the slots, but the same restriction applies.
“Everybody knows full-well that the house always takes a cut. You’re necessarily paying to play,” says Ambrus Kecskés, associate professor of finance at York University’s Schulich School of Business in Toronto.
“If you keep playing a game on an enormous scale forever you are still going to get less than the actuarially fair value,” he says.
Investments with no revenue is also gambling
The line between investing and gambling starts getting murky with speculative investments that don’t produce revenue-generating goods or services, such as cryptocurrencies.
Kecskés says putting money in conventional cryptocurrencies is gambling because they have no underlying physical or digital assets and do not store value. A cryptocurrency’s current value is derived from an intangible belief that others will also believe in its value over time.
That belief was rocked in late 2021 when the price of Bitcoin plunged by over 70 per cent in one year, after a nearly six-fold increase during the previous year. High profile reports of market manipulation further eroded confidence in the sector.
“More and more you discover that Bitcoin has severe flaws. Certain actors can collude and eventually take over control of the underlying block chain technology and ultimately create new Bitcoins for themselves at will – completely diluting its value,” Kecskés says.
Investments with no earnings might be gambling
Kecskés says investments in publicly-traded companies that produce something, on the other hand, have at least the potential to appreciate in value because they typically have underlying assets intended to generate revenue over time.
“An investment – high or low risk – will have a stream of cash flows that it will generate. That’s why you’re willing to pay something today for the stream of future cash flows,” he says.
But cash flow and revenue do not translate into earnings if they do not exceed costs. The current value of a stock is a reflection of the market’s confidence in the company’s ability to create or grow earnings. Share prices in the fledgling cannabis sector soared from pennies to meaningless highs to pennies again and the industry has yet to post profits.
Investing in profitable businesses is not gambling
Real investors like Warren Buffett get rich by investing in companies that earn and grow profits over time by growing their revenue while keeping costs down.
That requires scouring earnings statements and establishing metrics to measure a company’s earnings in proportion to its current price, such as the price-to-earnings ratio. If the price of a stock lags the company’s recent past or projected earnings, it’s a buying opportunity. If the price is higher, it’s a sell.
This week Buffett added homebuilders to his portfolio of companies that consistently beat or exceed earnings expectations.
One example is the big Canadian banks, which deliver the added bonus of growing dividends.
Kecskés is careful to point out, however, that 200 years ago the bluest of blue chip Canadian banks were a gamble.
“Given the valuation of Canadian banks at the time, what would you pay for a share of that business? Could you reasonably foresee the success of that business and the economic system of the country that had not yet been formed?” he says.