Speculative stocks represent a type of stocks characterized by high risks and the potential for high returns. They are issued by small or relatively unknown companies with little to zero earnings or assets to support their valuation. These stocks are also traded on over-the-counter markets or avenues outside established stock exchanges. This article lists and discusses the advantages and disadvantages of speculative stocks.
Pros and Cons of Investing in Speculative Stocks
Advantages of Speculative Stocks
Several well-known investors succeeded in investing in some speculative stocks. Warren Buffett might be known for his value investing approach but has made some successful investments in speculative stocks. These include his investment in American Express in the 1960s which later became one of his best investments.
Peter Lynch has promoted his “invest what you know” philosophy and he used this approach to determine promising companies. He made successful investments in several speculative stocks such as Dunkin and Hanes. Jesse Livermore made a fortune by aggressively speculating on the stock market in the early 20th century
Nevertheless, considering the aforementioned, it is important to underscore the fact that investing in speculative stocks is a form of speculation. There are some benefits to speculation and they center on a higher potential for sizeable gains. The following are the specific advantages of investing in speculative stocks:
• Higher Return Potential: One of the main advantages of speculative stocks is that investing in them means betting on companies in their earlier stages of growth and their potential for exponential growth. This means that the value of these stocks can increase dramatically to provide investors with significant returns.
• Lower Investment Cost: These stocks also have a lower cost of entry or initial investment cost. Some are even traded for less than a dollar per share. Take note that some small-cap stocks and growth stocks can also be considered speculative stocks. Investing in them is accessible for individuals with limited or budgeted capital.
• Advantage of Volatility: Investors and traders can also take advantage of the inherent volatility of these stocks. This might be a disadvantage but it is also important to note that volatile stocks can experience significant price movements in a short period. This means potential for immediate large investment gains.
• Diversification Options: Those with diversified stock portfolios that include growth stocks, value stocks, defensive stocks, and cyclical stocks across different market cap sizes may also invest their spare capital in speculative stocks across different sectors and industries for further investment diversification.
Disadvantages of Speculative Stocks
The risk-return tradeoff states that investments with high return potentials also have a high risk for losses. This is the main disadvantage of speculative stocks. Not all investors would succeed in investing in these stocks. Those who succeeded are exceptions rather than the rule. Their success can be attributed to a combination of skills, experience, and luck.
Hedge fund manager Bill Ackman made several high-profile investments in speculative stocks but some of these were not well-planned. An example is his investment in Valeant Pharmaceuticals. John Paulson invested in the supposed China-based commercial plantation operator Sino-Forest but it turned out to be a fraudulent company.
Nevertheless, considering the aforementioned, these stocks should be off-limits to individuals who do not have spare capital that they are willing to lose. Investing in these stocks is akin to gambling because of the high level of risk involve which translates to a higher potential for losses. The following are the specific disadvantages of speculative stocks:
• High Loss Potential: Remember that these stocks have for generating significant returns but they also have the potential for incurring significant losses. This comes from the fact that these stocks are issued by small and relatively unknown companies with no proven financial stability and demonstrated track record of success.
• Disadvantage of Volatility: Volatile stocks can have an advantage as mentioned above but they also have a disadvantage which centers on unpredictability. Investments are not guaranteed to provide returns and specific investments in speculative stocks have the lowest guarantees or higher levels of uncertainties.
• Lack of Market Information: Another disadvantage of speculative stocks is that the companies that issue them do not have substantial market information to provide probable investors with informed investment decisions. It is difficult to conduct thorough research about these companies and analyze their performance.
• Limited or Lower Liquidity: Most of these stocks are traded on over-the-counter markets or small exchanges. This translates to limited liquidity. Specifically, because of this limitation, it can be difficult to sell these stocks as quickly as possible, thus making it difficult for investors to exit their positions.
• Susceptibility to Fraud: Some speculative stocks might come from companies with fraudulent operations. Scammers can also target legit stocks by spreading misleading information to artificially drive up their prices and later sell their shares at a profit. Susceptibility to fraud comes from the abscence of market information.
