Investing is a loosely defined term. By the textbook definition, it is the act of purchasing an asset with the expectation that income and appreciation will produce something greater in the future. Under that definition, nearly everyone par-ticipating in the stock market is an investor. Yet, we would not apply the label quite so generously.
The stock market comprises two broad groups: investors and speculators. The distinction is fuzzy, and the groups overlap. Investors focus on the excess cash flows a company can generate over its lifetime. Their objective is to pur-chase that stream of cash flows at a price offering attractive prospective returns. Speculators, by contrast, focus primar-ily on future prices. They buy because they believe someone else will eventually pay more.
It feels sanctimonious to say, but we are investors or at least we strive to be. The virtue of investing is that it is ground-ed in first principles. A stock represents an ownership claim on a business whose worth is tied to the excess cash it can generate for its owners. That cash can be returned to shareholders through dividends or stock buybacks. It can be used to repay debt, increasing the value of the equity as liabilities shrink. Or it can be reinvested with the goal of producing even more cash in the future. Value always ties back to the cash a business can and will generate.
Private business owners understand this instinctively. They do not wake each morning wondering what a stranger might offer for their company. They think about what the business earns, what it can distribute, and how those earn-ings may grow. At one price, selling would be foolish because the owner could harvest far more by continuing to hold. At another, refusing to sell would be equally foolish. What matters is the cash the business can generate over time rela-tive to the price being offered.
Investors value; speculators price.
That distinction should not be mistaken for a moral judgment. Speculators are not necessarily irrational, nor should their behavior be ignored. Price momentum, investor positioning, liquidity, supply and demand, and market sentiment can all exert enormous influence over where a stock trades. These factors may tell us little about intrinsic value, but they can tell us quite a lot about the price someone may be willing to pay tomorrow.
Even among investors, there is a continuum. Some are overly conservative with their assumptions and, as a result, fre-quently miss opportunities. Others are too aggressive, sometimes to their benefit, but often at the cost of undue risk. Somewhere along that continuum, aggressive underwriting morphs into outright speculation.