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Hey, this is Sasha Evdakov and welcome to another episode of Let's Talk Stocks, episode number 133.
In today's video what I'd like to do is cover some of the differences between speculative stocks versus more stable companies, companies that have been around for a little while or the companies that you probably are more aware of and more importantly which ones should you trade.
What is your risk tolerance?
If you're looking for a quick and simple point or simple answer to this question, it really comes down to you, what is your risk tolerance, where are you personally? For some people that want less risk, with less risk, of course, comes less returns or smaller returns, then, by all means, you'll probably want to stick to more stable companies.
If you're willing to take on more risk, then you'll also probably get some higher returns or higher losses, but in that case you'll probably want to go and move towards more speculative companies or companies that are a little bit less unknown.
Let's cover some of these topics and get more insight behind these things so that way you can be aware of what to look for, what to watch out for and get deeper into this subject.
Stable vs Speculative companies
The next thing that I'd like to do is take a look at some more specifics behind the differences between stable companies and more speculative companies; because what is a stable company? How do you define a stable company? And what is a speculative company? How do you really define it?
Ultimately there's a huge range or if you look at kind of a spectrum, let's just use over here as a stable company and over here is more of a speculative company, there's a huge range that you could go in between.
Any company that you choose on the stock market could fall somewhere in between this range and all we're really doing is kind of categorizing the extreme, somewhere over here.
There's a lot of companies in the middle, so it's important that you remember that we're really looking at some of the extremes and where you're trading or some of the stocks you're choosing could be somewhere in another range, so keep that in mind as we go through the rest of this lesson.
As we take a look at a stable company here on the left and a speculative company here on the right, one thing to note is, as we go through some of these fields, we take a look at the time, how long has this company been around or available?
Oftentimes a speculative company has been around a lot less, so it's usually a much younger company than something like, let's say a Microsoft.
A company that's been around only a few years, like let's say a Groupon or a GoPro, comparing that to the time frame of let's say Microsoft, that's been around for quite a long time. So the time period really plays a role because there's more consistency.
Also the volume can also play a large factor. Usually, this is a lot less volume, let's say the lower 10% of traded volume compared to other companies, whereas often times more stable companies will trade in the top 10% of volume, or higher volume than normal.
It's not always the case, but often times that can give you an indication of what's more of a stable company versus a speculative company.
In addition, the behavior. The behavior of stable companies is also predictable because they have a longer history, they often have that revenue growth that continues to compound time and time again.
That's not always the case, sometimes the revenue actually continues to decrease time and time again, but at least you get to see that consistency, whether that consistency is to the upside or the downside.
When it comes to speculative companies, sometimes things or behavior can be a little bit to the downside, then a little bit to the upside, it's less predictable of what's going to happen, so you can't really predict that behavior as much, it's more erratic.
Also earnings, you typically have much higher earnings and you also have more predictable earnings, whereas in a speculative company earnings are a lot less, but you're looking for major growth because that's kind of why people choose the speculative companies.
Manipulation and Market cap
In addition, manipulation. It's a lot more difficult or harder to manipulate more stable companies and there's less of it, simply because they have a large market cap, whereas here we have a smaller market cap and there's more manipulation.
Price per share
And finally the price per share, usually they are higher priced companies and these are lower priced companies. This could be like penny stocks or stocks that are trading for five dollars a share, whereas here a stable company, it could be something in the $30 to $50 range, but it could also be something like in the $150 range, like an Apple or something like that, like a Netflix.
That's why they're also harder to manipulate, because it requires more cash, whereas if a stock is $1 or $2, it’s a lot easier to manipulate those kinds of companies.
Which one should you choose?
That's kind of the differences. Of course, you're probably wondering: Why would you choose one over the other?
Of course many people choose speculative companies for one main or big reason, and that is because the percentages or the potential of growth, since we have a lower price per share, you can use leverage to go ahead, buy your share amount and then when the stock does explode, you go ahead and make more.
This, of course, is that get-rich-quick mentality. This is what many people who trade speculative companies really bet on, is because it's a lower stock price, they use the leverage, buying more shares, because in the end the way they look at it is they only really need one or two companies for them to explode and that's where they make their money.
When you look at stable companies, it's a lot less returns, when you look at the profitability, but you get that consistency, so the behaviour is really what's key when it comes to stable companies because you're getting that consistency time and time again.
It all depends on your personality
For some people, depending on their personality, speculative companies are great with an A type personality, more aggressive, people who like more risk or people who are more retired, like stability, then probably going with a stable company is better, because you'll get that consistency.
I'd like to also share with you a couple of charts and graphs to kind of illustrate some of the things we just talked about, and it really comes down to your end result as far as your profitability.
I want to look at one chart, which we compare profits versus the risk that you take on, and then also profits versus your chance of success or your probabilities of success.
Profit vs. Risk
When we look at your profits versus the risk that you take on and we look at this diagram, on the left axis what we have is kind of our profit area, this would be our profit on the left, which goes up and down, as we move higher or up, this would be a higher profit and as we move low or lower, this would be a lower profit; and here the risk that we have is on the bottom, as you go left to right you have lower to higher risk.
As we go ahead and start plotting some points here, when you start going into investing, if you have something that’s low risk, you're probably going to get not as much capital or not as much profit.
We'll just jot a little point right here on the lower left area and this would be something like a bank CD, so you're kind of starting out with low risk, but you also get low profit, because you're consistent on this, because with a bank they're going to pay out your CD or Certificate Of Deposit time and time again; less risk but less profitability.
As you continue to move towards the higher end risk of the curve, of course your risk increases but your profit potential also starts to increase. As we continue and move more into, let's say ETFs, you continue to increase, then we continue and we get into stocks or more stable companies, continues to increase.
And as you continue to drive up that risk, you might get into the speculative companies, where you have a higher profit potential but the risk is also greater. In either case, as you increase the risk, your profit potential also continues to increase.
Profits vs. Success
On this other side we have the profits versus the chance or the percentage of chance of success. When you have a low chance of success, which means you'd be kind of in the high-risk area, you have that higher profit potential, it would be somewhere over here; let's just put a dot in the upper end top left area of this chart.
This is kind of how things start out, and as your chance of success gets increased, as you
get into that middle or higher chance of success, your profitability or your potential profits start to die out, they slowly start to diminish here.
Eventually there kind of becomes this stability point, so you might have kind of a stable area, where your chance of success kind of gets into that 50/50, but you still have that profit potential that you make, which could be like a nice little sweet spot which, let's just say this is the stable companies or the stable stocks.
And then eventually, this also trickles down, because you're getting into a very high chance of success; as you get into a very high chance of success you get that diminished amount of profits or a very low amount, and this could be kind of like your bank CD's.
Find the sweet spot
The point I want to make here for you is, when you start looking at the speculative companies versus what's under on the stable companies, the amount of area that's really underneath this spot, you really start to get a good grasp of, where do you want to be kind of in the sweet spot, where is the sweet spot?
You have a couple different choices of course; if you're looking for the higher profit potential, the speculative companies obviously are the way to go, but they do have a higher risk.
If you're looking at stable companies, yet that consistency and you still have a large amount of stable companies you can choose from, but that's where the majority of money is made when it comes to the stock market, so you want to focus kind of on that stable area because you have that higher chance of success.
There are a few people that really do well on speculative companies, some people who trade speculative companies, penny stocks, those kinds of things and can play on the manipulation and can deal with the fast trading that you have to do here, they can do fantastic and well and make profit in a big way because the risk is higher, but you have to take advantage of that little area.
But for those of you that are a little bit more average, want stability, then you want to focus more on those stable companies because there's more consistent returns.
Obviously if you want extreme high chance of success, then going into doing something like a bank CD would be better, but of course you'll barely make any money on that, just basically covering that state of inflation.
It's important to kind of find your balance, where you want to stick to, and it comes down to your personality and your own risk tolerance and risk levels; if you have an A-type personality, you might want to trade the higher risk stocks, if you have kind of more of a calm B-type personality, then you want to trade more the stable companies or invest more in stability.
I hope this gives you a nice little breakdown and comparison and things to think about when it comes to trading stable companies versus more speculative companies or companies that are more well known or bigger cap stocks, usually the companies that are more stable are a little bit more higher priced versus kind of the penny stocks.
Find what works for you
Again, it really comes down to you, finding your balance, where's your sweet spot, because for everybody different things work out a little bit better. If you're looking to purchase a van, are you going to go with a Honda or a Toyota or maybe something completely different?
If you're looking to get kind of a four-door sedan, again some people will like maybe an Acura, other people will like a BMW, other people will like a Toyota or something completely different, everybody has their taste. You need to find what works for you and your personal risk tolerance and risk levels.
Thanks for joining me in this week's lesson. I hope you really found it helpful and insightful to making your own trading decisions and figuring out whether you should trade more stable companies or more speculative companies.
Resources & Helpful Tools
April 20th, 2017
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