No matter how experienced you are or how much research you have done into the stock market, stock investment always comes with a level of risk.
If you’ve recently heard of the term ‘speculative stocks’ but aren’t sure what it means, you’ve come to the right place.
Speculative stocks are one of the riskiest (and potentially most rewarding) aspects of investing in the stock market, so it’s important to educate yourself on this kind of investment early on.
In this article, we’ll be defining speculative stocks and discussing the complexities involved in both speculating and investing when it comes to these kinds of stocks.
What Are Speculative Stocks?
So, what are speculative stocks? Simply put, speculative stocks are stocks that traders ‘speculate’ may generate greater returns in the future despite their current underperformance.
Speculative stocks are typically traded at very low prices because they are currently not performing at a rate that would indicate good returns.
If traders suspect that this is likely to change in the foreseeable future, they might consider investing at the current price in the hopes that they will make significant profit on that investment when prices eventually rise.
For obvious reasons, investing in low-performing stocks on the chance that they might improve is considered a very risky strategy.
This is why ‘investing’ in such stock is often referred to as ‘speculating’ because there’s very little certainty involved regarding the return.
In most cases, speculative stock is owned by companies that are still in their early stages of development.
However, sometimes, blue chip companies may undergo circumstances that cause them to underperform, and their stock may become speculative.
You might hear the term ‘fallen angel’ used in this kind of situation.
The Difference Between Investing And Speculating
You may have heard people talk about ‘investing in speculative stocks’, but we want to reinforce the fact that trading speculative stocks is exactly that (‘speculating’), not investing.
In order for something to be considered an investment in the context of stocks, the investment should be relatively low-risk.
Of course, you can never totally eliminate risk when it comes to investing in stocks, but you should try to keep the risk as low as possible.
With speculative stocks, the risk is very high. In fact, trading speculative stocks is basically akin to gambling because whether or not you see returns on that ‘investment’ comes almost entirely down to chance.
What You Should Know About Investing In Speculative Stock?
If you’ve read everything we’ve told you so far about speculative stocks and have decided that you want to take the risk and try speculating yourself, you’ll need to educate yourself thoroughly on the subject.
The first thing you need to know is that you’re more likely to get returns on speculative stock in the context of bull markets because the risk tolerance is higher.
You’ll want to avoid bear markets (see also ‘What Is A Death Cross In Stocks?‘) because investors tend to be more risk-averse.
You also can’t rely on traditional price-sales and price-earnings ratios to calculate performance and returns for speculative stock because these stocks don’t usually have enough sales to yield reliable figures.
Instead, you’ll probably need a DCF (Discounted Cash Flow) valuation as well as valuations from peers to tell you about speculative stock’s potential in the future.
Obviously, these valuations are less reliable than the above ratios, so even with a lot of this kind of research, you’ll have to accept the risk that comes with dealing in speculative stock.
It’s best not to speculate unless you’re an experienced investor, and generally speaking, speculative stock should only make up a small percentage of your overall, diversified portfolio.
To maximize your chances of seeing returns on speculative stocks, you should prioritize companies that have good prospects for business in the long-term, reassuring balance sheets, and competent management teams.
Make sure to be especially careful when speculating during a recession because investors are much more likely to pull their money from high-risk investments during unstable financial times in favor of safe-haven investments.
Frequently Asked Questions
What Is An Example Of Speculative Stock?
There are many examples we could give to demonstrate what speculative stock is, but a common example is penny stocks (see also ‘How Can Money Be Made Quickly In Penny Stocks?‘).
Penny stock is a type of common stock currently valued at less than $1 per share.
This means that investing (or rather, speculating) in this case is low-cost but high-risk.
When Can You Sell Speculative Stock?
When you choose to sell speculative stock should be a decision based on multiple factors.
Overall, you should sell speculative stock if it becomes clear that it is not likely to appreciate in value.
You can determine whether speculative stock is likely to appreciate or depreciate in value based on DCF (Discounted Cash Flow) and peer valuation.
If the stock seems likely to depreciate, it’s best to sell it before it does so that you don’t end up losing money.
Are All Stocks Speculative?
There is a misconception that all stock investments are inherently speculative.
This is based on the fact that you can never be 100% sure whether you’ll see returns on any investment in the stock market because prices are susceptible to sudden and unexpected change.
However, not all stocks are speculative. While there’s a level of risk involved in any investment, there are both high-risk and low-risk investments.
Low-risk investments are not risk-free, but they are more likely to yield returns based on price-earnings and price-sales ratios, which are statistics you can’t rely on with speculative stock.
Speculative stocks are stocks that are currently not performing well (and therefore, probably selling for low prices) but that traders suspect might appreciate in value based on DCF and peer valuation.
Investing in speculative stock is known as ‘speculating’ and carries a high level of risk, similar to gambling.
Some investors will choose to make speculative stock a small part of their portfolios for the purposes of low-cost diversification, but this is only an advisable strategy for experienced investors.