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The Difference Between Gambling And Investing

Posted On March 7, 2018 2:10 pm
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Pass through equity types, such as REITs, MLPs, BDCs, YieldCos, and LPs, frequently turn to the market to sell new shares/units in order to grow. This is built into their business model because they are designed, and sometimes required by law, to pay out the majority of their cash flow as dividends/distributions. However even regular corporations, who mostly fund their growth internally, need the stock market.

For example many mergers and acquisitions are funded partially or entirely with equity. Without the stock market many such deals would not be possible. Of course given that most mergers are ill-conceived and wealth destroying attempts at empire building, that may not be such a good thing. However as with most things the key is to find a management team that is disciplined and avoids making stupid, non accretive deals.

But here’s the most important thing to realize about investing. Owning shares is not the same as gambling. Shares merely represent a piece of a real company, where real employees are working hard to provide goods and services while earning exponentially growing profits. In other words a stock is an income producing asset. And if the stock is a quality company, then that rising income means that shares will appreciate in value over time. Even if a stock pays no dividends, such as popular growth names like Amazon (AMZN), Alphabet (GOOG) or Facebook (FB), they still generate rising earnings and free cash flows.

Ultimately the value of a stock is the net present value of all its future cash flows. That’s a fancy way of saying that any company is worth no more than all its future profits, discounted to the present day. Of course in reality no one has exactly the same discount rate, (how much return investors demand compared to risk free investments such as US treasuries). In addition because the future is uncertain no one actually knows how quickly a company will grow or for how long. Thus there is a certain amount of “art” to investing, in addition to the hard-nosed analytics that come from studying fundamentals such as income statements, and balance sheets.

But at the end of the day there is a long-term method to the short-term madness. Or as father of modern value investing Benjamin Graham put it, “in the short run the market is like a voting machine–tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine–assessing the substance of a company.”

Now that’s not to say that there isn’t plenty of rampant speculation, ie “gambling”, going on as well. However this is mostly done by short-term traders, including the high frequency trading algorithms that sometimes cause flash crashes. In addition human psychology naturally leads to both bubbles, and the crashes that follow. However just because the stock market is misused, or even abused by some, doesn’t mean that smart retail investors are going to lose money over time.

The key is to always focus on the fundamental, and unchanging truth of investing. Which is that if you buy a quality income producing asset, at a fair value or better, (beneath the present value of its future cash flows), then you will make money over time. Either through capital gains, dividends, or likely both.

About author

Dividend Sensei
Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I currently write for both Seeking Alpha, Simply Safe Dividends, and DividendSensei.com My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams, and enrich their lives. With 22 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams. I'm currently on an epic quest to build a broadly diversified, high-quality, high-yield dividend growth portfolio that: 1. Pays a 5% yield 2. Offers 7% annual dividend growth 3. Pays dividends AT LEAST on a weekly, but preferably, daily basis