The difference between gambling and investing

Key takeaways 

• Investment is rooted in informed decisions and gambling is guesswork
• Uncertainty and market volatility widely acknowledged as “new normal”
• Growth today doesn’t inevitably translate into growth tomorrow
• Fully informed decisions not achieved by concentrating on growth or value alone
  
  

What separates investing from gambling? Maybe the neatest answer is that the former, at least ideally, is rooted in fully informed decisions, whereas the latter, at its worst, is the stuff of pure guesswork.

I’m aware of only one instance in which the line between the two has been successfully crossed. This brings us to Back to the Future: Part II and the time-travelling investment potential of Grays Sports Almanac.

The Back to the Future trilogy’s chief villain, Biff Tannen, uses a 21st-century copy of Grays to place a series of wagers in the 20th century. He can’t lose, as the book details the winner of every event he bets on.

Biff becomes obscenely wealthy and is dubbed “the luckiest man on Earth”. But luck doesn’t enter into it, of course, because he really isn’t gambling at all. In essence, he’s making fully informed investment decisions. 

The new normal

With uncertainty and market volatility widely acknowledged as “new normals”, today’s investors could be forgiven for yearning for their own Grays. We would all like to be able to predict tomorrow’s winners with no fear of being wrong.

How do we do this? In the continued absence of handy fractures in the space-time continuum, arguably the most effective approach lies in harnessing the power of data and appreciating the appeal of growth at a reasonable price.

Growth or value – or both?

Many investors have long been extremely interested in growth. The seemingly relentless rise of a handful of US technology titans – the “Magnificent Seven” of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla – underscored the purported merits of this focus for a number of years.

Yet growth today doesn’t inevitably translate into growth tomorrow. As recent events have shown, it’s unwise to assume a particular company’s share of the pie – or the pie itself – will get bigger and bigger in perpetuity.

In reality, sentiment can change. Expectations can become more grounded. As a result, share prices can be negatively – and heavily – impacted.

Aware of this possibility, some investors instead seek out value. The goal in this instance is to benefit from being ahead of the curve in recognising a business’s true worth and/or promise.

This represents a determinedly contrarian ethos. Value investors buy companies that appear cheap and then reap the rewards when the herd at last gets wise and belatedly jumps on the bandwagon. 

But simply snapping up cheap businesses left, right and centre is unlikely to do the trick. It’s wrong to believe value stocks generally outperform. Success in this arena tends to stem instead from a small cohort of companies that deliver exceptional returns over time.

All of the above strongly suggests the ideal of fully informed decisions – or a decent approximation thereof – can’t be achieved by concentrating on either growth or value alone. This is why the investment process we use is designed to identify businesses that can deliver both.

Data as a source of empowerment

I mentioned earlier the idea of growth at a reasonable price. This is the “GARP” in the SmartGARP methodology that underpins several of our funds.

SmartGARP is a proprietary program that sifts through a vast array of data in order to pinpoint companies that have both above-market growth and attractive valuations. As well as taking account of businesses’ own information, it examines shifts in forecasts of profitability, dividends and other key considerations.

Incorporating measures such as return on capital, assets and equity allows us to build a comprehensive picture of whether a company is capable of sustained growth. Crucially, we can also gauge whether it’s accurately valued by the broader market.

Novel datasets are constantly adding depth to this form of investing. Importantly, the human touch has a role to play as well – usually in checking the few factors or dynamics that somehow fail to enter the software’s reckoning.

Granted, there are no sure-fire bets in the Biff Tannen tradition. Even when armed with all this information, investors are likely to experience occasional periods of underperformance over the short term. Such is the nature of an uncertain world.

As in Back to the Future, though, it’s the long term that really matters. In this respect, as a wealth of evidence shows, a process that uses an abundance of data to inform investment decisions can be highly successful.

Needless to say, this isn’t the same as having a far-flung edition of Grays to hand. If only, eh? But let’s not be too jealous. Perhaps we ought to remember there was one thing “the luckiest man on Earth” conspicuously failed to predict: his own demise.