Speculative Company
What Is a Speculative Company?
The term speculative company refers to a business that invests a majority of its earnings and assets in high-risk investments to generate extraordinary returns. Speculative companies need not be new or small yet can be large and well-established companies as well. Biotechs, startups, and others, including those that pour their resources into product development and research and development (R&D), would be classified as speculative companies as these tend to be genuinely risky ventures. Energy companies are some of the most common examples of speculative companies.
Understanding Speculative Companies
Speculative companies assume a ton of risk by putting a large portion of their money into projects that have uncertain returns and a high probability of failure, such as product development and research and development. These companies can be newer, smaller businesses that don't have a viable history. They may also be large, well-established corporations. Albeit a considerable lot of these companies are in the energy industry, others can be found in the biotech sector. Startups are also considered speculative.
Risky investments that succeed can be very lucrative, leading to big returns for companies and their investors. However, the potential for loss is just as great. So on the off chance that these investments fail, the stock price could plummet and company earnings could take a hit. While the investment risk associated with small early-stage speculative companies is often significant, the possibility that they might track down a monster mineral deposit, invent the next big app, or discover a cure for a disease is enough incentive to take on the risk.
Despite what the title implies, investing in a speculative company isn't necessarily high-risk. This is especially true assuming that company has a credible, successful business model. The stocks of speculative companies like Exxon Mobil (XOM) or Royal Dutch Shell aren't classified as speculative since their expected return can be estimated with a reasonable degree of confidence.
Speculative companies often account for a small portion of an investor's portfolio. Their stocks might improve the return prospects for the overall portfolio absent a lot of extra risk, thanks to diversification. Experienced investors who dabble in speculative stocks typically search for companies with experienced management, strong balance sheets, and excellent long-term business prospects.
Special Considerations
Deciding to invest in a speculative company is troublesome because the conventional valuations metrics like the price-to-earnings (P/E) and price-to-sales (P/S) ratios can't be used since they are often early-stage and unprofitable. For such companies, alternative techniques like discounted cash flow (DCF) valuation or peer valuation may be needed to project future potential.
Most investors should try not to invest in speculative companies unless they have the time to dedicate to research, while traders should be sure to use risk management techniques when trading speculative companies to keep away from sharp losses.
A speculative company, all by itself, need not constitute a speculative investment for investors even however its stock price might be volatile.
Speculative Company vs. Speculative Stock
A speculative company is a corporation that bets its money on risky ventures. A speculative stock, then again, is one that a trader uses when they speculate on the direction of the market. Companies associated with these kinds of stocks tend to be genuinely risky and they might even have sketchy business models. The stocks often trade at a low price and are relatively volatile to similar companies that are more established.
Just like the ventures that speculative companies invest in, the returns of speculative stocks can go either way. As such, investing in a speculative stock can be equally as rewarding because when there's uplifting news or when the market is favorable, investors might see big gains. Similarly, on the off chance that conditions go south, the risk of loss is just as great.
Albeit the stocks of most speculative companies tend to be in their early stages, a blue-chip can occasionally become speculative in the event that it falls upon difficult situations and has rapidly deteriorating prospects for the future. Such a stock is known as a fallen angel and may offer an attractive risk-reward payoff in the event that it can manage to turn its business around and stay away from bankruptcy. General Electric's (GE) stock plummeted due to a fraud settlement and changes in its business so that today it could be considered a fallen angel.
Example of Speculative Company
Energy exploration companies are prime examples of speculative companies. That is because they continuously commit big chunks of their assets to exploration projects that more often than not end in failure. However, should one of these ventures succeed through discovering a new source of oil or natural gas, the investment has paid off. The opposite is true in the event that a company fails to satisfy the goals of its investment project.
Highlights
- These companies can be newer, smaller businesses or larger, well-established ones.
- Energy companies are prime examples of speculative companies since they commit a significant percentage of their assets to exploration projects.
- A speculative company invests a bulk of its resources into higher-risk growth projects.
- Investing in a speculative company doesn't need to be a high-risk investment, especially assuming that company established a credible and successful business model.
- Investments made by speculative companies can be lucrative assuming they are successful yet in addition have the potential for big losses in the event that they fail.
