This article was first published on May 30, 2014
Investopedia defines investment as the purchase of an asset or item with the expectation that it will generate income or appreciate in the future. Simply put, you want your money to “work for you”. This would help us in our life goal of doing “more fun stuff” other than work.
How does an investment work?
In essence, one has to believe in delayed gratification coupled with the mind-set that a dollar invested now would be worth much more in the future. This idea ties in with our previous article concerning the Time Value of Money.
Today we will focus on investments from the perspective of an individual instead of a business. But the underlying fundamentals and the objectives are cut of the same cloth. For example, given that you own a factory, you might want to mechanize your operations to improve efficiency which in turn leads to increased profitability. An example close to home would be Riverstone Holdings Ltd’s (SGX: AP4) investment in new production facilities, which led to an increase their average annual production capacity from 2.5bil gloves at end 2011 to 3.1bil gloves by end 2013.
This resonates with the idea of an individual purchasing either a stock or a bond to benefit their future self financially from this concept of delayed consumption.
Of course investments aren’t restricted just to stocks and bonds.
What investments are there?
From the above definition, basically anything can be construed as an investment given a demand. And we all know that a salesman with the gift of the gab can sell almost anything to their targeted audience. This rather broad definition would lead to inclusions of art, wine, comic books and even racehorses as “investments”!
But today, we will narrow down the definition of investments involving just financial assets with an expected stream of future cash flow. Financial assets are assets that derive value because of a contractual claim unlike direct investments in land and property which are physical assets. Direct investments would not be considered for this article.
Notice that some “investments” like gold would be excluded from the list due to the absence of an expected stream of cash inflow. As mentioned in Berkshire Hathaway Inc’s (NYSE: BRK.A) FY 2011 Shareholder Letter, gold doesn’t have much of an expected stream of cash flow or earning power relative to a company like Exxon Mobil Corp (NYSE: XOM). Hence, the author was of the opinion that an asset class such as gold belonged more as a hedging tool rather than a straight investment. Profiting of the purchase of gold appeared to be akin to a “game of the bigger loser” which would be akin to speculation.
This leaves us with the more conventional investments of:
2) Lending investments such as Bonds and Perpetual issues included issues such as Genting SP S$ 5.125% Perpetual Subordinated Capital Securities (SGX: P9GZ) and The Land Transport Authority of Singapore 4.17% Bonds (L07Z). Even Saving accounts are considered as such an investment.
Value In Action
Almost anything can be vaguely construed as an “investment” thus in the author’s opinion, considering an asset class with the possibility of an expected stream of cash flow would serve as a litmus test for an investment.
Wealth accumulation through investing requires due diligence and not by just discerning the difference between an investment and a speculation. But being able to tell the difference is a very important first step!
At the end of the day, there is no one way of investment! What matters is a framework based on fundamentals that one can consistently follow for a decent return and it also helps if you are comfortable enough with your strategy to sleep at night 😀
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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Cheong Mun Hong’s personal capacity and do not in any way represent those of his employer and other related entities. Cheong Mun Hong doesn’t own shares in any companies mentioned above.