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 in order to generate extraordinary returns. Speculative companies need not be new or small but 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 fairly risky ventures. Energy companies are some of the most common examples of speculative companies.

Key Takeaways

  • A speculative company invests a bulk of its resources into higher-risk growth projects.
  • These companies can be newer, smaller businesses or larger, well-established ones.
  • Investments made by speculative companies can be lucrative if they are successful but also have the potential for big losses if they fail.
  • Investing in a speculative company doesn't need to be a high-risk investment, especially if that company established a credible and successful business model.
  • Energy companies are prime examples of speculative companies since they commit a significant percentage of their assets to exploration projects.

Understanding Speculative Companies

Speculative companies assume a lot 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 track record. They may also be large, well-established corporations. Although many 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. But the potential for loss is just as great. So if 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 may find a giant 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 if 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 may improve the return prospects for the overall portfolio without much additional risk, thanks to diversification. Experienced investors who dabble in speculative stocks typically look for companies with experienced management, strong balance sheets, and excellent long-term business prospects.

Special Considerations

Deciding to invest in a speculative company is difficult because the traditional 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 might be needed to project future potential.

Most investors should avoid investing 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 avoid sharp losses.

A speculative company, in and of itself, need not constitute a speculative investment for investors even though its stock price may be volatile.

Speculative Company vs. Speculative Stock

A speculative company is a corporation that bets its money on risky ventures. A speculative stock, on the other hand, 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 fairly risky and they may 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 good news or when the market is favorable, investors may see big gains. Similarly, if conditions go south, then the risk of loss is just as great.

Although the stocks of most speculative companies tend to be in their early stages, a blue-chip can occasionally become speculative if it falls upon hard times 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 if it can manage to turn its business around and avoid bankruptcy. General Electric's (GE) stock plummeted due to a fraud settlement and changes in its business so that today it may be considered a fallen angel.

Example of Speculative Company

Energy exploration companies are prime examples of speculative companies. That's 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 in the form of discovering a new source of oil or natural gas, the investment has paid off. The opposite is true if a company fails to fulfill the goals of its investment project.

Article Sources
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  1. Yahoo Finance. "General Electric Company (GE)."

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