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Timothy R. Clark: Facebook and the bitter lesson of speculation

Published: Sunday, June 3 2012 11:25 p.m. MDT

Winston Churchill said, “The longer you look back, the farther you can look forward.” This is true only if you comprehend what you are looking back on. Take the Great Recession, for example, which is not far back at all, and yet judging by the financial behavior of some, seems to be in the distant and forgotten past.

Have we taken inventory of it? Have we learned enduring lessons, especially ones we can pass on to our children in order to ensure that they avoid the consequence and sting of the same lessons?

I can think of one: People quickly forget that investing and speculating are not the same thing. It’s not a new lesson, but one we often learn through bitter experience instead of sweet avoidance.

In Charles Dickens’ third novel, "Nicholas Nickleby," the father of the Nickleby family, beset with the expenses of a growing family, “looked about him for the means of repairing his capital.” And then he looked to his wife for advice:

“Speculate with it," said Mrs. Nickleby.

"Spec-u-late, my dear?" said Mr. Nickleby, as though in doubt.

"Why not?" asked Mrs. Nickleby.

"Because, my dear, if we SHOULD lose it," rejoined Mr. Nickleby, who was a slow and time-taking speaker, "if we SHOULD lose it, we shall no longer be able to live, my dear."

"Fiddle," said Mrs. Nickleby.

In the end, Mr. Nickleby bet the farm. As Dickens explains:

“Speculation is a round game; the players see little or nothing of their cards at first starting; gains MAY be great — and so may losses. The run of luck went against Mr. Nickleby. A mania prevailed, a bubble burst, four stockbrokers took villa residences at Florence, four hundred nobodies were ruined, and among them, Mr. Nickleby."

I wish those words — “A mania prevailed, a bubble burst … four hundred nobodies were ruined” — could be etched in stone as a superscription above the thresholds of our homes. “Ever learning, and never able to come to a knowledge of the truth” is the phrase that keeps sounding. Is it the love of money that is responsible for successive rounds of irrational exuberance? I suppose it is.

How do we pass on life’s financial lessons? First, we have to learn them ourselves. Mr. Nickleby passed through the experience, but it was too late to reverse the consequences, which his family was left to bear upon his sudden death. Dickens knew all too well about the corrosive and destructive effects of speculation and debt. His own father went to debt prison and the family joined the ranks of the anonymous poor.

The abiding lesson here is to accept the premise that investing is a discipline not a game. It requires analysis, logic and the placing of a measured bet based on calculated risk. People forget this truth in every generation.

An outstanding example of this is Facebook and its recent initial public offering. The company generates nearly $4 billion in annual revenues from advertising. At the time of the IPO, the company was valued at almost 100 times current earnings. I ask you: On what basis can the company be valued to the stratosphere? On the basis that somehow Zuckerberg and his team will find new ways to leverage the platform’s near billion-person user base to find new revenue streams? That is precisely the heroic assumption being made. But we really don’t know how or where those billions in yet unrealized revenue will appear. Do we?

When you have scant data and stacked odds, we call it speculation. There is simply not a strong rational basis to value the company this way. As a discipline, investing is based on the intent to avoid downside risk. If you apply that standard, putting money into Facebook is highly speculative. If you can afford to lose your wager, you are at liberty to speculate. If you can’t — if you’re like the Nicklebys — manage your risk to preserve your capital.

Always remember that the sheep-like behavior of so-called investors is a given in a capitalistic society. And the sheep are prone to mania and panic.

Unlike Mr. and Mrs. Nickleby, may we teach our children to make wise investments and avoid unwise speculation.

Timothy R. Clark is the founder of TRClark LLC, a management consulting and leadership development organization. His new book, "The Employee Engagement Mindset" was recently released from McGraw-Hill. Email: trclark@trclark.net.

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