Are You Investing in the Stock Market? Or in Companies?
Are You Investing in the Stock Market? Or in Companies?
The initial response to this question is usually a puzzled expression from kind people and the question: “What do you mean? Aren’t they the same thing?” The un-kind folks sometimes say something like: “That’s a dumb question, aren’t they the same thing?”
The answer is NO. It is not the same. Please read more
Have you ever had the experience of shopping and saying: “Wow, this item is really cheap at this store.” Or “that is a great price for _____” Or maybe: “I cannot believe they are charging $---. It is not worth that much.” Or “I’m going to wait until after the holidays and things go on sale.” Or “Because of the shortage of parts and the supply chain, the price is of __ is way too high now and it is not worth that price.”
These are comments on value. Price is what you pay or receive when something is bought or sold. While value is what it is worth to you, what are you willing to buy it for.
The price of stocks is in some ways similar to shopping for bargains. Realize that prices go up and down. Just like items are cheaper at the Mall after the holidays, stock prices are often cheaper in times of uncertainty when people are fearful like the early days of Covid.
The stock market is that number that is reported every market day for the DOW Jones Index, NASDAQ, or S&P 500 index. These numbers are an “index” calculated from the price of the stocks that make up each separate index. You cannot invest directly in an index. These indexes were invented to provide people with a number to compare with previous numbers to determine if stocks are “priced” today at a higher or lower price than at an earlier time.
These stock “prices” are the amount that buyers and sellers are willing to pay each other for the exchange of shares of that stock on that day. Read carefully now. I am talking about the price paid to buy or sell a stock on that specific day and time. Price can be very different from the “value” of a company. Allow me to explain.
The price of a company’s stock (and also an index) is really a factor of two components:
- The profits (earnings per share) of a company and the dividend they pay to shareholder’s are both measurable. This is the intrinsic or real value of the company.
- The emotional value are what investors are placing on potential changes the future will bring to the company’s profits. In other words, are investors optimistic or pessimistic that the company will be more or less profitable in the future. This factor is not measurable. It comes from the gut, is emotion driven, and subject to being wrong probably more often than right. This is what causes investors to flock to the market in times of euphoria (tech bubble of the late 90s) with crazy expectations and dreams of riches or sell at the worst possible time (financial crisis of 2008 or the Covid crash of 2020).
Companies are run by people that are responsible to the employees and customers of the company, the company’s Board of Directors (who hire and fire the Chief Executive Officer), and finally shareholders. Usually, upper management of companies and members of the Board of Directors are some of the largest shareholders. Therefore, company management and the Board are very sensitive to maintaining and increasing the profits of the company because those profits have a direct impact on share prince.
The second factor that influences the company’s stock price are external items or things that can add or subtract value from the company. These items include tangible factors like new product announcements, research breakthroughs, new contracts, more locations, and business partnerships. These are things we can see and touch. Other external items affecting that positively affect share price are intangible such as growth in the national CPI, unemployment declining, government spending, or the Federal Reserve (FED) lowering interest rates. Many of these may not directly affect a company but as is often said, “A rising tide floats all boats.” In other words, when you feel better about the future you will buy more shares…but this is feelings…not facts.
On the negative side, stock prices in general often decline due to the FED increasing interest rates, unemployment increasing, a war or rumor of war, a global pandemic or fear of pandemic, all of which may lead to a recession (that may or may not happen) that may or may not be a big deal. What I am saying, is that fear or concern about what might happen will cause some people to sell shares out of concern of possible stock price declines whether or not the company is less profitable. It’s not that the company is less profitable but it is the fear of what may happen often cause some people to sell.
When a company’s share price declines due to an emotional selling of shares (without a fundamental decline in the value of the company), it is often only a function of time until serious investors realize the bargain price and begin to buy and the price of the share goes back to the higher price.
Over time, as the profits and earnings of a company continue to grow, share price will go up as well. Perhaps not at the same rate or as consistently, but go up none the less. At times realize, the opposite can be the case. A share price can be a bit “frothy” or higher than it should because investors got a bit too enthusiastic and are willing to pay more for a stock than the company is valued.
A couple examples are: 1) company “A’s” stock went up a lot and then down over the last year. Shares were selling at over $400 per share in the Fall of 2021 and $350 by the Spring of 2022 all the while company earnings are up slightly over that same time frame. The stock is now less than $200 /share. This can mean the stock is a bargain at the current price or people simply got caught up in the hype and paid way too much for it at $350 or $400.
Allow me to give another example. Company “B” had earnings /profits per share over $5 in 2020, over $8 in 2021, and over $9 in 2022. Good trend. The dividend was up each year from 2019 through 2023. All this would make one think the share price should be consistently going up. Well not so much. The share price was about $150 near the end of 2019, and over $180 early in 2020…Then COVID hit and the stock dropped to less than $140 during the COVID market crash. So the stock price dropped by one-third all the while the dividend was up from previous years and earnings were good….Why??
COVID was a new unknown “game changer” that scared the pants off investors and feelings were negative so many sold in fear of the “end of the world.” But after the world didn’t end, the stocks recovered quickly. Company “B” price was back over $200 by the end of the year and over $300 one year later. All is good, right?
Well not exactly. In 2022, the FED began an aggressive campaign of increasing interest rates to combat inflation and a recession seemed likely. Stock prices dropped by about 20% during the first three quarters of 2022. Company “B” share price was close to $200. Profits are up. Stock price is down. Why? Fear of rising interest rates, the Ukrainian war and a potential recession. Today the stock is approaching $300 again.
These are merely examples of how prices can change even though the profitability of the company has not changed. It is not a suggestion or recommendation to buy or sell a particular company.
The price of shares of companies is a bit like Goldie Locks and the Three Bears. Sometimes too hot, other times too cold, and sometimes just right…. meaning the share price might be trading higher that the real value of the company, sometimes less than the real value and occasionally at a price that reflects the “real value” of the company.
Good companies with good management increase their “real value” over time. This means they expand and grow their profits. When the profits grow the share price increases. However, as I discussed, it is common for events (like COVID, a recession, war, etc) separate from the company and its profits can affect the “view of future profits” and some investors “loose the faith” and sell shares that drive prices down as in the example of Company “B” discussed above.
The first key to financial success involves time in the market…..not timing the market. Have a plan with clear financial goals. Select investments that will allow you to accomplish those goals. Stay in the market.
Key #2 is to keep sufficient cash for emergencies and spending needs for a minimum two-year period. Only sell stocks when the market is up. Market declines tend to last two to three years or less. Refill your cash reserves periodically when markets are up. However, if you are not spending portfolio income then you may have little need for a large cash position.
In closing, investment planning is really, cash flow planning. Know your cash needs. How much…and when? Decide on a target cash need. In a perfect world, that amount is fixed. However, when markets decline, you spend down some of that money. When markets go up, you fill that cash bucket back to the target. Plan to have the bucket of cash large enough to provide peace of mind / no-risk knowledge you can pay all your bills even when the market is down.
Investment success / cash flow planning is all about the plan. Make the plan….then execute the plan….but above all stick to the plan. I know it is hard. I know how easy it is to become distracted by the news, current events, politics, family, the opinions of others, etc. That is why we are here. To help you to learn and understand. To help you write your plan. To help you stick to your plan.
Wollman Wealth Designs, Inc is a financial planning and investment advisory firm in Escondido, CA partnering with families, friends and clients in San Diego County and around the country. Please visit our website, call the office or send us an email with your comments or questions.
“These examples are hypothetical only, and do not represent the actual performance of any particular investments. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and when sold or redeemed, you may receive more or less than originally invested.”
“The return and principal value of stocks fluctuate with changes in market conditions. Shares when sold may be worth more or less than their original cost. All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.”
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"The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.