How Much is Too Much for Stocks?
Market Value Not Equal to Actual Value
A small loan can help you if you are short of cash until your next payday, but if you invest in the stock market and follow the crowd in their buying and selling habits, you may end up with many more liabilities than assets. Why is that? Have you noticed how much the stock market fluctuates in a day, and also the ups and downs of prices? Does this mean the value of a company fluctuates just as much as share price, or is there some sort of other force at work? As you will see, the market value of the share does not equal actual value of the same share in terms of a company’s value.
Market Price Based on Emotions, Not Logic
One of the pioneers in value investing, Benjamin Graham, believed that many people rely too much on their emotions when investing rather than their logic. This explains the fluctuations of the market, and also why a lot of people think it's risky to invest in it. The risk is constant buying and selling that is always going on in the market. This constant buying and selling is what either drives the share price up or down, and it’s what creates the risk.
Ben Graham suggested in his book “The Intelligent Investor” that if you want to build your wealth from the stock market, you need to use a “dollar cost averaging” technique, meaning to consistently buy more shares at a lower price over time. As inflation and company values grow over time, your investments will be worth more in the long run. It’s also known as the “buy low and sell high” technique. Unfortunately, most people tend to bring their emotions into their investing, and will panic and sell when the price is going down, because they are afraid to lose any more money on their investments, leaving them open to take out a small loan to survive.
Beyond the Smoke and Mirrors
The stock market is riddled with confusing terms, acronyms and policies, making it very difficult for the average investor to understand. It's mostly smoke and mirrors to keep customers oblivious and dependent on brokers, that get a lot of money, to do the investing for them. However, if you were to peek behind the curtain, you would see that all the confusion is just smoke and mirrors.
Inflated Price? Inflated Value!
In an effort to control the market prices, brokers and fund managers will either buy or sell enough shares to drive the price back up or down, depending on where the prices are going. Maybe it’s because a company got some bad news, or even good news, and investors are trying to position themselves to either make or avoid losing a lot of money. This tends to skew the value of a share price, and unbalances the market. Thus, a share price that has risen too quickly will have many shares sold off by fund managers or brokers to drive the price back down. Similarly, if a share price is dropping too fast, they'll buy as many shares to even up. So, if you see share prices inflated, don’t make the mistake of thinking it is worth that much. In fact, they may not be worth much at all!
P/E Ratio Tells it All
There is a very simple way to determine if a certain share price is on target or not—look at the Price per Earnings ratio. This is a valuation method that takes the company’s current share price on the market divided by the per-share earnings over a certain time frame, usually one year. So, if a company’s share price is $ 24 and the earnings per share over the past 12 months have been $ 2, the P/E ratio is 12. Typically, the higher the P/E ratio is, the higher the expectations investors will have for company growth. This means you'll likely see higher earnings over the next year with this company. However, the lower the ratio, the slower the growth regardless of what the market is doing.
Buy Low, Sell High
When you can learn how to find the correct value of a company or share, you will know when the share price is at its lowest, and when you can buy. After the share price tops out, you can sell your shares and pocket the difference without needing a small loan. If this is the track you take, you could make money in the stock market while others are losing.
Tags: Ben Graham, small loan, stock market investing, value investing