There is more then just numbers
Let’s be honest, if an investor can simply apply a few ratios to determine whether to buy a stock or not then everybody would be a millionaire. There is much more needed to exactly value a company. First you must completely understand what the company is doing and how it’s operating. That also means you have to check out the competition. If you don’t understand the products or services the company produces, you should not invest. Because then you have no clue why their products are selling and if they can keep it up in the future.
25.1 News & media
The mainstream media has a profound effect on stock prices. Bad news can make a stock plummet while good news can make a stock rise. That might mean that the stock is under or over valued because not all news is true. In today’s world (2021) news and social media has a huge impact on investors. One of the best examples is Elon Musk, owner of Tesla (and other companies). His tweets caused many investors to either buy or sell Tesla stocks:
Just one tweet caused a major sell off and a lot of people lost money. In the case of Tesla, it is crucial to follow every tweet Elon Musk makes. That may save you a lot of money.
Another example is the stock from gamestop. A group called Wallstreetbets who are very active on the social media channel reddit were quite positive about the stock and started buying. This was noticed by Wall Street and large Hedge Funds. They looked at the stock and determined it was overvalued and started shorting. Wallstreetbets members made a plan to counter this by buying and holding even more stocks. This caused the price to rise and rise while Wall Street and Hedge funds made big losses. The stock raised from $10 to a whopping $480+ at the highest peak. It is still trading very high:
Source: Penke trading - year 2021
News can have a big factor and if you are buying stocks you should be aware of the latest news and insights. If you didn't know about Wallstreetbets you have no idea why gamestop has such a high price per share while the fundamentals tell you something totally different.
25.2 Insider trading
Insider trading can give you information about how insiders of the company think about the current price and the future. If many insiders are selling while the stock price is rising you should take a closer look. Why would insiders sell stocks while the fundamentals are good? Insiders always know more about the company then any investor. It can be a valuable source of information. Would you sell anything that has a bright future?
But it can also be tricky because you simply don’t know why insiders are selling. Maybe they need money for whatever reason. At this time of writing (2022) the stock market is soaring and all time highs are formed everywhere. As a result, many top executives are massively selling their stocks. People like Mark Zuckerberg (owner of Meta (Facebook)), Larry Page (owner Google) and many more. Elon Musk also sold $1 Billion worth of Tesla stocks. Berkshire Hataway, the investing company from the world's most famous and most successful investor to this day, Warren Buffet, has the most amount of cash it ever had. So there is a good reason to look closer at the current market (2022). Inflation rates are hitting highs and interest rates may start to rise very soon. And if that happens, stock prices will fall.
25.3 Local and global Interest rates and inflation
Interest rates have a profound effect on inflation. When money is cheap people are motivated to borrow and spend more money. This will increase inflation because more money in the market means money is less valuable (less buying power). How do interest rate and inflation relate to each other:
- When inflation is high, interest rates are low
- When inflation is low, interest rates are high
- When inflation is high, there is more money circulating in the market
- When interest rates are high, there is less money circulating in the market
- When inflation is high, borrowing money is cheap
- When interest rates are high, borrowing is expansive
|High Inflation||Low interest rate||High interest rate||Low inflation|
|Interest rate decreases||Inflation increases||Inflation decreases||Interest rate increases|
|Borrowing money is cheap||Borrowing money is cheap||Borrowing money is expansive||Borrowing money is expansive|
|Goods and services are traded at higher prices||Goods and services are traded at higher prices||Goods and services are traded at lower prices||Goods and services are traded at lower prices|
|More money in the market||More money in the market||Less money in the market||Less money in the market|
There is a very tight relation between interest rates and inflation. If one decreases or increases, the other does the opposite. At this time of writing (2022) interest rates are historically low and practically zero. At the same time, inflation starts surging. Many financial products rely on this. This is called interest risk rate I talked about before. For example, higher or lower interest rates can have a big effect on the return of bonds.
The trend is your friend. This is not only true for day trading but also when investing in stocks. Actually, the trend is a very important factor for any investment you’ll ever make. Without sufficient data you can’t determine the trend. And without a clear trend, you never know where things will go.
Trends are very important indicators. Long term trends can give you valuable information. If suddenly the trend reverses you should take a closer look. This can be applied to all the ratios mentioned in former chapters, income statements and balance sheets. You can also compare trends from companies within the same industry.
25.5. Leadership changes
Companies change overtime. CEO’s and top executives are hired and fired many times. A new CEO means new changes in business philofosy. Why would you fire a CEO if everything goes well in the first place? When companies are struggling, changes in leadership might be a good thing. Think about all the businesses that went bankrupt because they thought they don’t need a website or online marketplace. They did not have terrible finances or bad products and services, they had bad leadership.
If you want to buy a stock, you need to know everything. From the finances to the persons that are leading the company. Elon Musk is a great example, he is a genius man but his frequent twitter messages also makes him very unpredictable.
25.6. Compare with other companies within the industry
Looking at finances is one thing, comparing them to the whole industrie gives you a much better picture. If a company has a healthy balance and income sheet, that does not mean there are no bigger companies doing even better. Every company can produce good results in a bull market (when stock prices are rising in a larger period of time). Just like every investor can make money in a bull market. Most investors get burned when things are going the wrong way.
It's crucial for any investor to always compare the company you want to buy with other companies in the same industry. You can spot trends within an industry and see if the company you want to buy shares from is following the same trends.
25.7. Seasonal cycles
It’s also crucial to know how the company and industry works. Some companies have seasonal cycles. Meaning they sell more products in summer vs winter or the other way around. Companies selling skis and related stuff will sell more when it’s winter. Likewise, restaurants will have more profits in summer because days are longer, people stay outdoors longer, there are more tourists because of vacation and on hot days people drink more beverages.
Car companies also sell much more cars in the summer vs winter. On colder days people tend to stay at home more often. Not only because of the cold but it also gets dark outside sooner. An investor should know if a stock is seasonal or not. This will be reflected in quarterly income statements. This can give faulty readings if you are not aware that the stock is seasonal and lower profits are expected.
25.8. Don’t follow others
A common mistake most investors make is copying portfolio’s or advice from other people. This is not a bad thing but if you don’t know why someone else has that stock or bond in it’s portfolio then you should first figure that out before buying them yourself. You can imagine that if someone posts the next big thing on a forum or website, thousands of people have already seen that same message. It can be very tempting to jump on the next thing because your favorite investor or youtube channel tells you but keep in mind that everyone that is following that person or channel thinks the same thing. Besides, if someone posted it somewhere then the person in question has already bought it before and might try to pump up the price by spreading information.
You should always do your fundamental analysis first before buying. Trust but verify. For the simple reason everyone only thinks about themself. Why would someone else give you valuable financial information without benefiting from it?
Chapters: The Ultimate Investing Guide
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