Over the past 100 years, the stock market has returned %10 annually. There have been some major recessions in the past, but overall, the stock market always tends to come back stronger.
There are many reasons why I choose to invest in stocks and promote investing in stocks. The main reason is simply because the stock market is an investment opportunity available to everyone (unlike business opportunities).
The problem I see with the stock market is that roughly only half of Americans invest in individual stocks. This number is decreasing as younger people are seemingly becoming more uninterested in the stock market.
If we are ever going to be able to achieve Financial Independence, then we need to begin investing now!
Traders vs Investors
In order to fully understand how the stock market behaves, it is important to understand the difference between an investor and a trader.
Investors in the stock market are focused on owning quality companies (i.e. stocks) that they believe will grow and provide a safe investment into the future. I consider myself an investor (and you should too), where investors typically ‘Buy and Hold’, not ‘Buy and Sell’. There are numerous strategies to investing that differ drastically. Some people invest in high paying dividend stocks (Johnson & Johnson or Apple), growth stocks (Amazon, Netflix, Snapchat), value stocks (Etsy, Fitbit, Go-Pro), or a mixture of all three. I will dive into these different types of stocks in a later article.
Traders on the other hand try to take advantages of short-term moves in a stock where some traders even trade intraday, buying and selling a stock in the same day. Most traders are heavily equipped with models and triggers that tell them when to buy and sell stocks. These models have become so technical that every bank and hedge fund manager has begun trying to trade using AI and pre-programmed loss limits (called stop-loss thresholds).
To be clear, I do not aspire to be a ‘Trader’, but I absolutely plan to invest in the stock market as a long-term investor. The term ‘long-term investor’ is a redundancy, as investing by definition is a long term act. So henceforth, when I use the term ‘investor’, I am implying a lifestyle commitment to investing.
The problem for the investor is that traders typically influence short-term fluctuations in the market by providing analyst reports, like this one from Goldman Sachs on AMD or this article from Pacific Crest on Nvidia. Articles like these two can cause serious doubt in a company’s outlook, and can even cause individual investors to sell shares of a very promising company.
Sudden movements in a stock’s price can cause immense joy or serious melancholy. The key is to remain calm and wait for the truth about a company to come out. In this case, the truth about a company is its earning reports.
All publicly traded companies have to provide an earnings report every quarter, and are available online. Some companies even provide earnings reports from previous quarters and years.
It is in this report where you can see if all the speculation from the traders, analysts, and financial experts (I’m looking at you Jim Cramer from Mad Money!) hold any water or has more holes than Swiss cheese.
These earnings reports are key to understanding the ins and outs of a company. Major areas of focus I like to concentrate on are:
- CEO’s Comments To Employees and Stockholders
- Year over year (YoY) growth
- Month over month (MoM) Growth
- Operational costs growth as a percentage compared to overall revenue
- Cash on the balance sheet
- Company future earnings forecasts
Seeing these terms may make little sense to most people, but let’s go through a company that everyone is familiar with. Below is a screenshot of Amazon’s earnings report from February 2nd, 2017. Currently, Amazon shares are priced at a point where the P/E (price to earnings) ratio is about 180. The book ‘Intelligent Investor’ recommends paying no more than 20 times earning for a stock as a safe rule of thumb for valuing stocks.
So why is Amazon trading at 180 times earnings? Let’s take a look.
Some key points to take away from the above.
- Amazon had a YoY Net Income Growth of %397 (this can’t be real, right?)
- Amazon had a Quarter over Quarter Net Income Growth of %55
- Amazon has less inventory costs this year than last, showing they are becoming more efficient
- Most of the costs were in investment opportunities, showing that Amazon is still focused on growth
- Amazon has $15.89 billion dollars on the balance sheet. I don’t see Amazon going bankrupt anytime soon.
It may not be clear from the earnings report whether or not Amazon is worth its current price of $900 per share. What is clear is that Amazon is a well run company with a great history of growth. It is no wonder that Amazon is currently valued so highly among stockholders.
After announcing this great earnings report on February 2nd this year, Amazon’s share prices dropped %4 the following day. But why? Didn’t the earnings report show a company with promising growth?
The problem is that between quarterly earnings, which are roughly three months apart, everything in between is speculation. The %4 dip was due to the fact that analysts overestimated how well Amazon would perform and ‘corrected’ the mistake once the truth was revealed.
A company’s earnings report reveals the true state that a company is in. Once a company releases their earnings report, the company’s stock price will adjust or correct itself based on their latest report. This is the point where stocks are the closest to representing their ‘true’ value.
The Calm Before The Storm
There are a multitude of reasons as to why stock prices move up or down. The market can be influenced by political issues, large banks/hedge funds, or a million other reasons.
The market has currently been at a standstill on Wall Street. Since March this year, the stock market has been incredibly flat (see NASDAQ below). Many investors are unsure whether or not the stock market is going to have a great 2017 or a dismal 2017. Once the earnings for the first quarter are announced, the market will then be able to see where the economy is headed and which companies are the winners and which are the losers.
The markets rallied once Trump was elected in November due to his promise to cut corporate taxes, but have stalled due to the political gridlock in Washington. The combination of having a fickle president like Trump and a historically overpriced stock market have many investors wary of investing any more money until the first quarter earnings for 2017 are announced.
This week, the week of April 23rd, is a huge week for investors. This will show how many of the major companies in the stock market are doing.
Just take a look at Jim Cramer’s list below. McDonalds, Chipotle, Boeing, Pepsi, Twitter (ARGH Twitter!), Starbucks, Google (Alphabet), Dominoes Pizza, Microsoft, General Motors, and Exxon Mobile are just a few of the major companies that are announcing their earnings this week!
So, keep your eyes peeled for any stock that you are interested in. The market is not truly ‘efficient’ and stocks ‘reset’ to their true value once every 3 months.
One stock that I am looking at for this quarter is Nintendo (NTDOY). With the incredible sales in the new Nintendo Switch console and the new Zelda game, I am confident that the share price will increase significantly. The Nintendo Switch is now the best selling console in history (outselling the Xbox One, PS4, and Wii). Nintendo will report their 2017 Q1 earnings on April 26th, just 2 days away!
Understanding why and how the market moves is key to becoming a good investor.
So, if you are interested in investing in a particular stock, then it is good to find out when that company’s earnings report will be announced and see if your outlook for the company matches the actual true earnings. You may be surprised at how good you are at picking stocks!
*DISCLAIMER: Do not invest in any stock based solely on the information above. This blog is meant to be supplementary to personal research. I may persoown some of the stocks mentioned above*