Understanding Stocks

Understanding Stocks

At the time this article was written, the U.S. stock market had just lost 12 percent in the preceding 2.5 months. This type of market decline causes a serious amount of angst and worry among stock investors. Watching their account balances deteriorate and the subsequent sense of losing a significant amount of money is quite unnerving. One minute you have $1,000,000, and the next minute you have $880,000. Fear begins to set in, and you think about selling your stocks to preserve what you have. You logically assume that if your account gets back to $900,000, then you will sell…and then the market falls even more. Sooner or later, panic sets in, and you begin to sell your stocks, locking in the losses.

On the flip side, when the market goes up by 15 percent, and your $1,000,000 grows to $1,150,000, you sit back and enjoy the ride. Every day your earnings climb higher and higher, and you wonder whether you should sell off some of your stocks to take advantage of the earnings your stocks have made. Greed sets in, and you wait for higher and higher stock values until you either sell or hold onto your stocks, assuming that the market will continue to rise forever.

Because they do not understand stocks, both of these types of aforementioned investors have fallen prey to the stock market casino. The root of the problem lies in simply watching the price movements. Watching price movements without understanding what you actually own is the mortal mistake of most investors. The stock price is the equivalent to the lotto or a slot machine, and the actual asset you own is equivalent to a wise investor.

For example, if I own just one share of Apple stock, then this means that I own around .000000002 percent of the Apple Corporation. Apple is a U.S. corporation with real products, real patents, real revenue, real earnings, and real assets, such as $66 billion of cash. They also have real debt, real competition, and real expenses. It is important to understand the reality of what I own and what the market is willing to pay for this very real corporation. If Apple pays part of their earnings out as a dividend, then you will absolutely get your real share of those earnings from your stock purchase. If Apple is acquired, then you will absolutely get your share purchased from you. The U.S. Government will absolutely defend your rights in your ownership of Apple stock.

When you disassociate your investment in stocks with the actual ownership of an asset, you set yourself up to be attacked by greed and fear. Consider the following two investors, one who monitors stock price movements (PM) and the other who is an asset owner (AO) of the same stock, Apple. (This is merely a theoretical example and not a statement or opinion of the ownership of Apple stock.)

Client A—Mr. PM—looks at his computer and notices that Apple stock is up $5 (2 percent) after news of Warren Buffett owning the stock is released. Mr. PM is excited that he made a great investment of a stock that he intends to hold onto forever. Weeks later, the value of the stock continues to climb higher, and Mr. PM is confident of his stock-picking acumen.

A week later, there are reports that Apple suppliers are receiving cancelled orders for iPhone parts, and research analysts forecast that Apple stocks could take a hit. The stock is off $7 (3 percent) that day, and a shadow begins to loom over the stock. Because the value of the stock remains high—and Mr. Buffett is not selling his shares—Mr. PM is not worried.

A month later the stock is down by 20 percent, and Mr. PM feels the crunch. The stock falls another 10 percent, and all of Mr. PM’s gains are lost. Reports on Apple stock forecast greater losses, and now the stock value is just a few dollars more than what Mr. PM paid for it. The whole idea of the stock market is becoming frightening, and Mr. PM swears that if his Apple stock can increase to a particular price that will make it worth selling, then he will sell his stock. Apple starts to rally, and his stock grows in value, coming close to the price in which he swore to sell, but greed takes over, and he waits for the stock to increase a bit more. Once more, stock broker analysts report more gloomy news for Apple, and the value of the stock gets pummeled again. Mr. PM cannot handle the constant roller coaster ride and sells his Apple stock for nominal gain.

 

Client B—Mr. AO—has always been a big fan of Apple products. He has been a long time believer in the Mac computer and was an early adopter of the iPhone and iPad. He decides to research the stock to determine whether the stock price truly reflects the long-term potential of the stock. He considers the balance sheet and the income statement and discovers that Apple makes a lot of money on apps and that revenue is growing very fast. Mr. AO realizes that Apple has a stranglehold on their customers, but their customers are quite happy to be in the embrace of Apple.

 

Mr. AO calculates that Apple could easily grow at 15 percent per annum and that in 10 years, the stock could double in value. He also realizes that even if he is wrong about the growth potential, the current price of the stock is relatively reasonable even if the stock tanks. Mr. AO decides to buy the stock at its current price. He reads that Warren Buffet owns Apple stock and thus feels encouraged given that Buffet is also a long-term investor.

 

Mr. AO does not react when Apple stock continues to increase in price—the rising price is meaningless to him given that his focus is on the long-term potential of the company. When the stock broker analysts predict greater losses for Apple, Mr. AO realizes that such predictions are merely short-term fluff to promote selling of the stock. A few weeks later, the stock is down 30 percent from Mr. AO’s original purchase price. As a result, he buys a little more Apple stock while it is on the decline since he has a long-term view of the market. Two years later, Mr. AO still owns his Apple stock. Apple releases a whole host of popular Apple consumer products and items, and the stock is now worth 100-percent more than what he originally paid for the stock. Because Mr. AO used sound reasoning to purchase the stock in the first place, he ignores the daily market fluctuations and instead focuses on the asset that he owns.

Many investors who purchase mutual funds should realize that the same story is true for a diversified stock portfolio of strong companies as it is for an individual stock. When you own a mutual fund, you own the equivalent of many Apple stocks. As long as you feel confident about the long-term economic well-being of both domestic and international markets, then stock ownership should override any daily price fluctuations.

Warren Buffet once said that daily stock price fluctuations—up 1 percent, down 2 percent, etc.—are really daily popularity contests. Those who emotionally “vote” on the basis of stock popularity are gambling for short-term price gains. Buffet says that over the long term, the market is a weighing machine on the efficiency of world economies. No politician, dictator, or monarch has yet been able to stop the long-term powerful positive evolution of markets. Politicians may positively or negatively impact a specific stock or industry with their policies, but markets as a whole march on. Trump is absolutely different than any other president in modern times, but our country’s government and economy are bigger than under any U.S. president before.

Investors should be continually vigilant about recognizing three big economic issues that can cause market disruptions: collapsing money supply, bankrupt banks, and sovereign crisis. Collapsing money supply is what occurred during the Great Depression, “bankrupt banks” was the root of the 2008 financial crisis, and Venezuela is currently experiencing a sovereign crisis. At present, the United States is not experiencing any of these three market disruptions (these are rare occurrences in developed countries). Of course in 2008, the United States experienced a banking crisis, but that was the first of such an occurrence since 1930. Today, American banks are healthy and may be stronger than ever before. Money supply has slowed with the flattening yield curve, which is why the market is trembling, but it is not collapsing nor is it likely to collapse.

The investor who watches price movements is destined to fall prey to greed and fear. The investor who understands that stocks are the ownership of the majority of the world’s assets, the majority of the world’s income, the greatest invention patents of the world, and the greatest talents of the world will not be unnerved by short-term market gamblers. The future of the world, despite its problems, is destined to be more amazing than what we have already experienced. The majority of the world population is now exiting poverty forever and entering into a bright tomorrow. Do not let the daily popularity contest of the market cause you to fear the loss of your hard-earned assets—selling is the only way to assure that you will lose.