The stock market has historically been a pretty good source of investment income, but you may be wondering if that’s still true today. After all, the world’s largest corporations now thrive in an environment where the spread of Covid-19 has made markets less efficient and more volatile. So is it still a good time to enter the market? Let’s take a look.
The UPSIDE
First, let’s discuss the upside. Despite what you may have heard, the stock market isn’t as bad as it could be. True, the Covid-19 pandemic has temporarily halted stock trading (for now), but that hasn’t reduced the demand for quality investment vehicles. If anything, the growing demand for exposure to the stock market has led to a surge in the number of brokers offering traditional, actively-managed exchange-traded funds (ETFs). So while it may be a rough patch for individual investors, the pros have already factored in this volatility and are busy looking for the next big gain.
THE DOWNSIDE
Now, let’s discuss the downside. Just like any other investment, taking a look at the stock market can be both thrilling and frustrating. On the one hand, you may wonder if stocks are actually undervalued, and on the other hand, you may worry about the fluctuations that come along with day trading. While the pros may have already anticipated some of these market movements, they can still surprise you with the speed and ferocity of the swings. This is what makes the stock market so difficult to forecast.
EARNINGS AND GROWTH
One of the biggest questions investors ask themselves is whether or not to take a look at a company’s earnings and growth. While the stock market in a broader sense looks at a company’s revenue and earnings, you need to determine whether or not these figures are worthwhile when it comes to your investing. This is especially important if you’re viewing a company’s 10-Q, which is their annual report filed with the Securities and Exchange Commission. In these filings, the company usually lists their earnings and growth alongside their other financial highlights, such as revenue and cash flow.
Often, investors will look at a company’s earnings and growth when determining whether or not to invest in that business or stock. After all, you may wonder how a company can generate such enormous revenue given the state of the economy and how challenging it may be to sell their products or services given the pandemic. As an investor, this is important information to have to determine whether or not to buy a stock, because while some businesses may be able to ride out the pandemic, they still have to generate revenue to sustain themselves. Without going into a lot of financials, that corporation may not be able to do this if they don’t improve sales in the next quarter.
VALUATION
Another important factor to consider when investing in the stock market is the stock’s current valuation. Most publicly traded companies are valued using one of the many commonly accepted valuation methods, such as the price-to-earnings (P/E) ratio or the price-to-book (P/B) ratio. The P/E ratio is usually measured by taking a company’s share price and dividing it by their earnings per share. A lower number indicates a stock is undervalued, and a higher number indicates that it is overvalued.
The price-to-book (P/B) ratio is similar, except it is based on a company’s share price and the sum of their all of their assets (i.e., book value). Simply put, the higher the number, the more assets there are on the books compared to the stock price. A low P/B ratio may indicate an undervalued stock, and a high P/B ratio may indicate that the stock is overvalued.
WHEN IS THE BEST TIME TO INVEST?
Now that you have some idea of the factors that you need to consider before investing in the stock market, let’s discuss the best time to invest. Based on the above, you may wonder if now is the right time to invest in stocks, given the pandemic and the state of the economy. After all, as bad as the economy may be, the demand for stocks hasn’t gone away. The economy may simply be shifting to a new normal, but that new normal has opened up a whole new world of investment opportunities for you. So while the pandemic may be keeping investors away from the stock market, it hasn’t kept professionals from analyzing the market and looking for the next big investment opportunity. This is where you come in.
CHOOSING THE RIGHT STOCK TO INVEST IN
When it comes to the stock market and individual investors, the first question that comes to mind is how to choose the right stock to invest in. To answer that question, let’s first discuss the importance of a quality piece of paper when trading. Similar to real estate, the quality of the paper the stock is printed on can have a massive impact on the value of that security. This is why it is so important to get a good night’s sleep before heading to the office each day. The less stress you have, the better the quality of the work you’ll produce.
Determining THE PRICE OF A STOCK
A critical part of any investment opportunity is determining the price at which you will purchase the security. To do that, you need to consider a number of factors, such as the P/B ratio, the P/E ratio, and the dividend yield. These are all important in determining the price of a stock, but you also need to set a limit as to how much you are willing to pay for a security.
Taking all of the above into consideration, you can set a price limit for the security that you are considering purchasing. If the business has a low P/B ratio and a high P/E ratio but pays out a high dividend, then that may be a sign that the business is undervalued. In other words, if you believe the business has great potential but can’t find a good enough price, then you may decide it is not worth your time pursuing.
PURCHASE PRICE VS. MARKET VALUE
One of the most important things to do when investing is to determine the difference between the purchase price of a security and its market value. To do that, you need to look at what other investors are paying for the stock and compare it to what you are willing to pay. This is where most people get confused when trading because they don’t know how to value a security once they’ve purchased it. However, there is a simple way to figure this out, and for the sake of this example, let’s assume that you’ve purchased 1000 shares of XYZ Inc. (NYSE: XYZ) for $50 per share. One of your coworkers also thinks that XYZ is a great stock and has told you that other investors are paying $60 per share for it. What should you do?
Well, first, it depends on how long you’ve been holding the stock. Second, it depends on how much you’ve already paid for it. Third, it depends on your willingness to pay. Let’s assume that you determine that the market price of XYZ is actually $60 per share and that you’re not 100% sure of what the price should be. In that case, what you need to do is to sell half of your shares at $60 per share and buy the other half at $50 per share, effectively giving you 1/2 of a share for free (since you’re using leverage). This is how you determine your cost basis when using margin, and this is how you determine your gain or loss on any trade you make. For example, if you purchased a share of XYZ for $50 and decide that it is now worth $60, then you’ve made a $10 gain on the trade. In other words, you’ve doubled your money on something that cost you $50. In general, you always want your gain to be greater than your initial investment in the stock, and in this case, you’ve more than doubled your money. But if the market price had been $70 instead of $60, then you would’ve only made a $5 gain on your investment ($50 x 2). This illustrates the importance of always comparing apples to apples when comparing the performance of different investments. In this case, apples are measured by the S&P 500, and the oranges are measured by the price of a single share of XYZ.