Stock Market Investing 101 #2

Before we get into the nitty gritty of stock market investing, there’s something really important that needs to be said. Economics is a complex subject involving what’s happening around the world, production of goods, banking policies, consumer buying habits, investor confidence or lack thereof, etc. etc. ad infinitum.

Here’s an example. Let’s just say the cost of oil goes up (not that it would ever do that). Let’s also say that XYZ corporation manufactures a widget that happens to be its main source of revenue. Everybody out there is racing to the store to buy XYZ’s widget. Suddenly there’s a price hike on the widget to compensate for the increase in cost to deliver widgets to stores. Consumers just as suddenly decide they don’t really need the widget anymore because the widget price has gone up plus it takes more of the consumer’s spendable income just to get back and forth to work.

In this instance XYZ is showing a lower sales volume, investors that hold stock in XYZ notice the drop and start to dump shares. The stock drops in value. Makes sense, right? Not necessarily because maybe XYZ has seen this coming and is developing widget #2 that will save money on fuel, but widget #2 hasn’t hit the market yet. Shrewd investors aren’t going to dump their stock, on the contrary, they’re going to buy more since the price has dropped on XYZ stock.

Now let’s say XYZ has widget #1 on the market, there’s been no decrease in gas prices (don’t we all wish), and sales are hot. XYZ, however has been basking in the glory of its widget and ignored the fact that there’s a Japanese import almost identical to widget #1 at half the price. Can you guess what’s going to happen to XYZ’s widget and XYZ’s stock price? The smart investor is going to see if XYZ has widget 2 and or how they plan on dealing with its competitors.

XYZ’s board of directers is unhappy with the management of XYZ and decides to fire the CEO (Chief Executive Officer). Investors get nervous when there’s a change, even if it’s for the better. Not wanting to take the risk of a new CEO, they dump their stock. The shrewd investor looks at the qualifications of the incoming CEO. Where did he or she come from? In other words, was the new CEO just fired by another company or wooed away. What business successes or failures are part of the new CEO’s history?

The reality is the market is fickle, but fun, at least I think so. If you want to invest in a company, you better understand what the company is up to. There are ways around having to keep your fingers on the pulse of the companies in which you invest, that’s by investing in enough companies, that poor management of one or two of them won’t have that big of an impact. When you do this, you’ll be investing in mutual funds, index funds, I shares or other funds that will stretch your investment dollar into many companies. You can also do this on your own, but average investors doesn’t have the money to sufficiently diversify their portfolios

Warren Buffett takes a different approach. He opts to invest his money in the sectors of the market he understands and he sticks with those companies for a long time. He looks for companies that he considers are undervalued based on the product they sell and the debt load they carry. We’ll be going into detail on that a little later, but suffice it to say the man seems to have a winning formula for market success. He’s not alone in his success either, if you follow the investment success of George Soros, you’ll see another market success story. Warren Buffett enjoys profits at about 20% and George Soros comes in with a whopping 30%. These are guys we should listen to, don’t you think?