I would like to tell you my view on stocks. I used to invest almost exclusively in stocks. Stocks are one of the easiest investments to invest in and also the easiest to lose. I have recently moved from most of my money from stocks to investments that are backed by hard assets or contracts such as real estate or bonds. Stocks I have learned are what I like to call an intangible asset meaning that other than cash, the rest of the value of the stock is based mostly on future cash flows. This makes them hard to give a valuation on and easy to get wrong. I am not saying don't invest in stocks. I am saying do not be a stock picker. If you want to invest in stocks, by an index fund/ETF or a mutual fund. One thing I do not like about funds is that they are trying to beat a benchmark. I would rather have them try to beat a benchmark AND be profitable. Instead of a fund being happy that they only lost 10% instead of the 30% the benchmark that they compare to lost, I would rather have them sell everything and not lose that last 10%.
I would like to make a few comments/observations on stocks and why it is hard to pick stocks.
1. This is what usually happens to me and most investors. You pick a stock that you think is going up for whatever reason. Just by picking the stock you have a 50/50 chance that it will go up or down. Say you pick correctly and it goes up. So you bought it for $100 and now it is $200. What usually happens is you sell it take your $200 and use it to buy another stock. This time however, you guess wrong and the stock goes down and you lose most of your $200. This has happened to many investors and I do not think it is possible for most people to get it right enough times to make money over a period of time. Even the best money managers who were good for the last 10-15 years, eventually got it wrong and lost all the money they had made. Here's an article on Bill Miller.
Its almost like flipping a coin. You can guess right 10 times in a row, but on the 11th you may lose.
2. How to pick a stock. I, like so many have picked stocks that are 5 star rated, picked by Jim Cramer, passed a stock screen, but it still goes down. Why? I have learned that there are just too many variables that make a stock go up or down to keep track of. For example, say you want to buy a solar stock. So you read a bunch of analyst reports, listen to Cramer and buy the best of breed, do a stock screen for a low P/E ratio. So at the end of the day there are 2 stocks left. You pick one and buy it. Now what happened in Oct/Nov 2008 is that because some banks had worthless mortgage back securities, your solar stock goes down because of the credit crisis. Now, in order for you to have forseen this, you would of had to do research on banking and housing stocks. Now, I find that very hard to do and even to know that you need to do it. There seems to be an infinite number of variables when investing in stocks.
3. What is the value of a stock? I kept reading that $2 trillion worth of money was wiped out in 2008.
Now, this is not really true. For example, say the stock price of Apple is $100 and say there are 1 million shares outstanding for example. That would make the market cap $100 Million. Now, if you sell 50,000 shares the price of Apple will probably go down to $99 or $98. This happens because there are not enough buyers at $100. So if you want to sell 50,000 shares, maybe 25,000 will go at 100, 10,000 at $99.5 and 15,000 at $99. So the $100 is really the maximum someone is willing to buy it for which means that the market cap of $100 million is not really true. The only exception is when a company buys another company, they usually pay a premium to the existing market cap.
There was a period from 2003-2007 where the market was up 100%. In the last 10 years, though there is around a 1% return, they call this the "Zero Decade." They say that the first year after a recession is over is the greatest gains for stocks. I moved most of my money out of the market and into bonds. But what I am doing is maximizing my 401k and currently buying stock mutual funds at low levels. This way if there is a rally I am going to take part in it. All my other money is in bonds. I do plan to take it out of the market once it goes up 30% or more, maybe when the DOW is over 10,000 again. My next post will show some theories about the next 10 years.
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