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Overview
We all want to grow a little nest egg for our later years, and investing in the stock market is one way of doing that.
However, how many of us are confident enough to manage our own investments? Most of us leave it up to the experts. This is wrong because they charge enormous fees for their expertise and often get it wrong. Instead, we should be managing our own investments but how? These key points show you what factors you should look out for when judging the profitability of a share. If you follow them, you will beat the market average by a decent margin.
In this passage, you will learn the magic formula for business success. You’ll also discover who “Mr. Market” is and how to beat him in the game of business. Finally, you’ll find out how to cheat on your taxes without getting caught.
Big Idea #1: It is extremely difficult to find a good financial professional who can guarantee you large returns on your money.
When you were young, you used to believe that money magically appeared under your pillow. However, as an adult, this idea doesn’t seem so crazy because you know that investing in the stock market can increase your wealth.
Most of us understand the basics of the stock market, but we still need experts to help us manage our investments. Unfortunately, most financial experts aren’t worth their fees because they don’t know how the stock market works and simply sell you any investment product that pays them a commission. They have no incentive to sell you products that are actually good for your portfolio; they just need to sell you something.
Mutual funds are a popular way to manage investments. They can have high fees, so you may not get the best results. However, there is one type of fund that performs better than others: an index fund which matches the market’s top performers and has lower fees when compared to actively managed funds.
If you’re happy with someone else managing your money, then invest in index funds. However, if you want to maximize profit for yourself, learn how to manage your own investments by following the key points below:
Big Idea #2: The stock market values of most companies swing drastically over short time periods for no rational reason.
If you were to graph the stock prices of Google or Disney over the last five years, what would it look like? Probably a steady increase in price with only minor fluctuations. However, that is not always true; even successful companies experience changes in their stock prices.
For example, on November 13, 2014 the price of Google stock was $558.25 and its price ranged between $510.67-$615.04 over the previous 52 weeks. On that same day, Disney’s stock was at $89.90 with a range from $68.80-$92 over the previous 52 weeks. Why are prices so different? The real value of a company is not reflected in its share price; sometimes it’s undervalued and other times it’s overvalued. One way to understand this is by thinking of the market as an emotionally unstable person (Mr Graham). He really wants to sell you shares but he can be volatile some days offering his shares too high or low depending on how happy he feels about his company that day. You can exploit Mr Market’s temperament by buying when he’s feeling down and then selling back at a higher price when he feels better.
The following are some key points to remember when using Mr. Market to your advantage:
Big Idea #3: Look at the “earnings yield” and the “return on capital” when putting together your investment portfolio.
If you want to beat the stock market, you need to buy shares when their price is below the company’s value and sell them when the share price is above it. To do that, find out whether a company’s share price is too high or low by using two numbers. The first number tells you what the company earns in relation to its share price (earnings yield). Find that ratio by taking earnings before interest expenses and taxes (EBIT) divided by enterprise value (EV). EV includes debt plus equity market value.
