Every day, at the end of the day, there is a series of articles wrapping up the market. There always is some sort of facile explanation in the headline and then a few facts in the article around the headline. Every market day and usually a wrap up on the weekend. There normally are a couple of pithy comments and reference to some news item of the day. Typically there is a comment on the Fed, or the latest job news, of maybe a reference to Asian markets or some economic item in Europe.
There are similar news items on individual stocks, especially famous ones, just about every day as well. Some little news items is grabbed for Apple and attached to whatever the stock price movement is that day. Even for lesser followed stocks, when they do their earnings release any movement is attached to the market’s reaction to something in the release or a comparison to analyst expectations. Often there is a quote from the latest analyst report supporting the reasons cited for the stock move.
I can tell you, if you want to be a better individual investor, you need to learn to ignore such articles of reasoning. They tend to be very shallow and are written more to fill space than they are to offer any sort of thoughtful response to what actually has happened. Same thing for much of the instant analysis that is on the live financial news shows.
I am not saying that real news does not move stocks. If a company genuinely releases unexpected news, either good or bad, then the stock may immediately react. If there is a major geopolitical news item like a terrorist bombing in a financial or political center or some surprise currency move, then markets can and often will react and that news will be the cause of the reaction. However, news of that nature tends to be pretty rare and even rarer for an individual stock.
In my first substantial blog post for this site, I discussed my strategy of selling puts to generate income and profit. In that blog I listed several long tables of share prices that I suggested should be studied before deciding on a stock and committing to an investment. In my blogs on investor conferences and non-deal roadshows, I talked about the process the typical fund uses to decide to buy and sell and emphasized that the process tends to be slower without an immediate reaction causes by one conference meeting or visit in their office.
The same thing can be said about the analyst reports that appear right after an earnings call. Normally the analysts are rushing to get something written and they have call after call during earnings season. Their time with management is normally limited to. The questions you can hear on the call and about 15 minutes afterwards are all the time they normally get with the company and then they publish. Quite often what is written is a rewording of the press release with a highlight or two from the conference call. Earnings calls can be catalysts but they are more of a retail investor or a fast trading hedge fund play than the longer term investment trends that give stocks their underlying values.
If you want to learn about the market or a company, you need to do more than just read headlines or look for one answer to what something is happening. A good example is oil prices and energy stocks. There is a connection between the two, but small changes in oil prices that are within the range of normal expected volatility are almost for sure not causing the move in one particular stock or sector. An above average increase or drop is more likely a larger investor increasing a position or decreasing a position, and the chances that it happened that day because of the news item being identified is almost zero. A .5% move in Yen value is not going to change investment decisions on a company that gets some of their revenue from Japan.
This goes back to my advice to CFOs on doing the outlook section — you need to look past your spreadsheets and listen to the other functions and what they are telling you. When you are making long term capital commitments, you will a lot of simple answers to questions. These answers may sound right, but when making an investment decision you need to think a little more on it. Make sure that your question was really answered. Try and look at the question from a couple of more angles and ensure that you are making the right choice for your company.
Of course, most individual investors don’t have the training or the background to understand what is happening with the markets. From reading books like Flash Boys by Michael Lewis, even my understanding of the trading in the markets is somewhat shaken. With all the “Dark Pools” and algorithm based trading that is happening and the speed and velocity of dollars being committed, even the basic fundamental reasoning for stock valuation might be broken down. Individual stocks may get caught up in this trading and change pricing for no reason other than it was traded.
I try and keep my financing deals as simple as possible and avoid derivative collars or enhancements to them because even after I study carefully I cannot account for all of the factors that might move their deciding valuation factors more than expectations. If I cannot reasonably assess risk, then I do not commit. It is the same for me for investing decisions. If I do not understand and agree with how a stock is being valued, then I do not invest in it.
This blog entry is the reasoning I use when I encourage people that ask my advice on what to invest in to avoid individual stocks and buy low cost index funds. You have little chance of getting rich quickly but you’ll at least make the market average returns which are quite compelling. If you want to gamble with a stock, accept that you are doing no more than buying a lottery ticket or pulling a slot machine handle. Nothing wrong with dreaming, but recognize that you are dreaming. As a CFO, you need more than a dream. Lottery tickets are not a good strategy to make sure that you can meet payroll and pay suppliers.
I am not saying that you should not invest in individual stocks. With careful reasoning and some luck you do have a good chance of beating average returns. As a CFO you will be asked to greenlight new products or business areas. In the short run saying no is more safe but you may not have a long run if you say no to everything. Just make sure you understand the ways you can lose money on the deal and what you would do if that happened. If it does happen, you will at least have a plan. No different than if you were acting as CFO. You can take the risk and say yes to a new area of business or a new customer, but have a back-up plan you can execute on.
If you do want to invest in a particular stock, investing in something you know and maybe not in the industry you work in (to avoid concentration risk). Try and understand the product you like and other investing reasons for the company. Try and figure out who owns the company and why they would want to own it. A classic example of this for me is Hasbro. They own Wizards of the Coast and they own Magic the Gathering and Dungeons and Dragons. I play and like both games and think that Magic is important to Hasbro and I can at least tell if that game remains popular. They pay a dividend and raise it annually which I like. They have the rights to Star Wars for toys. They have been able to monetize their other properties in the form of movies that have done well at the box office. All were good reasons to buy. That stock is up almost 100% for me and continues to pay a good dividend. Every quarter there is a news article of two update based on the earnings release but because I keep track of the company, I know that the news articles are very superficial. I think I understand the main valuation drivers and what causes short term swings in value (short term is usually tied to movie releases).
Musashi tells you to study well. Not just your sword work and strategy, everything you do. Don’t be fooled by what is on the surface and easy explanations. Understand your decisions and make them as well as you can. People are depending on you.