Have you ever initiated an investment that provided you with an abnormal return? An abnormal return results when an asset price surpasses expectations of what the asset price should be. For example, let’s say that you wanted to purchase stock in Apple at $400 per share and that you expect the share to be worth $450 each in three months. If the share price rises to $475 per share, then you would have achieved an abnormal return of $25 per share. This was the return that you experienced that was above and beyond expectations.
It’s important to note that expectations for stock prices can refer to a variety of different asset pricing models. It’s not realistic to simply pull numbers out of the air and say that “I expected the price to go to (x) therefore my abnormal return is (y)”. There must be some sort of analytical methodology behind your analysis. You should ask yourself a few easy questions:
- What do you expect the stock price to be?
- When do you expect the stock price to reach that point?
- Why do you expect the stock price to be at what you claim?
Positive abnormal returns are usually found with high growth companies that have a lot of buzz surrounding their business. However, if you’re not careful and you choose the wrong stock it is possible to have a negative abnormal return. Pay close attention to your investment techniques to ensure that you are setting yourself up for growth you can trust.
Categories:
Glossary of Stock Terms, Stock Valuation, Stocks and Shares Tags:
Abnormal Returns, DCF, DCF Valuation, Discounted Cash Flow, Profits, Returns, Stock, Stock Market Valuation, Stock Valuation, Stocks, Valuation
An IPO is an acronym that stands for ‘initial public offering’. IPOs represent the first time that an organization sells shares of stock on the public market. IPOs are typically used by organizations to raise capital, but can also be used to increase exposure, gain notoriety, and increase liquidity. Many times organizations that file for IPOs are small, but large private organizations can also file for IPOs.
In today’s complex business environment, high potential fast growth start-ups seem to find capital without the need for filing an IPO. Many of these organizations have been called ‘Death Star IPOs’. Death Star IPOs are highly anticipated IPOs with significant upside potential. Some companies that fit the profile of Death Star IPOs include Google, Yahoo, LinkedIn, and Pandora. Facebook could also become a Death Star IPO, although some investors think that ship has sailed.
How can you cash-in on IPO mania? Pay close attention to highly anticipated IPOs. Look out for names of organizations that seem to get a lot of media attention. It is also important to pay attention to the fundamentals of that organization. Although Death Star IPOs have strong short-term upside potential, if you’re looking for a long-term stock pick you shouldn’t just get caught up in the mania. Speculation can destroy your principle.
It’s important to note that investing in the stock market is not all about finding shares that are most likely to double or triple in market value over a short period of time. Although that would be nice, it’s very difficult to pick winners solely based on this methodology. That is why there is more to stock market investing than simply trying to pick winners in the rapid growth game. It’s called seeking the stock dividend.
As alluded to above, the main philosophical division among stock market investors is in the decision to invest in a growth stock or dividend stock. A dividend is portion of an organization’s earnings that is paid out to shareholders periodically throughout the year. Most of the time dividends are quoted as a percent of the share price or dividend yield. From the most basic perspective, if an organization pays a $1 dividend and is trading at $10 per share, the dividend yield would be 10%. Dividends are typically paid quarterly.
When picking stocks, you should always remember the dividend. It is certainly possible to invest in stock that is both growth oriented and pays a dividend. However, keep in mind that when a company pays a dividend they are not reinvesting the money in research, development, and future growth. So, ask yourself: “what are dividends and how important are they to my investment strategy?” If all you want to do is eventually sit back and collect dividends, then remember the dividend stock. It’s the gold of stock market investing.
Stocks that are in oversold situations typically sell at prices that are well below true value. So what do you do when a stock that you hold suddenly becomes oversold? The first thing that you need to do is do not panic. The reality is that you can use an oversold situation to generate profits from your trades. This is true even if you already hold the stock. The key is to be able to identify when an oversold situation occurs so that you can profit from it.
When you already hold a stock that suddenly becomes oversold, the first step is to try to understand why the stock is oversold. In most situations, stocks become oversold because the market overreacts to what it perceives as bad news. An oversold situation is usually results from panic selling. You can use technical indicators to determine if this is the case, but common sense often prevails. If you determine that your stock is oversold, the best solution is to you buy the stock down. This means that you buy more of the same stock at the lower price, which lowers the total average price that you paid for that stock. When the stock increases in value so do your profits.
If the stock is under heavy pressure and you determine that the price per share will fall a lot more, then it may be best to simply sell the stock and cut your losses. However, if you are in it for the long haul and can ride the waves you should hold your position. Just remember that we all win some and lose some on occasion, so don’t be afraid to cut your losses and move on when you have to.
Have you ever wondered how you can quickly and easily determine the risk of a stock or stock portfolio? You can start by doing a little bit of research on the beta coefficient of investments that you are considering. The beta coefficient of a stock or stock portfolio is the measure of volatility of a stock or stock portfolio’s return versus that of the rest of the market. Typically the ‘rest of the market’ is a benchmark index which has a set beta of 1.
For example, if you are interested in a stock that has a beta coefficient of 2 (which is double the benchmark index of 1) then the stock is likely to move twice as much as the benchmark index. It’s important to note that the direction of the movement is not isolated to positive movements. In other words, the stock may climb twice as fast as the benchmark index during positive market movements, but it also might fall twice as fast as the benchmark index during negative market movements. Therefore, a higher beta coefficient means that a stock or portfolio is more volatile and a lower beta coefficient means that a stock is less volatile.
The beta coefficient can be a quick and easy way for an investor to gauge the risk of a stock or stock portfolio. Although the beta coefficient is a excellent metric to reference, you should always look at a variety of metrics when determining whether or not a stock or portfolio fits your investment objectives.
If you’re new to the world of stock market investing, you might not be familiar with some of the common mistakes made by investors. Although these mistakes have been made over-and-over again, and although these mistakes have been written about time-and-time again, stock investors continue to ignore these common pitfalls. This post will bring these pitfalls to light so that you can avoid making the same mistakes.
3. Overconfidence – It is natural for investors to gain confidence as their experience increases. And, confidence is not a bad thing! However, getting too confident can actually blind you. You don’t want to miss important trends in the market because your head is in the clouds.
2. No Plan or Objective – Why risk your hard-earned investment dollars by simply hoping for the best? Create an investment plan and objective. Why are you investing in the first place? What is your risk tolerance? This certainly doesn’t have to be 100-page document. However, you need to have some sort of guide to help you reach your end goal.
1. Emotional Investing – Don’t let your emotions take over. If you invest in a relatively strong and stable stock but happen to get your timing wrong, don’t jump ship just because the share price lost value. Create a plan for buying down the share price. Or, set limits for your losses.
Evade the trap. By avoiding these common mistakes early on in your investing career, you will be on your way to investing with success.
Share prices can easily become subject to bubbles. One of the most notable share price bubbles in recent history resulted in the stock market crash of 2001. Another recent (and painfully notable) price bubble occurred in the housing market in 2007. That bubble triggered the Global Financial Crisis of 2007 – 2009. For the most part, bubbles eventually correct themselves and prices do stabilize. However, if you get caught in the hysteria you may end up with empty pockets.
Share price bubbles are very difficult to identify at the macro level. However, the easiest way to spot a share price bubble in a specific stock is to scrutinize the fundamentals of the corporations issuing the stock. Compare metrics like the corporation’s P/E Ratio to that of a market index like the S&P 500. Is the P/E Ratio for the company significantly above the ratio for the index? If so, this may be a sign that the share price for a corporation is overvalued and that a price bubble exists.
Another way to spot share price bubbles is to be realistic about the growth potential of a corporation. Since the fair value of a share is often determined using the Discounted Cash Flow method of valuation, and since this method requires assumptions related to growth potential, make sure that investors are realistic about growth expectations. If you determine that growth expectations for a corporation seem grossly overstated, then that may be a sign to stay out (or get out if you hold the stock). These are just a few examples of how you might be able to identify market hype and profit from it.
Try answering this question: How do I know if I should invest in the stock of a specific company? Regardless of whether you are a novice or seasoned investor, this question is probably one of the most frequently asked questions in stock market investing history. Contrary to popular belief, the answer to question is relatively simple. It is the same thing that you do when you decide to purchase a house, car, cloths, or anything else. Do you know what it is yet? The answer is find value.
That was easy, wasn’t it? All you have to do is find value! Well, that’s actually the hard part. What is value? How do I know if buying shares of stock at the current price makes sense? These questions are the harder questions to answer and are typically the questions that scare investors. However, In order to become a successful investor you must get comfortable with the concept of finding value.
So, how do you find value? There are several tools available that can help you answer that question. One of my favorite tools is the P/E Ratio. Remember that share price alone does not tell us much about the value of stock. However, when taken together with a company’s earnings you have a metric that can tell you whether or not a stock actually has value. A good way to look at it is if the P/E Ratio for the company is significantly higher than that of the S&P 500, then the stock is probably overvalued. If the P/E Ratio for the company is significantly less than that of the S&P 500, then the stock is probably undervalued. If the stock is undervalued then that is a good stock pick. It’s as good as gold!
I know that this is oversimplifying it, but for the most part the P/E Ratio one of my favorite ways to quickly and easily find good stock investments. Stay tuned for more!
Market capitalization (or market cap) is a useful descriptive metric for stock market investors. It is a metric that describes the size or total market value of a corporation. Market capitalization is calculated by multiplying the current share price by the total number of shares outstanding. For example, if the current share price for a given stock is $100.00 and there are 10 shares outstanding for the corporation, then the market capitalization for the corporation would be $1,000.00. Below is one example of a breakdown of classifications based on market cap:
- Mega Cap
- Large Cap
- Medium Cap
- Small Cap
- Micro Cap
To a stock market investor, market capitalization helps with a variety of important aspects of investing. One of the most notable aspects is in the development of investment portfolios. Although neither a mega cap nor a micro cap corporation can be classified as a good or bad investment without looking at other metrics, market cap can help by giving an investor insight into the profit potential and risk of an investment. Generally speaking, mega caps have less risk and less profit potential while micro caps have more risk and more profit potential.
The bid price and ask price are two of the most quoted, yet at the same time least understood, share price metrics available to stock market investors. Together the two price metrics give birth to a more complex metric called the bid-ask spread, but for now the focus will be on the basic price metrics.
In the context of stock markets, the bid price is the highest share price that a buyer is willing to pay for stock of a corporation at a specific time. The prevailing bid price is also the price that an investor must pay if he wishes to purchase a given share of stock. For example, if the current share price for a security is $100.00 and the current bid price is $100.05, an investor will have to pay $100.05 for each share. In contrast to the bid price, the ask price is the lowest share price at which a seller is willing to sell stock of a corporation at any given time. The prevailing ask price is also the price at which an investor must offer her stock if she wishes to sell it. The difference between the bid price and ask price is called the bid-ask spread.
Neither the bid price nor the ask price alone tells much about whether or not an investor should invest in a given stock. However, when taken together the bid price and ask price give birth to the bid-ask spread, which can give helpful signals. The bid-ask spread will be covered in more detail in a future post. For now just remember that you will pay the bid price if you wish to purchase stock and will offer your stock at the ask price if you wish to sell it.
From my experience with stock market investing, it is important to start with the basics. That is why our discussion will begin with the topic of share price (which is also known as stock price). Although share price is by no means an easy topic to cover, it is a core principle in stock market investing. Without a good understanding of share price, it will be nearly impossible to successfully invest in the stock market.
That said, what is share price? In its most basic and commonly used form, a share price is the current market value of a single share of stock that issued by a corporation (for more information about stock and what stock represents, please visit our What are Stocks page). There are several ways to find the share price for a company. One of my favorite sources for share price information is Google Finance. Here is an example of the current share price for the stock symbol AAPL. The current share price is located just below the name of the company Apple, Inc.
On its own the share price does not tell us much about whether or not a stock is worth buying. Sometimes the share price is high for a company, and other times it is low. You should never assume that a high share price is a good thing or that a low share price is bad. You may be asking yourself if the share price on its own does not tell us much about whether or not a stock is worth buying, then why is it important? The answer is that when the share price is taken into consideration along with other metrics like an organization’s earnings, it becomes one of the best tools for finding “value”. Value is what drives whether or not a stock is worth buying and is thus the key to successful stock market investing.
Have you ever initiated an investment that provided you with an abnormal return? An abnormal return results when an asset price surpasses expectations of what the asset price should be. For example, let’s say that you wanted to purchase stock in Apple at $400 per share and that you expect the share to be worth $450 each in three months. If the share price rises to $475 per share, then you would have achieved an abnormal return of $25 per share. This was the return that you experienced that was above and beyond expectations.
