To the outsider, the stock market appears random and erratic. What makes a stock go up or down? Experts can't seem to predict the market, so why should I even try? This uncertainty scares many potential investors away from the market and its high rate of returns. People are missing out on good money!
This is sad, because the stock market is more predictable than it appears. While they may look similar, stocks are not gambling. This article will shed some light on the unpredictable stock market and will hopefully make things predictable.
First, I have to concede one thing. The stock market is very unpredictable in the short-term. The market severely overreacts to news, whether it's company earnings, economic factors, or something silly like who wins the Super Bowl. Nobody can predict all the news, which makes the stock market unpredictable in the short-term.
But in the long-term (6-months to a few years or more), the stock market is very predictable. If the company makes a lot of money, the stock's price will go up. If the company doesn't make money, the stock price will go down.
When I purchase a share of a company, let's call it Predictable Stock Market, Inc., I am buying a portion of this business...and a portion of the money the comapny makes. I pay $60 for one share, which represents one of 6 million shares of the company. Let's say Predictable Stock Market, Inc. then earns $6 million in profit the next year. That means my portion of the earnings is $6. That's how much you're $75 share of Predictable Stock Market, Inc. made!
Now Predictable Stock Market, Inc. has a choice. The company can give that $6 directly to you as a dividend, or it can reinvest that $6 into the company to make even more money in the future. Let's say Predictable Stock Market, Inc. decides to give $2 to you as a dividend and reinvest $4 into expanding operations. The reinvested portion of earnings make the stock price go up, making your $60 share of stock will be worth around $64. And you'll have $2 of cash in your hand. It's that simple!
So you purchased the stock at $60. It's not worth $4 more and you have $2 in cash. That means your return was $6/$60...10%.
Now company's earnings are not erratic or random. If you were asked how much money Coke will make next year, where would you look first? Most likely, you'd see how much Coke made last year? (You might also look for the years before that and see if there's a history of growth, and then add that growth to last year's profits, but that's not really important). And you'd be pretty close! Unless something drastic happens, Coke will probably sell as many sodas and make as much money as it did last year.
So let's see how much we should expect to make this year if we purchase one share of Coca-Cola (KO). I go to finance.yahoo.com to find the data. One share of Coke sells for $48. Last year Coke paid $1.24 per share in dividends, and earned another $2.23 per share that it reinvested into making more soda. If the same holds true (it probably will), then I'll earn $3.47 ($1.24 + $2.23). Spending $48 to earn $3.47 equates to a 7.2% return. That's a lot more than my bank account or money market will make!
Now this won't be 100% accurate. Remember that the market will overreact to news and current events. But over the long haul, Coke will keep earning that same rate, and you can accurately predict the unpredictable stock market.
Are you still skeptical? Try it for a year! Track some sticks and predict what will happen this year. Most likely, you'll be very close in all your predictions. Although I have to warn you - You'll be disappointed by all the money you missed out on!
Don't forget, you will want to include broker fees into your calculations. For more on minimizing broker fees, read Avoid Broker Fees! Here are the Best Places to Buy Stocks.
And there you have it! Stock market investing is not gambling and it's not rocket science. If a company makes money, its stock will go up! Now that you know this, you can accurately predict the unpredictable stock market. And hopefully you can earn good, predictable returns on your investments!
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