“I can’t recall ever once having seen the name of a market timer on Forbes’ annual list of the richest people in the world.” Peter Lynch.
What is the right price for a stock? In the end, no matter what the company does, how much it earns, how much debt it has and a myriad of other ‘how muches’, the right price of a company’s stock today is the highest anyone is willing to pay. If no one wants it, it’s worthless.
Stock markets give you a price for stocks. And if you need cash now from your investments, you’ll have to take the market price. But as any analyst will tell you, the price of a stock will often wander far from anyone’s estimate of value—in both directions.
The disparity between price and value may be caused by many things, including investor emotions such as fear and greed, the amount of money available in the hands of investors and the availability of attractive alternative investments. But stock prices will always, from time to time, return to a rational approximation of value.
Prices change faster than values
Assessment of a company’s value is, of course, a subjective thing. And it varies greatly from investor to investor. But when stock markets take wild swings, you can bet prices are moving much more than are values. The market may be creating bargains. Or it may be creating excesses. Or it may be correcting either.
The problems of governing your investing behaviour to profit from these swings of value are many. Picking a time to buy or sell is the first and most obvious. But what if you’re wrong? Many value-conscious investors sold out of the stock market earlier this year when prices were much lower than they are today.
When you sell, you’ll have to pay income taxes, assuming you made a profit and you held the stock in question outside a registered account. So when you decide to get back in, you’ll have less money with which to do so.
And what if prices keep rising after you sold? At what point do you throw in the towel and buy back in at higher prices. A related question would be, at what point do you get back in even if you were right and prices fell after you sold? If you sell, buy back at lower prices and they fall even further, would you sell again?
That’s why we think attempts to time the market are counterproductive. You’re generally better off gradually accumulating equities during your working years and confining your selling to those years just prior to and after retirement. And by following a dollar-cost averaging program—buying stocks with a preset amount of money on a regular basis—you’ll always get at least some opportunities to buy stocks at attractive prices during your investment career and thereby profit handsomely over the long term.
Is this market a bubble?
The rebound in North American stock markets since March has had many market observers talking about a bubble. Though this is probably not a term that appropriately describes the overall market, it’s arguable that the rise of technology stocks during the pandemic has some resemblance to a bubble. Regardless of whether it is or not, anyone using the term has in mind the suddenness with which a bubble can burst.
Bubbles develop when investors lose any sense of value, and buy securities only in the belief that someone else can always be found to pay more. While stock prices in a bubble can fall with mind-numbing speed, values take much longer to change. And equity values depend largely on earnings.
A price of 23.3 times earnings, the current price/earnings ratio of the S&P/TSX, suggests a return on investment of 4.3 per cent. That’s a better return than you can get on most bonds.
This is an edited version of an article that was originally published for subscribers in the October 30, 2020, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.
Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846