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Robert Abbott
Robert Abbott
Articles (718)  | Author's Website |

Value Investing: About the Stock Market

What investors, especially value investors, need to know about the markets

January 20, 2020

So far in “Value Investing: A Comprehensive Beginner Investor’s Guide,” Blaine Robertson has sought to explain what it is that value investors do and how they do it. In chapter seven, he explained the arena in which they buy and sell.

He pointed out that what we call the “stock market” is really a collection of markets and exchanges where buyers and sellers meet. To begin, it is a place where corporations can sell shares, or ownership stakes, in themselves. They do this to raise money that will allow them to expand.

The market is also the place where buyers go to find assets that will grow more rapidly than they would normally earn in savings accounts or without the challenges of starting their own businesses. It’s important to remember there is a symbiotic relationship between companies and shareholders—each needs the other.

Within the market, there are two distinct areas: primary and secondary. Primary refers to the area in which shares are basically created, and the best-known example of this is known as the IPO (initial public offering) market. It’s here that big institutional investors and hedge funds subscribe to the forthcoming shares of both existing companies and private companies making their first share offerings. The secondary market, which we generally refer to as the “stock market,” is where individual and institutional investors trade shares with each other. The New York Stock Exchange and Nasdaq, as well as the over-the-counter exchanges, are secondary markets.

Robertson went on to list some of the factors that drive prices in the stock market, or generate the volatility that makes stock prices fluctuate above and below what investors might consider fair value or intrinsic value:

  • Interest rates: Low rates attract investors and push up share prices, while high rates repel them and depress prices.
  • Economic growth: When national economies grow, companies can grow their earnings and that attracts investors and pushes share prices higher. The opposite occurs with low or no growth.
  • Political stability: Events such as political crises and terrorist attacks make investors nervous and less likely to invest or pay higher prices.
  • Confidence and expectations: These refer to the moods of investors, and of course they are willing to pay more when they feel confident and enjoy positive expectations.
  • The bandwagon effect: Often, the market in general overreacts, sometimes positively which can drive prices above intrinsic values, and sometimes negatively, causing markets to plunge lower.
  • Related markets: Robertson offers no examples in this case, but we could point to currency markets and the currency crises that cause instability and indirectly depress stock prices.
  • Price-earnings ratios: Again, we will offer our own rationale, which is that low price-earnings ratios attract investors and new money, while high price-earnings ratios can repel them.

In the words of the author, "the value investor is immunized for stock price volatility." When prices fall, value investors see buying opportunities, and when prices go up, value investors become alert to selling opportunities. Once again, he turns to specific advantages of value investing:

  • It’s a strategy available to all investors because access to it is not about how much money you have, but how willing you are to work hard and exercise patience.
  • Low risk and high rewards are achievable if you do your homework intelligently. Good analysis will help you find low-risk stocks that you can buy at a discount and sell later at a premium.
  • Being financially smart means being patient where others are hasty and being able to spot opportunities. As Robertson argued, being financially smart is about making the right decisions.
  • Indifference to short-term fluctuations is another advantage. It means value investors expect market fluctuations and use them to their advantage.
  • Lower tax rates are possible because value investors hold for the long-term and avoid the capital gains taxes that catch short-term investors.
  • Value investors can save more because they avoid transaction fees. Frequent trading means frequently paying transaction fees, each of which reduces the amount available for investing and compounding.
  • Speaking of compounding, value investors and other long-term investors have time on their side.
  • Finally, Robertson argued that the value approach is a “fun way to invest,” citing the ability of value investors to be in control of where their money goes, allowing them to buy for less and sell for more.

Conclusion

I was pleased to see that Robertson wrote about stock markets; it’s probably the first time I’ve seen the subject discussed in a book about investing for beginners.

In covering the markets, Robertson explained that what we think of as “the stock market” is really a collection of markets, aka exchanges where sellers and buyers come together. In doing so, corporations and investors each benefit by serving each other’s needs. Robertson also listed some of the factors that drive volatility in the markets - volatility that leads to opportunities for value investors.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


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