Friday, 11 December 2015
Stock Price: The Most Important Stock Parameter
From the debt–equity ratio to the interest-coverage ratio, from cash flows to operating profit, traditionally, analysis of stocks has entailed myriad parameters. Stock analysts have their pet parameters against which they try to evaluate stocks. Indeed, one of the greatest quests in the stock market is to find a parameter or a combination of parameters that can find winning stocks most precisely. Unfortunately, no one has found one yet, though many people may claim they have. In my view, the most important parameter has always been there in front of us: the stock price.
Many seasoned investors may be amazed at the last statement. How can stock price be most important? Stock price is most important because your profits (and losses) in the market are governed by it. If you buy a stock at 100 units and sell it at 200 units, you make a profit of 100 units because the stock price reached the level of 200 units. If it had sunk to 50 units, you would have lost 50 percent of your money. So, you win or lose because of this “insignificant” thing called the stock price.
Still confused? To put it simply, in order to succeed at stock investing, it's important that you follow a strategy that is directly linked to the stock price. Ask yourself: What causes the stock price to go up? Then craft a strategy around this. Stock Market Investing for Employees discusses the EPS approach, which is based on the notion of the stock price. The approach says that the companies that grow their earnings at a reasonable rate over time see their stock prices moving upward.
A complete disregard to what causes the stock price to move and focusing on other distantly-related parameters will only prolong your quest for profits. The fundamental analyst is so engrossed in his own paraphernalia of tools that the stock price is the last thing that comes to his mind. The value investor turns a blind eye to the stock price as well. For him intrinsic value is more important than what the stock price is reacting to. Many investors are willing to sit over low to negative returns for years just because they prefer some other “magical” formula. Perhaps a technical analyst is more astute because much of his analysis is based on the stock price.
The conclusion is that no matter what strategy you follow, just see how well it relates to the stock price. If the relation is tenuous, profits may evade you for long. If the link is clear, you are very likely to make money.