By Wade B. Cook
FEAR AND GREED just written a new book. He said to me, “Dad, what makes stocks go up?”
Virtually every movement in the stock market is created by one of two human emotions: fear or greed. This aspect of stock market movement cannot be overemphasized.
Remember, when you buy stock in a company you are buying it because of “fear” or “greed.” If you really believe a company has the potential for making a lot of money, your purchase would fall under the greed category. Conversely, you sell because of fear. Yes, you’ve been greedy—your stock is up—so you sell before it goes back down. In short, fear and greed are the underlying emotions of all stock movements.
THE LAW OF SUPPLY AND
DEMAND
I was getting ready to go play basketball and my young son of 14 came in to see me while my wife and
I were talking. We were discussing some reports I had just read about the up-trending market, about which I had
WADE B. COOK
We only had a few minutes to talk so
I basically told him that stocks go up and down because of the law of supply and demand. I continued briefly that there are only so many stocks in anyone company, and when there are many people who want a particular stock, the price of the stock will have the tendency to go up.
Conversely, when a lot of people do not want the stock but want to sell, that emotion will create more selling and the stock will have the tendency to go down. All I had time to explain was that there was a middleman, like a warehouse. In this case it would be either the Specialist on the New York
Stock Exchange or the Market Makers on NASDAQ. That person is the middleman in buying and selling stocks, similar to a warehouse in buying and selling groceries. For example: at a certain time of year if there is a big demand for oranges, and the warehouse is getting low, they could raise their price and people would be willing to pay the higher price because they want oranges.
There is a demand for them. If the
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oranges have aged, or if nobody wanted them for whatever reason and if they were sitting there not selling, then the warehouseman would lower the price in order to create a price level where people would want to finally buy.
This law of supply and demand, while simplistic, still answers most of what goes on in the marketplace every day. As a matter of fact, to make it even more simplistic, let me share with you what my stockbroker frequently tells me. I know that he is very busy and when I call him about the market and/or a particular stock and it is up to $30, I usually ask the question “Well what caused that?” He is probably at that point in time typing away to get the stories or related information about the stock so he can give me a good answer. But while he is doing this he has this cute little answer he gives in a non-committal way. He says “More buyers than sellers.” Within that simple statement are deep implications. Conversely when stocks go down he answers,
“More sellers than buyers.”
Many years ago when I was teaching real estate seminars and other aspects of wealth accumulation from maintenance to retirement, I would frequently tell people that one of the keys to wealth is to own things that other people want to own. I am sure that anyone reading this has
WADE B. COOK owned something that has no value to anyone else. It could be an old car in the garage. It could be a 20-year-old mink coat. It could be a host of other things you have laying around the house. They have no value because nobody else wants them.
The way to accumulate wealth is to constantly accumulate things that other people want. In those instances I was primarily talking about real estate. We would discuss the areas of town; we would think hard on the type and size of houses; and also look at the quality of the house—how well it would hold up over the years—and then come to a conclusion that there is a certain type of property that could be purchased at the current time, which, in the near future and in the far-out future, would probably still be in demand by a lot of other people. If that area of the town grows, say, as the population grows, or as improvements are made to the property, then additional demand will be created and the investment will pan out and have the highest likelihood of staying profitable. But, if we buy real estate in a bad area of town, or buy a horrible property that is not only hard to maintain but virtually impossible to make profitable or improve upon, then our investment is probably not going to pan out because we have something that not too many other people want.
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As we turn to the stock market it is substantially the same wealth principal, yet obviously in a different arena. One of the keys to wealth accumulation, especially if you want to do it in a little bit more rapid manner, is to buy stocks that a lot of other people want.
There are different types of stocks, let me make a quick list:
1. Cyclical—these are stocks that either go through a two or three year cycle of expansion and bust, or a cycle completed a lot faster, say within calendar quarters throughout the year.
2. Value stocks—these stocks, compared to the other stocks in their sector or in the market place, are low priced. One calculation for this low price is the price to earnings ratio, or
P/E. P/E basically determines how many dollars we are spending for one dollar of earnings. This is a barometer of how well the company is doing because we can get the P/E on any stock and determine if the stock is undervalued or overvalued. Other measuring sticks would be the debt ratio, the dividend yield, and the book value of the company. Basically these would be categorized under the fundamental approach to looking at stocks, which is a way of measuring the health of a company.
3. Growth Stocks—I would put virtually all value stocks under the
WADE B. COOK growth stock category, but there is a separate category for pure growth stocks. These are the ones that in any industry have the highest likelihood of increasing in price, because the company has the highest likelihood of being profitable not only now but also in the future. These are companies that have a great product that is in its early stage of development and marketing. Other companies are expanding into competitive areas they have not formerly been. Other companies are dominant in their field, and virtually have a monopoly-like aspect to them.
Many mutual fund companies,
ETFs (Exchange Traded Funds) and financial professionals specialize in these growth stocks and they are constantly putting out lists of them.
They are not only easy to find, but they are easy to study. I love growth stocks, but as you can tell from the last five or six years in particular, there has been such a rapid increase in business innovation that some of these stocks have faltered as of late. What seemingly were great growth stocks have not grown at all and some have even declined in value.
4. Income stocks—some stocks are purchased for the dividends.
Dividends are usually paid out on a quarterly or annual basis. Some large companies have MIPS, or Monthly
Income Preferred Securities.
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Underlying all four of these approaches to me is a fundamental principal of finding value, or bargains.
I go looking for stocks that have the highest likelihood of going up so I can answer my son’s question that the law of supply and demand takes over and if I want to get in the way of a large demand, then I simply need to look for great companies that have current that is easy to explain. They need a management team who can concisely put forth what the company is doing and then run the company at maximum efficiency. We don’t have to go in and run these companies, but we can sure look at them and analyze them. Part of this is a fact that does not readily meet the eye: that is the float. cash Cows, and the highest likelihood of continuous cash flows with the probability of earning large amounts
The stock float is simply the number of shares issued and outstanding. In certain SEC of money. All in all the most basic fundamental aspect of the stock guidelines, even outstanding options or warrants to buy the stock need to market in increasing the value of any be included. Let me put this in company, is not just earnings but the anticipation of future earnings. perspective. New investors often ask this question: “If this stock is $40 and
“The current stock price is that stock is $30, isn’t the $40 stock better?” OR, “Isn’t the company with based on the anticipation of the $40 stock better?” This question future earnings.”
—Wade Cook just shows a lack of understanding.
Yes, it may be a better company, but
You can take anyone of the four the price of the stock is irrelevant to types of stocks listed above and fit the the discussion. The $40 stock may be particular stock you are looking at in a company with 10,000,000 into a test model. You can pose the outstanding shares on the float. The following questions: is this company market capitalization of the whole going to make money? And, as the company is four hundred million company starts to make money and dollars. The $30 stock is in a the stock starts to move up, will that company with 1,000,000,000 (one create a momentum in and of itself? billion) shares outstanding. Its market
Will there be a likelihood that many cap is thirty billion dollars. people will be attracted to this stock The price of the stock, in-and-of and want to get involved and own it? itself, gives an incomplete picture. It
One of the core aspects of all of can only be used in math formulas to this is accompany that has a product
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determine other things, like the P/E ratio.
The float would signify not just the amount of stock that the insiders or founders own, but the complete public float. Even though there is a high demand for the stock, with so much supply (for example, in the billions of shares) the demand is overwhelmed by the huge amount of stock available. The stock hardly moves at all with good news or even bad news.
I would put Microsoft and even
Intel, and soon Google, Amazon, and the like. I would also include many
Chinese stocks like Baidu, Alibaba and other internet and technology stocks in this category. The point is that will the older, highly successful companies, if people want to own stocks, they already own them. Think what it would take to move the
Microsoft stock up. As of late it’s showing some life, but it has been around $22 to $32 a share for about
10 to 12 years (the early 2000 to about 2014).
A few years ago Dell Computer
(DELL) did multiple stock splits.
Seemingly they were doing stock splits about every twelve months and it felt like they were going to continue to do so. Not only were stock splits
WADE B. COOK becoming popular—I mean by that, the splits themselves were a specific reason for buying the stock—but
DELL was very prominent in the industry with all types of advertising in many mediums and with a great business plan. They also had a charismatic leader and good management team and it seemed like it would never end. But as we all know “this too shall end.”
There was a five-year period of time when DELL did this series of 2:1 stock splits. DELL stock, after it did the each split, would run back up to near its pre-split high. But remember that if there are 300 million shares of stock before a 2 for 1 stock split, there are 600 million shares after the split.
After the next 2 for 1stock split there are 1.2 billion shares and after the next 2 for 1 stock split there are 2.4 billion shares. (These numbers are a general example and do not relate to
Dell—DELL went private.) Now the situation changes. People have stocks that have doubled and tripled and quadrupled in price. They have so many shares in their portfolio, that they can sell some and still maintain a large position. There is so much supply and not enough demand to absorb all the new stock.
Each time Dell did the split, even though it went up, the stock price did not go up as high as the previous high before the stock split. As a matter of
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fact you see a down trending high from one split to the next. Each time it did a split the highs would continue to be lower. This is about the time when we determined that this game was over. I had made a lot of money on several of these stock splits but when we saw this huge supply and the stock not recovering to its previous highs, it told us there were too many shares on the float to be absorbed.
See the write-up about Dell (now private), including a chart of this time period in STOCK SPLITS.
DRIVING FORCES
I mentioned before that a stock price today is based on the anticipation of future earnings. Pause and consider this. The saying doesn’t say the stock price today is based on the past, though that set of facts has some relevancy. No, it’s all about the future. One does not buy a stock for what it did, but what it will do for them going forward. The market news may be wrong, but something as simple as new management or as broad as the Federal Reserve raising or lowering interest rates, play into how companies will do.
The stock market is an open-air market place. There is constantly a herd mentality, and the herd is usually wrong. It’s nigh on impossible to anticipate the anticipation of others,
WADE B. COOK and the news today—with several
Financial TV shows and radio programs, numerous magazines newspapers with financial sections, and now the ubiquitous internet— means people can be informed of choose to stay uninformed, at their choosing.
I for one, trade and invest with all of this in mind. Fear and Greed.
Supply and Demand. And let me end this with a plug for Writing Covered
Calls. We like movement, say a stock going up and down $1 or so every few days, but with this strategy, one can make money constantly.
It’s what I call No,R.M. This stands for No Required Movement.
Writing Covered Calls and certain
Spreads let you make money with virtually no movement in the stock.
“The current stock price is based on the anticipation of future earnings.”
—Wade Cook
©2015 Wade B. Cook. All Rights
Reserved.
This article was excerpted and edited from Cash Flow the Stock
Market.
Marketed by wealthinformationnetworkinc.com
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