Investing in Stocks

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CAN YOU BEAT THE MARKET?
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MARKET EFFICIENCY THEORY
BUY AND HOLD
MARKET TIMING
VALUE STOCKS
DIVERSIFIED PORTFOLIO
LONG-TERM INVESTMENT HORIZON
PRICE/EARNINGS RATIO
DIVIDEND YIELD
INTEREST RATE
DOW JONES INDUSTRIAL AVERAGE
INDEX FUNDS
An elderly economics professor was walking down a busy street with
one of his energetic students to the local café for lunch. Along the way,
as he was explaining the concept of market efficiency to his student, the
professor stepped right on a wadded up $20 bill and continued to stroll
on. The student, who was looking down in studious thought at the time,
was amazed at his good fortune and stooped down to pick it up. As the
student rushed to catch up with the professor, he asked the professor
whether he had seen the $20 bill. The professor quipped "My dear lad,
haven't you been listening to anything I have been saying about
efficient markets? Although I saw the $20, I knew my eyes must have
been deceiving me. Efficient markets theory dictates that it couldn't
possibly be there because if it had been, someone else would have
already picked it up."
• All stock prices
accurately reflect all
historical and current
information.
• Whenever you buy a
stock, you are getting
the best price based on
available information.
• In A Random Walk Down
Wall Street, author Burton
Malkiel convincingly showed
that most investors lack
consistent skill at timing
markets or picking winning
stocks over the long-term.
• His most controversial claim
was that a monkey throwing
wet paper towels at a stock
chart on the wall could beat
an expert armed with
statistics and stock picking
formulas.
• Somebody has to be the first
to notice the $20 bill on the
street.
• Some investors believe they
can identify under-valued
stocks (Value stocks).
• The economic incentive for
correctly timing the market
can be huge, making market
timing a tempting
proposition.
Buying a diversified
stock portfolio and
holding it long enough
to benefit from its
growth in value over
time, regardless of
short-term price
fluctuations.
Hershey makes candy and
candy is popular at
Halloween.
Should I buy shares of
Hershey stock at the
beginning of October and
sell them in November?
• Gains from following the
advice in the question
over the last five
October’s combined:
-7% (plus fees)
• Gains from buying HSY
on 9/1/09 and holding
it until 8/1/09:
+137%
http://www.econedlink.org/interactives/EconEdLink-interactivetool-player.php?filename=main.swf&lid=333
The link above will take
you to three graphs
showing actual price
movements for several
different stocks over a
multi-year period.
Decide what you would
like to do.
Professional
investment managers
have a variety of
statistics they
examine in an effort
to estimate the
relative value of the
stock market.
Price/Earnings (P/E) ratio:
This ratio describes how
much one is paying for
every dollar a company
earns. For example, if a
company’s stock price is
$15 per share and it
earned $1 per share over
the preceding year, its P/E
ratio would be 15.
• Dividend Yield: The DY is the dividend divided by the share
price. As an example, suppose you buy stock at $10 a share
and the company is pays $1 per share in dividends. The
dividend yield would be 10%. Ceteris paribus, the higher the
yield the more attractive the stocks is.
• Interest Rate: How much you can expect to earn on bonds.
Bonds are debt instruments that pay a fee for the temporary
use of capital. The higher the interest rate on bonds the less
attractive stocks will be because there is typically less risk with
bonds.
http://www.econedlink.org/interactives/EconEdLink-interactivetool-player.php?filename=main.swf&lid=334
The link above takes you
to an activity where you’ll
start with $100 and
attempt to accumulate as
much wealth as you can by
either investing in the stock
market or setting your
money aside safely in the
bank.
• Outperforming the market
by timing your transactions
is extremely difficult.
• Advocates of the market
efficiency theory suggest a
long-term investment
strategy of buying and
holding a diversified group
of stocks or an index fund
that tracks a large basket
of stocks.
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