This is usually the part where I lose a few of you. Don’t worry, I feel the same way you do. Reading through columns and rows filled with numbers and abbreviated nonsense is not a good way to pass time. Still, I will share a well-kept industry secret with you. Most Fund Managers today do not bother to read financial statements. Shocking, right? I mean, they manage billions of dollars of other people’s money and do not take the time to read financial reports? Well folks… its true. Fund Managers can not read through hundreds of financial statements every single quarter to buy or sell stocks. It would take a herculean effort to do so. This is another edge retail Investors can exploit. I am of the belief that the stock market is a 2-way pricing mechanism. The first way it prices stocks is on the short-term news cycles that can move a stock. The longer term is the ultimate value of a company.
Famous hedge fund manager and CNBC personality Jim Cramer has an accurate way to describe this. He says that stocks go through rotations depending on what is hot or not on a day on the Wall Street fashion show. This means that stock prices move depending on the news stream of the day. On the short-term basis, stocks can make big moves based on industry news, political events, macro-economic data, large fund re-balancing, capital inflows and outflows, sector and industry analysis reports from analysts, or just plain rumors. Frankly, therefore most people believe that owning stocks is a gamble. I honestly do not see how a retail investor could ever beat the market by day-trading in and out of it on a minute to minute basis, otherwise known as scalping.
The edge retail investors can find is on the long-term basis. By long-term, I mean one year plus. If you take the time to read through the financial statements of your favorite company, you will be able to get a clear picture of how business truly is doing. Cash flow statements, revenue, keeping an eye on operating expenses, debt, and commentary from Management are some of the items you can use to make a more informed investment decision. I am not going to teach you how to become accountants here. Do not worry. All I want you to understand is that stocks will move randomly on the short-term basis. These random movements are the best opportunities we can take advantage of in the market to better our long-term performance.
If you looked through your favorite company’s balance sheet, income statement, cash flow statement, and stock holder’s equity statement, you will have more information at your hands than most Fund Managers do. So, whenever the price of your favorite stock drops for whatever reason, you will be able to know that the short-term movement may not have anything to do with the value of the company itself. These are the best chances you will get to buy that stock at a discounted price. Sort of like walking into your favorite clothing store and finding that shirt you always wanted at a 25% discount. Most of us would not stop to ask, “Is there something wrong with this shirt?” We would take it to the cash register and buy it instead. Use the same logic when spotting a price movement that catches your eye in the stock you have been tracking. If there is no news related to your stock, and you are aware that the financials look good, you can be sure that you are getting a bargain.
The most important aspect of this post is to let you know that it isn’t necessary to time the market just right. Prices can move wildly on either direction. Best case scenario is that you would have to wait a bit before the price of your stock gets to the level you feel comfortable paying for. I do not like to chase stocks on the upside. If I see a stock I like, and the fundamentals are solid, but the price has gone up substantially, I rather place that stock on a watch-list and wait for it to come back down. This being disciplined is most important. All you need to do is to establish a price that you like, wait for the market to throw a fit. Then buy the stock after it gets booted off the Wall Street fashion show. If you buy stocks this way, your long-term performance will greatly increase.
Therefore, reading financial statements and being familiar with them is such an important thing. Having this knowledge is crucial to determining how much you should pay for a stock, and figuring out whether the daily price move is to your benefit or not. Remember the discounted shirt we bought earlier when you see a stock drop on no news. As boring as this might seem, this is golden, information that you can make use of to see a substantial amount of net positive returns in your portfolio of assets.
