Smart Thought Of The Week: Prediction

The best thing about the stock market is its predictability. The worst thing about the stock market is its predictability.

In the short term, the stock market is predictably unpredictable. Anyone who tells you that they know how a stock will perform in a week, in a month or even in a year is either naive or disingenuous. We might want to believe that we know how our shares will perform in the short term. But the market has a habit of making us look foolish.

In the long term, however, stock markets can be surprisingly predictable. In the US, the average return from shares over the past 50 years has been around 9% a year. How is that possible when we consider all that has happened in the last half century….

…. Vietnam War (1975), Black Monday (1987), Tiananmen Square (1989), Gulf War (1991), Asian Financial Crisis (1997), bubble (2000), 9/11 (2001), Great Financial Crisis (2007), and the mother of all setbacks, COVID-19 (2019). How is it possible that despite all these major setbacks the stock market is able to perform so predictably?

The answer lies in how companies deploy their capital to generate profit, regardless of what is happening in the world. The price of a share, which determines a company’s market value, is the product of its earnings (earnings per share) and how much the market is prepared to pay for those earnings (price-to-earnings ratio).

But just because we have wars and crises doesn’t mean that companies can’t continue to generate profit. In fact, many companies can perform surprisingly well in times of crises. Their profit could even rise when crises abound.

The big unknown is how much the market is prepared to pay for those earnings in the short term. In other words, the PE ratio, which essentially boils down to a combination of market sentiment and what other investment alternatives are available, is unpredictable.

But over time, a company’s earnings, and the distribution of some of those earnings in the form of dividends, should still prevail. If a company can grow its earnings, and increase its payout to shareholders, then its yield can become too compelling for even hardened sceptics to ignore.

Peter Lynch said everyone has the brainpower to make money in stocks. But not everyone has the stomach for it. Warren Buffett has described the stock market as a manic depressive. Our job is, therefore, not to get caught up in the market’s short-term madness and always stay rational.

Over the long term, the stock market can be a wonderful place to grow our wealth. The key is long term rather than short term. At some point in our lives, we may choose not to work, we may not be able to work, or we may not be able to find work.

Wouldn’t it be great if we had an alternative income stream? This is where being salary independent can help. It can be an indispensable way to take control of our financial destiny. It is not hard. It just requires a robust framework, a healthy resolve, and time.

Salary independence is not a pipe dream. It can be a reality if we accept that saving is nothing more than delayed spending. By not giving into the urge to spend today, we could have more to spend tomorrow.

If you’d like to learn more investing concepts, and how to apply them to your investing needs, sign up for our free investing education newsletter, Get Smart! Click HERE to sign up now.

Get more stock updates on our Facebook page. Click here to like and follow us on Facebook.Disclosure: David Kuo does not own any of the shares mentioned.

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