LESSON THREE

A STOCK MARKET PRIMER

“ … Markets behave in ways, sometimes for a very long stretch, that are not linked to value. Sooner or later, though, value counts.”

A recent NASDAQ Money article offers a thought-provoking yet cautionary tale from Berkshire Hathaway CEO Warren Buffett: After observing an increased “casino-like behavior” in financial markets, he is reminding investors that it’s hard to beat the house gambling.

With that in mind, let’s get into our Stocks 101 “class.”

The Purpose of Stock Markets is for companies to raise capital (e.g., find people to invest in their companies), and for investors to buy and sell shares of public companies (e.g., own a piece of companies).

The Two Largest Stock Markets in the U.S. are the NASDAQ and the NYSE.

Did You Know? The first stock market in the U.S. began in Philadelphia in 1790.

“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.

The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.” —Warren Buffett

FACTORS THAT AFFECT STOCK MARKETS

  • Generally, when interest rates rise, stock market share prices fall. While it usually takes at least 12 months for a change in the interest rate to have a larger economic impact, the stock market’s response to a change is often more immediate.

    GOOD TO KNOW: The interest rate that impacts the stock market is the federal funds rate.

  • Simply put, if earnings are lower than expected, a company’s stock price may go down. If they are higher than expected, the price may go up. And they really are on the bottom line! Earnings are listed on the literal last line of a financial statement, often labeled “net income” or “net losses.”

  • Market psychology is the prevailing behaviors and collective sentiment of market actors at any point in time. The term is often used by financial media and analysts to explain market movement that may not be explained by other metrics.

    Why? A willingness to acknowledge and address issues can lead to improved performance in the long run.

TAKEAWAY CONCEPTS

value investing • hard to beat the house • interest rates • after-tax corporate profits • investor expectations

HELPFUL
DEFINITIONS

  • A security is any financial asset that can be traded to raise capital. Stocks are just one type of security. Therefore, a stock is a security, but every security is not a stock.

  • The federal funds rate refers to the target interest rate range that commercial banks borrow and lend their excess reserves to each other overnight. It is set by the Federal Open Market Committee, or FOMC.

  • A bull market is when the price of an asset or security rises for a period of time. The SEC says a bull market tends to be marked by “a rise of 20% or more in a broad market index over at least a two-month period.”

  • A bear market is defined by a prolonged drop in investment prices, generally when a broad market index falls by 20% or more from its most recent high.

  • The dotcom bubble was a rapid rise in U.S. technology stock equity valuations fueled by investments in Internet-based companies during the bull market in the late 1990s. It coincided with the longest period of economic expansion in the United States after World War II. Remember these dotcom busts?