How do investors choose stocks? - Richard Coffin

Summary

The video script discusses the decision-making process of investors in the stock market, explaining what stocks are and the goals of investing. It highlights the difference between active and passive investing strategies, with active investors seeking to exploit market inefficiencies for short-term gains and passive investors relying on long-term market growth through index funds. The script also touches on the S&P 500 as a proxy for market performance and the idea that stock prices reflect public opinion in the short term but company profits in the long term.

Takeaways

• 🌐 **Global Stock Trading**: Billions of stocks are traded daily on the NYSE, with over 43,000 companies listed worldwide.
• 📈 **Stocks as Ownership**: Stocks represent partial ownership in a company, sharing in its success or failure as measured by profits.
• 📊 **Price Determination**: Stock prices are determined by supply and demand, with more buyers than sellers driving prices up.
• 💹 **Market Perception**: The market price reflects what buyers and sellers believe a stock and company are worth.
• 🚀 **Investment Goals**: Investors aim to grow their money faster than inflation or 'beat the market' by outperforming the S&P 500 index.
• 🤔 **Active vs. Passive Investing**: Active investors believe in beating the market by picking stocks and timing trades, while passive investors trust in long-term market growth.
• 🏆 **Beating the Market**: 'Beating the market' typically means earning more than the S&P 500, which measures the performance of 500 large U.S. companies.
• 📉 **Market Behavior**: The stock market is seen as a 'voting machine' in the short term and a 'weighing machine' in the long term, reflecting public opinion and company profits respectively.
• 🔍 **Active Investor Strategies**: Active investors look for market inefficiencies to exploit, using business analysis, financial statements, price trends, or algorithms.
• 🌱 **Passive Investing Belief**: Passive investors believe market inefficiencies balance out over time, so a broad market representation through index funds will grow.
• 🔄 **Investment Flexibility**: Active and passive investing aren't mutually exclusive; many strategies combine elements of both for long-term growth.

Q & A

How many stocks are traded daily on the New York Stock Exchange?

Billions of stocks are traded daily on the New York Stock Exchange.

What does investing in stocks represent for investors?

Investing in stocks represents partial ownership in a company, allowing investors to share in the company's success or failure as measured by profits.

How is the price of a stock determined?

The price of a stock is determined by the number of buyers and sellers trading it; if there are more buyers than sellers, the price will increase, and vice versa.

What does the market price of a share represent?

The market price of a share represents what buyers and sellers believe the stock, and by association the company, is worth.

What is the goal of investors when purchasing stocks?

The goal of investors is to make money by purchasing stocks whose value will increase over time.

What does 'beating the market' mean in the context of investing?

'Beating the market' refers to earning a return on an investment that exceeds the Standard & Poor 500 index, which measures the average performance of 500 of the largest U.S. companies.

What is the difference between active and passive investors?

Active investors believe they can beat the market by strategically selecting stocks and timing trades, while passive investors believe it's not usually possible and prefer a long-term, diversified approach.

How does the S&P 500 index relate to the overall market?

The S&P 500 is a measure of the average performance of 500 large companies and is often used as a proxy for the overall market, although it doesn't directly represent all stocks, especially small and mid-range ones.

What is the 'voting machine' and 'weighing machine' analogy in the stock market?

The 'voting machine' refers to short-term stock price fluctuations reflecting public opinion, while the 'weighing machine' refers to long-term prices tending to reflect companies' actual profits.

How do active investors attempt to exploit market inefficiencies?

Active investors aim to exploit market inefficiencies by buying stocks they believe are undervalued, using methods such as investigating business operations, analyzing financial statements, observing price trends, or using algorithms.

What is the strategy of passive investors in the stock market?

Passive investors trust in the long-term 'weighing machine' aspect of the market, believing that market inefficiencies will balance out over time. They invest in index funds, which represent a cross-section of the market, and hold stocks for the long term.

Can you provide an example of a hybrid investment strategy?

A hybrid investment strategy might involve choosing stocks actively but holding them for the long term, as advised by passive investing principles.

Outlines

00:00

📈 Stock Trading and Investment Basics

The paragraph discusses the vast scale of stock trading, particularly on the New York Stock Exchange, and introduces the concept of stocks as partial ownership in a company. It explains how stock prices are determined by supply and demand, and how they reflect market sentiment and company performance. The paragraph also outlines the goals of investors, which include growing wealth faster than inflation or 'beating the market' by outperforming the average stock performance, as measured by the S&P 500 index. The distinction between active and passive investing strategies is introduced, with active investors seeking to exploit market inefficiencies and passive investors relying on long-term market growth through index funds.

Keywords

💡Stocks

Stocks represent partial ownership in a company. When investors buy stocks, they are essentially buying a share in the company's success or failure, as measured by its profits. This concept is fundamental to the video's theme of stock trading and investment. For example, the script mentions that 'stocks are partial shares of ownership in a company' and that investors buy into a company's potential for success.

💡Investors

Investors are individuals or institutions that purchase stocks with the aim of making a profit. They are central to the video's narrative as it discusses their strategies and goals. The script refers to investors deciding which stocks to buy and their differing approaches to investing, such as 'active' versus 'passive' investing.

💡Market Price

The market price of a share is determined by the balance of buyers and sellers and represents what they believe the stock and company are worth. This concept is crucial as it shows how stock prices can fluctuate based on market sentiment. The script states that 'the market price of a share therefore represents what buyers and sellers believe the stock, and by association the company, is worth'.

💡Active Investors

Active investors believe they can outperform the market by strategically selecting stocks and timing their trades. They are mentioned in the context of trying to 'beat the market' by exploiting perceived inefficiencies. The script describes active investors as those who 'believe it is possible to beat the market'.

💡Passive Investors

Passive investors, on the other hand, trust in the long-term growth of the market and do not actively pick stocks. They are contrasted with active investors in the script, with the narrative suggesting that they believe markets will balance out inefficiencies over time, as indicated by 'put their faith in the long term “weighing machine” aspect of the market'.

💡Beating the Market

Beating the market refers to earning a return on investment that exceeds the average performance of all companies' stocks, often measured by the S&P 500 index. This is a key concept in the video as it drives the debate between active and passive investing strategies. The script notes that 'beating the market' is a source of debate among investors.

💡S&P 500

The S&P 500 is an index representing the average performance of 500 of the largest U.S. companies, weighted by market value. It is used as a benchmark for 'beating the market' and is discussed in the script as a measure that 'doesn’t directly represent the market as a whole' but serves as a 'pretty good proxy for the overall market'.

💡Index Funds

Index funds are collections of stocks that aim to represent a broad section of the market, often tracking an index like the S&P 500. They are a key tool for passive investors, as explained in the script where it mentions that passive investors 'put their faith in... index funds, collections of stocks that represent the broader market'.

💡Inefficiencies

Inefficiencies in the market refer to the discrepancies between a stock's price and its perceived value, which active investors aim to exploit. The script discusses how active investors believe the market contains inefficiencies, such as 'stock prices at any given point in time may overvalue some companies, undervalue others'.

💡Voting Machine and Weighing Machine

This metaphor describes the stock market's behavior in the short term as a 'voting machine', reflecting public opinion, and in the long term as a 'weighing machine', reflecting companies' actual profits. It is used in the script to illustrate the different time frames that active and passive investors focus on: 'the stock market behaves like a voting machine in the short term, and a weighing machine in the long term'.

💡Profitability

Profitability refers to a company's ability to generate profits, which is a key factor in determining the value of its stock. The script connects this to the concept of stocks representing a share in a company's success or failure, as it states 'by buying a stock, investors buy a share in the company’s success— or failure—as measured by the company’s profits'.

Highlights

Billions of stocks are traded daily on the New York Stock Exchange.

There are over 43,000 companies listed on stock exchanges worldwide.

Stocks represent partial ownership in a company.

Stock price is determined by the number of buyers and sellers.

The market price of a share represents what buyers and sellers believe the stock is worth.

Investors aim to make money by purchasing stocks that will increase in value over time.

Some investors aim to grow their money faster than inflation.

The goal of 'beating the market' is to grow money faster than the cumulative performance of all companies' stocks.

Active investors believe in strategically selecting stocks and timing trades to beat the market.

Passive investors believe it's not usually possible to beat the market and avoid stock picking.

The S&P 500 is a measure of the average performance of 500 of the largest U.S. companies.

The S&P 500 doesn't represent the entire market but is a good proxy for it.

Stock market prices reflect public opinion in the short term and company profits in the long term.

Active investors aim to exploit market inefficiencies in the short term.

Passive investors trust in the long-term balancing out of market inefficiencies.

Index funds represent a cross-section of the market and are used by passive investors.

Investing strategies can have elements of both active and passive investing.

Investing is not an exact science, and there is no foolproof method.

Transcripts

Every day, billions of stocks are traded on the New York Stock Exchange alone.

But with over 43,000 companies listed on stock exchanges around the world,

how do investors decide which stocks to buy?

To answer this question, it’s important to first understand what stocks are,

and what individuals and institutions hope to achieve by investing in them.

Stocks are partial shares of ownership in a company.

So by buying a stock, investors buy a share in the company’s success—

or failure— as measured by the company’s profits.

A stock’s price is determined by the number

of buyers and sellers trading it;

if there are more buyers than sellers, the price will increase, and vice versa.

The market price of a share therefore represents

what buyers and sellers believe the stock, and by association the company,

is worth.

So the price can change dramatically

based on whether investors think the company has a high potential

for increasing profitability— even if it isn’t profitable yet.

Investors aim to make money by purchasing stocks

whose value will increase over time.

Some investors aim simply to grow their money at a faster rate

than inflation diminishes its value.

Others have a goal of “beating the market,”

which means growing their money at a faster rate

than the cumulative performance of all companies’ stocks.

This idea of “beating the market” is a source of debate among investors—

in fact, investors break into two main groups over it.

Active investors believe it is possible to beat the market

by strategically selecting specific stocks and timing their trades,

while passive investors believe it isn’t usually possible to beat the market,

and don’t subscribe to stock picking.

The phrase “beating the market” usually refers to earning a return

on an investment that exceeds the Standard & Poor 500 index.

The S&P 500 is a measure of the average performance

of 500 of the largest companies in the United States,

weighted by company valuation,

meaning that companies with a higher market value

have a larger effect on the S&P—

again, market value corresponds to what investors

believe a company is worth rather than actual profits.

The S&P doesn’t directly represent the market as a whole—

many small and mid-range stocks can fluctuate according to different patterns.

Still, it’s a pretty good proxy for the overall market.

It’s often said that

“the stock market behaves like a voting machine in the short term,

and a weighing machine in the long term”—

meaning short term fluctuations in stock prices reflect public opinion,

but over the longer term, they do tend to actually reflect companies’ profits.

Active investors aim to exploit the short term,

“voting machine” aspect of the market.

They believe the market contains inefficiencies:

that stock prices at any given point in time may overvalue some companies,

undervalue others, or fail to reflect developments that will impact the market.

Active investors hope to exploit these inefficiencies by buying stocks

they think are priced low.

To identify undervalued stocks,

they may investigate a company’s business operations,

analyze its financial statements, observe price trends, or use algorithms.

Passive investors, by contrast,

put their faith in the long term “weighing machine” aspect of the market.

They believe that even though markets may exhibit inefficiencies at any given point,

over time those inefficiencies balance out—

so if they buy a selection of stocks that represents a cross-section of the market,

over time it will grow.

This is usually accomplished through index funds,

collections of stocks that represent the broader market.

The S&P 500 index is one of many indexes.

The overall goal is the same for all index funds:

to hold stocks for the long term and ignore short-term market fluctuations.

Ultimately, active and passive investing aren’t mutually exclusive—

many investment strategies have elements of each,

for example, choosing stocks actively but holding them for the long term

as passive investing advises.

Investing is far from an exact science:

if there was one foolproof method, everyone would be doing it.