An average Nigerian is scared when the word “stock market” is mentioned because of the believe that it is a risky venture, which is true compared to other investment options like treasury bills and bonds.
Individuals therefore tend to believe the worst about the market instead of looking beyond the fears and consider the enormous opportunity to growing substantial wealth when perfectly understood.
You can beat the market!
The phrase “beating the market” (earning an investment return that exceeds the performance the general market) is a reality in the world of investment in any asset class provided an investor understands how to.
Due to the volatility inherent in the equities/stock market, the possibility for an investor to see both his gains and investments eroded is a reality. A lot of investors have gotten their hands burnt as they lack the knowledge of those things to consider when making investment decisions.
While some are influenced by investment decisions of friends, some by the popularity of the company, some by how high or low the prices of the stocks are, some by religious believe etc, others have made good returns by understanding the dynamics of the market such as Warren Buffet, the most successful investor in the world.
Some empirical analysis on the Nigerian stock market have proven the inefficiency of the market as it is driven more by investor’s sentiment rather than driven by available information and fundamentals, hence giving investors the opportunity to beat the market almost all the time.
An efficient market is one which market prices reflect all available, relevant information. If markets are efficient, then all information is already incorporated into prices, and so there is no way to “beat” the market because there are no under or overvalued securities available.
However, you don’t beat the market by guessing or by sentiments but by adequate knowledge of how the stock market works and how to make value creating decisions irrespective of the state of the economy, industry or company.
For effective understanding of market dynamism, we shall consider first the need for fundamental analysis in making investment decisions.
Fundamental Analysis
Fundamental analysis is the examination of key forces that affect the well-being of the economy, industry groups, and companies. As with most analysis, the goal is to derive a forecast and profit from future price movements.
It is important to understand developments around the macro space of the economy and how it translates into affecting the industry and ultimately companies within the industry. More often than not, shocks in the economy are regarded as systematic risk inherent to the entire market also known as “undiversifiable risk.” This type of risk is both unpredictable and impossible to completely avoid.
This is because events in the global economy can affect events in the domestic economy.
While some stocks are cyclical, others are noncyclical or defensive stocks. Cyclical stocks are stocks that move in the same direction as the economy. When the economy is in a recession the profits of a cyclical company tend to drop and so its share price. Also, when the economy is in good shape (expansion), the share price tends to goes up with the profit growth.
Defensive stocks on the other hand see the revenues, the earnings and the cash flows of the company remain relatively stable and so the share price, no matter how the economy is doing.
It is therefore important to note stocks within the market that fall into the category of cyclical or defensive stocks so as to determine what stocks are less volatile depending on the current state of the economy.
In our next article, we shall consider industry based analysis and how it should influence your investment decisions.
