Friday, June 6, 2008

Stock Market is Not a Zero-Sum Game

When I say the stock market is not a zero-sum game, I that mean the winners do not equal the losers. Basically everyone wins when the total value of the market goes up and everyone loses when the total value does down. When the markets go up, no one asks where the money was coming from to power the rise. However, when they come down, everyone wants to know where THEIR money went to. There are also relative winners and losers because people buy and sell stocks all the time. Some stocks will be winners when the market goes down and some will be losers when the market rises.

When the markets go down, you really only lose when you sell or the company goes bankrupt. Whether you should sell or not can be tricky. If your stock goes down just because the market has gone down, there is usually no need to sell. If this is not the cause, look to see if it is just a temporary set back. The stock market has a tendency to over react. If a stock has something negative happening, like the Earnings per Share (EPS) is not what was expected, the market can react harshly. This might only be temporary. If revenue and EPS are down and the debt ratio is high, you might want to reconsider if you want to hold on to a stock. Some stocks never recover and some take a very long time.

I also like to look at the Accrual Ratio. If this ratio is positive and high, it might mean that the company is hiding some problem. It also might mean that the Cash Flow is not as good as it appears. The Accrual Ratio is something I show on my spreadsheets.

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