The Stock market keeps going up. Although many think it is overpriced the rally is supported by earnings. What happens when earnings fall off? CBS News discusses the rising market and some standout stocks.
The question for investors of whether to bail or continue buying stocks is a most complex issue, considering that the S&P 500 has racked up 30 new all-time highs year-to-date through Aug. 7. Many are concerned that with stocks in the eighth year of a bull market, it may be time to go defensive, until a 5 percent to 10 percent correction, or worse, comes – and goes.
Investors have been encouraged, he pointed out in his latest market appraisal, “by better-than-expected earnings per share in the second quarter this year, as they have done in each of the last 22 quarters.”
The S&P 500’s posting of five new highs in July alone suggests that “the market may not to be ready to give up on momentum.
Too many investors are just following the herd and investing in stocks that have already gone up. But smart investors use intrinsic stock value as a guide and, as noted by Profitable Investing Tips, this metric relies on forward looking earnings.
Using fundamental analysis the intrinsic value of a stock is the expected company cash flow discounted to current dollars. It is a discounted cash flow valuation. An inherent weakness in this concept is that too often the medium and long term prospects of a company and its stock price are not clear. So, what is intrinsic stock value of a company if the future is uncertain? The ability to see into the future to see how well a company will manage its assets, products, costs, R&D, and marketing is of utmost importance in calculating intrinsic stock value as a means of deciding whether or not to purchase a stock.
To the extent that an investor believes that earnings are solid and will continue to rise it makes sense to pay a bit more for a stock. What happens to stocks when earnings fall off? The first thing is that intrinsic value investors will get out and as they leave the stock price will fall. Then the rest of the herd will follow suit and the stock price will probably overshoot its real value on the way down. At that point value investors will come back and start picking up bargains.
Options Anyone?
Traders do not need to sell a stock that has been going up just because it might correct. Buying put options is a way to protect your position in case of a correction and keep the stock in case it continues to go up. Options-Trading-Education.com discusses call and put options.
A put contract gives the buyer the option to sell the underlying equity which he will do if the equity price moves in the direction anticipated. A put contract confers an obligation on the seller (writer) of the put option to buy the underlying equity if the buyer executes the contract.
When earnings fall off we might expect a substantial correction in the market. Those who are prepared can preserve their gains at the top and pick up bargains after the correction completes.
