[February 5 update – GME is coming back down to earth, at around $61/share mid-day today, down from a high of well over $400/share. TSLA is up and down, likely a longer-term story to watch. This opinion about investing the lazy way is a great read. While Real Estate Wealth Planning recommends investors invest beyond just the S&P 500 since there are 10,000+ stocks around the world, the general concept here is worth digesting.]
[February 1 update – it’s still a roller coaster. Listen to The Daily podcast for some interesting commentary on the entire GameStop situation.]
[January 29 update – GameStop is up again, likely due to increased trading ability and Tesla is down, likely due to lower-than-expected financial reports… stay tuned!]
Original Post – January 27, 2021:
Why? Because while markets are largely efficient in the long run, short-term anomalies are more like gambling than a true strategy you can rely on.
Buckle up, this is a long one.
First, what is happening with Tesla and GameStop? Long story short…
Gamestop: Some hedge funds shorted the stock – basically, they are betting that the price will go down. When someone shorts a stock and the price goes down, that person makes money. If instead the price goes up, then whoever shorted the stock could lose an infinite amount of money. Also, what is shorting a stock, anyway? It’s not for the faint of heart.
So, a bunch of people online decided they wanted to collectively stick it to these hedge funds by driving up the price of the stock, thereby causing massive losses for the hedge funds, at least in the short term. Stay tuned!
Tesla: Investors have really high hopes for Tesla’s future, so they have boosted the share price significantly over the last year or so. To put this in perspective, investors are valuing Tesla at more than $1 million per car sold vs. other major automakers at $6-20k per car sold. While it’s certainly not a perfect metric, it does show how stock prices for individual stocks can sometimes be extremely different than what their fundamental business activity and profits currently are.
Bottom line: *if* investors can manage to “buy low and sell high” at the right moment – meaning, *if* they can accurately time the market twice – then, they might experience an unexpected windfall. And if you’re thinking this sounds an awful lot like winning at the blackjack table, you’d be right. Certainly awesome when it happens, but don’t count on it for your future!
Now, some data. Then, some definitions. Finally, some opinions.
Data as of January 27, 2021
What do all those numbers even mean?
When you buy a single stock, you are essentially guessing that it’s value or share price will continue to go up when you own it. A share of an index is basically a weighted average price of all the companies in the index. So when you buy VOO for instance, you are buying a tiny bit of all 500(ish) companies in the S&P 500.
Often, stocks are valued based on something called the “price-to-earnings ratio”. This is a somewhat simplified but widely used ratio that basically tells us what investors’ expectations are about the investment in the future. So, higher P/E ratio means that investors expect earnings and profits to grow, but it doesn’t necessarily mean the company (or index) has good earnings or profitability now.
Definitions:
- Hedge Fund: institutions and wealthy investors pool their money and can invest in almost anything with few rules. These are very different from a mutual fund or exchange-traded fund (ETF) with lots of regulations and typically used by regular investors.
- Stock: a single share of ownership in a public company. Most companies have millions of shares.
- Index: a large collection of investments (usually stocks or bonds) all bundled together so investors can buy shares of the entire bundle through either an ETF or a mutual fund (which are incredibly similar).
- Price-to-earnings ratio: A measure of the price of a stock, index, or other investment that takes the price and divides it by “earnings per share”. For example, if stock ABC is $50 and earns $2 for every share, then the p/e ratio is 50/2 = 25. If stock XYZ is $30 and also earns $2 per share, then the p/e ratio is 30/2 = 15. This means that an investor is paying less per share for the same amount of earnings per share for stock XYZ. In the case of GameStop, their P/E ratio is $0 (or not applicable) because they are not profitable.
Finally, some opinions:
Generally speaking, Real Estate Wealth Planning recommends low-cost broadly-diversified portfolios containing thousands of different stocks and bonds. This approach allows investors to lower their investment management fees, while having access to the broadest possible opportunity set, given their individual preferences and circumstances. It’s also the opposite of stock picking and market timing, aka “gambling”.
That said, there can be reasons why investors buy high flying stocks, such as anticipated future growth in earnings (for example, Tesla). Since there are literally millions of people buying and selling in the public markets every day, in the long run, markets are pretty efficient at pricing fairly. This means that it’s usually not a good idea to try to predict the future or outguess the entire market’s collective wisdom.
Finally, if you have a strong view on certain investments, consider the money you invest in individual stocks as entertainment, not your core savings. Just like smart people set a budget for themselves when they go to Vegas for a fun trip, approach individual investments the same way. And if you “win”, congratulations!
What’s next?
If you’re ready to start thinking about investing, or if you just want to re-think your current approach, you can start by asking yourself some key questions. And if you need guidance, schedule some time to talk.
