A lot of investors say they don’t understand the value of the stock market.
It’s a tough sell to some, and they’re often skeptical that it’s a wise investment for their circumstances.
The best investment advisors in the world aren’t convinced by that argument, and the results speak for themselves.
We asked three of the world’s most respected investment experts to explain the difference between an accurate appraisal of the market and a simplistic view of what to buy and sell.
What is a proper valuation?
“The market value of a company is how much money you can expect to get in return from that company,” says Peter Schumacher, president of investment consulting firm Schumaker & Mabry, which specializes in the stock-market valuation.
“The true value is the amount of value that you can get in the long term by keeping a company going.
The more you keep a company alive, the more you can earn.”
For instance, a company that generates $1 billion a year for a year may generate less than $2 billion in earnings for investors a decade from now.
A company with $1.5 billion in revenue a year might produce more than $5 billion a decade after that.
A $10 billion company may have 10 years of earnings to invest in, or 10 years to invest, while a $5.5 trillion company might only have two years to earn $10.5.
“You have to take a long view,” says Schumach.
“That means you have to understand what the company’s doing, how it’s doing it, and how the value is going to continue to grow.”
What does the term “market cap” mean?
In its most basic sense, the market cap is the number of shares of a stock listed on a stock exchange.
It can be anything from a company’s share price to its market capitalization.
“A market cap of a private company, or any private company with less than 10 million shares, is not necessarily a good indicator of how successful the company will be in the future,” says Richard Anderson, chief investment officer of investment firm Anderson, Evans &.
The stock market is a highly liquid market with high margins and very low volatility.
“If a company gets to the point where it’s profitable and the market caps are low, that’s a great sign for investors,” says Anderson.
“It means that there are many investors who are very willing to pay a premium for a good long-term investment.”
What do you mean by “cash flow” in the market?
The key concept here is that cash flow is the financial statement of the company, which is the information investors receive when they invest.
“Cash flow is what a company produces or receives from investors,” explains Anderson.
That means a company will report its cash flows and earnings to investors when they make their investment decisions.
“And in fact, that is the key measure for investors to use,” says Kohn Pedersen, director of equity research at Morningstar.
“So if you have a company with a cash flow of $1 million and you are making a $1,000 investment, you know that the company is earning $1 per share, not $1 and a half per share,” he explains.
“At the end of the day, that means the investor is getting a return of 3.5% in the first year.”
“But in reality, cash flow isn’t always the most important factor in evaluating an investment,” says Pedersen.
“In fact, you may not even be using it at all,” he says.
“Instead, you’re using it as a proxy for future cash flow, and that is a proxy that is usually an indicator of future profitability.”
To understand the difference, you have the opportunity to look at the company over a five-year period.
The longer the term, the higher the potential return, says Anderson, but you need to keep in mind that “cash flows aren’t the same thing as future earnings.”
Is there an annual tax advantage?
Tax advantage is a term that is often used to describe how much of the profits of a business or stock can be taxed at a lower rate than the tax rate that would be paid by most people.
The term has a few different meanings, depending on which part of the business you’re looking at.
“Generally speaking, if a company has an asset that is highly valuable and is highly taxed, you can deduct it at the lower rate of 35% on your federal income tax return,” says Adnan Khan, chief tax strategist at J.P. Morgan Asset Management.
“But that is not always the case,” says Khan.
“Some companies that are highly valued have lower tax rates, because they don (have) lower asset values.
And that means you’re getting a tax break on what you pay in taxes.
And some companies don’t have to pay taxes