Just establishing that a company is a good investment is not sufficient because the timing of your entry and exit in the market is as important. You will always find that the best profit opportunities will become available to you when you understand how prices in the market fluctuate. The ability to identify the strengths and weaknesses of a particular company is important but so is the manner in which you conduct a valuation of the company stock. You may have identified a company that is worth investing in but more homework is required before you enter the market to buy the stock.
You must understand that valuation is not a straightforward process because you have to understand what goes into the pricing of a particular stock by the market. The market price is meant to incorporate both current performance and future prospects but, as with any future event, this is easier said than done. You only have to look at some of the intraday fluctuation in some stock prices which is normally catalyzed by market rumors alone. The good news for long-term investors is that at the end of the day, fundamentals are all that is important. For instance, a stock price may drop because of negative rumors, but, if the fundamentals are sound, the stock price is bound to recover.
Your best friend continues to remain plain old common sense but it is necessary for you to acquire knowledge of some of the crucial metrics used for both valuation and comparison. You can find many of these metrics in any of the trading tools that you use because, sadly, that is no single correct method. Different metrics will provide you with the different pieces of information and, for instance, a price/earnings ratio but can you about earnings but not about debt and leverage. Similarly, metrics based on asset valuations and give you no information about the cash flows.
You can spend many hours using these metrics to crunch different numbers because, every time you change one assumption, the results will change. But alas, investment is not a question of mathematics alone but also requires you to consider a number of qualitative issues. You should also be prepared for the unexpected news and developments that can make nonsense of the most careful and meticulous valuation.
Don’t discount the impact of emotions and market sentiment on the share price. Fear and greed play an important role in the stock markets as does hype. For instance, in the high-tech industries, rumors of acquisitions and takeovers surface from time to time especially about promising new companies. That has the effect of pushing up prices even though there is no foundation to the news. Momentum is another factor which can create both advances and declines in prices across the board. Unless you have a large appetite for risk, wholly escape the fundamentals in mind when looking at rallies fueled by emotion or momentum. However, if one of your investments is experiencing an increase in prices that you believe is unfounded, it is much trickier to decide what you should do. Generally speaking, if your profit expectation has been fulfilled, it is a good idea to liquidate the investment.
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