Let’s face it – Stocks are volatile.
From global events to a single tweet – there are countless factors that might impact stock prices.
Many who value security shun the stock market, placing money in FDs, EPFs and CPFs.
Some are and will continue to predict the markets. There are some who speculate and there are a handful of sophisticated players who use technical analysis tools to identify patterns. Their key objective, either to “buy low, sell high”, “sell high, buy low”, “buy before climbs” and “sell before it crashes”, is similar. It is all about faster gains in the short-term.
I’ll consider them to be “traders” or “speculators”.
But are they investors?
To me, nope.
The primary difference for investors, including myself, lies in our objective. The goal is to amass, accumulating shares of profitable businesses at attractive valuations for both their dividends and capital growth in the long run. The mindset, strategies and outcome is different.
As I write, many fear a potential fall in stock prices.
What if there is a market crash?
Such becomes a stumbling block to investing in stocks. Take a look at the responses from our Dividend Investing survey:
We could see “falling stock prices” remains a major concern. Here, I’ll share a simple case study to reveal how genuine investors view falling stock prices and mitigate this.
Let me set the context right.
There is a situation where stocks fall due to weakening fundamentals. This is definitely bad. But, there are times where stock prices fall despite their fundamental strength due to external events beyond control. Here, the context is written for stocks with sound fundamentals as the main goal of investors is to accumulate their shares for the long-term.
Let’s assume A Ltd is a stock with great fundamentals.
It has a resilient business model, a good financial track record, and has a great capital allocation strategy that balances business growth and dividend payouts.
Let’s say I’m keen to invest, keep, and hold onto its shares for the long-term.
Assuming A Ltd reported $100 million in earnings or $1.00 in earnings per share (EPS) in Year 0 based on 100 million shares. I’d figured that A Ltd is valued on average at a P/E Ratio of around 20 in the past ten years.
In Year 1, I invested in A Ltd for $20 a share (P/E Ratio = 20 based on EPS in Year 0). A Ltd has delivered a rise in earnings to $110 million or $1.10 in EPS.
In Year 2, due to an external event, A Ltd falls to $16.50 a share.
To most people who’re “price-focused”, you’ll see that I incur a 17.5% capital loss on A Ltd as I’d bought my shares at $20 each. You may view this as poor performance on A Ltd and thus, have the motivation to sell off its shares. If so, you’ll realise a capital loss of 17.5%.
To investors, like myself, who are more “value-focused”, I’ll recalculate its P/E Ratio and find it to be at 15 (P/E Ratio = 15 based on EPS in Year 1). This is below the average P/E Ratio of 20. As such, investors can view A Ltd’s shares to be undervalued and thus, be keen to invest more.
Let’s say the external event is short-lived. In Year 2, A Ltd earns $115 million or $1.15 in EPS.
By Year 3, A Ltd is trading at a P/E Ratio of 20. Guess its stock price at that time.
The answer is $23.00 (EPS in Year 2 = $1.15 x 20).
As its shareholder, I would enjoy a 15% capital gain from my first investment at $20 in Year 1. To add on, I’ll also enjoy a 39.4% capital gain on my second investment at $16.50 in Year 2. Thus, I could make “falling stock prices” an ally to build wealth by being “value-focused”.
Instead of searching for “capital-guaranteed or guaranteed-profits” kind of investments, I’m okay, knowing that stocks are volatile (especially in the short run).
In fact, I’m excited to know that I can invest in shares of profitable businesses particularly, during market crashes, at attractive valuations. Falling stock prices aren’t a stumbling stock but more of a motivation to invest to build long-term wealth.
Below depicts the difference in mindset between being “price-focused” versus “value-focused”.
Thus, to overcome the fear of falling stock prices, the #1 step is to reprogram your mindset from a trading mindset who is price-focused to an investing mindset who is value-focused. This would help you to handle “falling stock prices” more effectively. The more you cultivate this mindset, it’s easier or even second-nature to position yourself to capitalise on “market crashes” for years and decades to come.
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