So you want to predict movements in the stock market?

I get pinged by people every now and then about what should the stock market be doing. Several of these requests have even been from co-workers with whom we share stock options. Of course we want to figure out the best time to exercise options!

I can list some of the behaviors:

  • the stock rallies then slumps by the end of the day due to day traders cashing in on the rally
  • company beats an earnings estimate and rallies over several days, even a few months
  • company misses an earnings estimate by a penny, and drops thirty points
  • news about an acquisition causes stock to rally five points
  • news about a new court case causes stock to drop fifteen points
These are just a few. By themselves, they make sense. But trying to guess what the ACTUAL behavior of the stock is going to be in aggregate has been studied and proven to be unpredictable. And of course I’m plugging in fake numbers. The actuals can vary widely. The time frames can vary
 widely.

The company that holds my stock option beat it’s quarterly earnings estimate three months ago and recovered from the mid 60s up into the mid 90s. Then it beat its latest quarter earning estimate by a penny. What happened? It dropped five points in after hours trading. The next couple of days didn’t improve much. What’s with that?

I recently formed a plan that I would wait until I got my final BIG chunk of stock, which is coming in the next week or so, and THEN make a real decision on whether to cash out. I have a certain price in mind at which I would sell immediately. My hope is that by beating the latest estimates, it will make it there. But who knows?!?

When I get the money, I hope to buy a big chunk of stock from my short list that I haven’t mentioned yet. I also hope to reload the cash reserves backing my real estate investments. I can then open a custodial account for the latest addition to our family. And after that, there should be enough cash left to buy a new CUV with no auto loans. Maybe just maybe the price will rally enough that I can actually buy two positions.

Metrics of a company

I have observed stocks miss an earnings estimate, tumble 30%, then make the next quarterly estimate and recovery most of what was lost. The thing is, we are talking a time frame of six months. Businesses don’t make huge, fundamental, life altering changes in such a short time frame. But their stock price can rise and fall by huge swaths.

And here’s the challenge. There are many metrics which serve as gauges on how a company is doing. Earnings, profits, debt, etc. There are countless charts to read. Some people in fact go out and develop their entire investing plans based purely on charts instead of the fundamentals of the business. But the key flaw in trying to predict the movement of stock prices based on these readouts is that every single trader applies different weights to each of them. P/E may be very important to you, but less important to others, and hence your decision to buy and sell will be slightly different from everyone else.

This means that situations where you expect the price to rise, others may decide to dump their positions, and it can push the price down. Like I said before: you CAN’T predict the movements of the market. Countless studies have been made that demonstrate day trading based on these factors tends to cause people to lose money.

Let’s study those that HAVE beaten the market consistently

We just discussed how you can’t predict movements of the market. Yet people like Warren Buffett HAVE beaten the market by wide margins 40+ years. How??? It seems sensible to investigate what he does compared to the entire investment industry, right?

Warren Buffett has socked away GOBS of cash. Berkshire Hathaway has something like $30+ billion (with a “b”) in pure cash. He sits there and waits for businesses that have strong fundamentals, quality products, and successful execution to have some “bad news” occur. Or he waits for these companies to miss some earnings estimate and for people to panic and dump stock. When stocks crash because of day traders and investment houses freaking out, he steps in and buys a solid business at a discount.

He either buys businesses themselves, or large chunks of stocks. That is why Berkshire Hathaway owns companies like Geico, Dairy Queen, and Acme Brick Company. But they also own millions of shares of Coca-Cola, Wells Fargo, and IBM. These businesses all built solid sources of revenue and many generated powerful cash flows that Berkshire Hathaway has managed to use to accrue yet more investments.

So in the end, I can’t help you predict the movements of stocks. I can’t suggest when the best time is to exercise your stock option. You have to choose for yourself and be happy with your deal. In my experience, it seems often that as soon as you exercise some options, the price suddenly jumps. Never look back. Instead, take the equity you just collected and put it into better performing places like blue chip, dividend kings or leveraged rental property. Or recharge your cash reserves.

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