Q&A with CMMB Securities

Q. More and more financial people seem to be suggesting that investing in the stock market is a smart move, but is there ever a bad time to get into the market?

Curtis, Cunupia

A: Stock Markets are subject to ups and downs, similar and related to the business cycle and the economic cycle. The cumulative effect of buying stocks low and selling high creates volatility in the market. The volatility can be explained in terms of a supply and demand concept. When stocks are considered to be undervalued, investor demand drives up prices and the supply of stocks becomes limited. The market is considered to be on the demand side or “bullish”. The optimistic expectations arising out of a “bullish” market tend to eventually push stock prices beyond a level that can be justified by a company’s expected earnings.

When this happens, the stocks are considered to be overvalued. When stock prices appear to be overvalued, the market is considered to be overheated and adjustments usually occur when companies announce their results. If earnings results of companies fall short of analysts’ expectations, the price of the stocks will likely fall. On the other hand, if earnings results meet or surpass analysts’ expectations, then the price of the stock and even demand will be sustained, depending on the future potential of the stock.

Interest rates and liquidity conditions also play a major role in the direction of the stock market. When interest rates are low and liquidity levels are high, investors seek to gain higher returns from the stock market and vice versa. Additionally, low interest rates stimulate capital investment by companies, which would go towards improving their performance and growth and increasing their stock prices. In summary, an investor should be cautioned about investing in the stock market when the market appears to be overheated, when the outlook on interest rates is to increase and when liquidity levels are becoming tight. One measurement of overvalued stocks is the price to earnings multiple.

A higher market multiple, especially when compared to historical levels, suggests the market may be subject to some downward correction when the earnings season begins. For most companies on our Trinidad and Tobago Stock Exchange, the earnings season is from March to April.

Q. I read in a local paper the view of a stockbroker that company performance is the best guide when investing in the stock market, but isn’t company performance sometimes erratic?

Robbie, Cross Crossing

A: A company’s performance can be a good guide when investing in a particular stock on the stock exchange, but as you point out, it can be erratic at times. It is because of the ups and downs of a company’s performance that the price of a share can exhibit significant volatility. When the company releases its financial results (which is mandatory because of its listing on the stock exchange) it heavily influences the price of the company’s stock. If a company releases its financial statements which show a growth in earnings with an impressive net income figure, it is expected that investors would interpret these results in a positive way. Demand for the company’s shares would increase, the effect of which would be an upward movement in the price of the company’s shares.

The opposite occurs if a company’s financial results reveal a decline in the earnings. When assessing a firm’s financial results, it is important that special attention be paid to the notes that accompany these results. For example, a company may change a method of dealing with an item in its balance sheet such as its method of handling depreciation. Investors would want to make sure that an increase or decrease in earnings is a result of real factors rather than differences in the method of accounting. Investors should also look out for other information concerning a company such as any new initiatives the company is undertaking and not rely on the statements only. It is the future growth potential of a firm that would ultimately determine the future direction of its stock price.

Disclaimer for Articles:

“All information contained in this article has been obtained from sources that CMMB believes to be accurate and reliable. All opinions and estimates constitute the Author’s judgement as of the date of the article; however neither its accuracy and completeness nor the opinions based thereon are guaranteed. As such, no warranty, express or implied, as to the accuracy, timeliness or completeness of this article is given or made by CMMB in any form whatsoever. CMMB and/or its employees or directors may, where applicable, make markets and effect transactions, or have positions in securities or companies mentioned herein. Neither the information nor any opinion expressed, shall be construed to be, or constitute an offer or a solicitation to buy or sell.”