Among inexperienced investors, it’s common to purchase stock based on price alone. Following the Wall Street maxim of “buy low, sell high,” they buy larger quantities of low-priced stocks, believing that when the stock price rises, they will rake in huge amounts of cash.
While there are certainly documented cases of investors making significant profits using this strategy, it’s rare that a stock represents a good investment based on simply its price. A stock’s value is determined by a number of factors, including the long-term growth potential of the company, the company’s profits and several outside factors, including consumer confidence and retail index. By understanding these factors and how they affect the stock market, you can more effectively select investments to leverage your current assets and maximize your wealth.
When you watch the news, you hear plenty of talk about economic indicators: the benchmarks that experts use to gauge the economy’s health. These indicators do not happen in a vacuum, and have a direct effect on the price of stocks and how much you can earn with your investments.
Gross domestic product. The most general gauge of a nation’s economic health, the gross domestic product (GDP) is the total amount of goods and services produced in the borders of a particular nation. When the GDP is high, the economy is healthy and growing — and the stock market rises accordingly. Conversely, when the GDP decreases, the market decreases with it.
Consumer/product price indexes. How much it costs to produce and buy goods and services can have a significant impact on the stock market. When the producer price index (PPI) is high, it costs more to make goods for sale, thereby increasing the consumer price index (CPI), or the cost for consumers to purchase items. As the CPI and PPI increase, companies have less money for expansion while consumers have less money to spend on discretionary items. As a result, company profits decline, thereby decreasing their stock value.
Retail spending. Related to the CPI and PPI, retail spending is a major indicator of economic health. Almost 70 percent of the U.S. GDP is related to consumer spending; when reports indicate consumers aren’t spending any money, especially around traditionally robust shopping periods like the holidays, that causes ripples in the stock market. For example, if a major retailer reports lower-than-expected earnings in December, that could lead the company to reduce its workforce and revise profit estimates. Investors are then likely to sell their shares of the company to avoid experiencing losses, which only compounds the problem. However, if the reports indicate consumers are spending more money in retail, then it generally follows stock prices will go up.
Employment indicators. Every month, the federal government releases a jobs report, revealing the current unemployment rate and how many jobs were created in the previous month. Obviously, the lower the number of people who don’t have jobs and the more new jobs that need to be filled each month is an indicator of a healthy economy. When fewer people are working and jobs are scarce, consumers and companies are not spending any money, profits decline and the outlook is not good, resulting in a downturn in the market.
The Value of Money
How much money is actually worth also plays a major role in the rice of stocks and the health of the market. For example, inflation creates a rise in prices, which then lowers the amount of money that consumers have to spend. The Federal Reserve regularly adjusts interest rates to control inflation. Keeping interest rates low not only keeps prices low, it also makes it likelier that businesses and consumers will borrow, which increases spending.
While key economic indicators are important factors in determining stock values, outside factors also play an important role. For example, unrest in the Middle East impacts the availability and price of oil, which raises fuel prices in the U.S. — and increases the CPI and PPI. Trends in individual industries, legislative decisions and tax-rate increases or decreases also influence the market.
With so many factors influencing the market, it’s easy to see buying a stock based on its price alone may not be the soundest financial move. To truly increase your wealth and build a solid portfolio, consider these outside factors before making your purchases.
Image by Jeroen van Oostrom from freedigitalphotos.net
About the Author: Blogger Maria Kirk began investing as a child, when she worked with her grandfather to choose stocks and learn about making smart investments.