Why a Stock Increases

Investing

The successful investor invests in a stock not based on its momentum, but on its underlying value, earnings, and future earnings potential. To emphasize, a stock’s price is driven by its growth over the long term. Logically, if earnings increase, a business will grow. For example, the successful investor would invest currently in Wal-Mart’s stock because he believes Wal-Mart’s market capitalization will be higher in 2040. While the successful investor cannot predict Wal-Mart’s future growth with utmost accuracy, he can with some certainty project its future growth based on its past growth. Thus, if by 2040, Wal-Mart triples its net income to $42 billion, Wal-Mart’s stock price, and in effect its market capitalization, should also triple to about $150 and $540 billion respectively, returning 10% compounded annually from 2010 to 2040. However, understand that a stock’s price increases in line with its underlying growth only in the long term. In the short term, a stock’s price increases in line with investor sentiment. As Ben Graham, the father of value investing, once said, “in the short run, the market is a voting machine, but in the long run it is a weighing machine.”

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