There are still three skills to learn to invest in US stocks.

Views 38KAug 9, 2023

Is it easier to invest than to speculate? Two advantages of ordinary people in investment

In the capital market, there is no shortage of the myth of speculation to create wealth. For example, at the end of 2020, riding on the east wind of the "stall economy", Wuling Motor increased more than tenfold in two months.

In fact, there are many stories of speculative wealth creation in the market. to put it bluntly, both Hong Kong stocks and American stocks are naked casinos full of speculators rather than investors. As for a novice who has just entered the market, it is easy to lose a lot of money if he is not clear about investment and speculation.

Investment or speculation?

There is an essential difference between investment and speculation. The former is an act of earning sustained returns based on future sustained cash flow returns, while the latter is buying and selling securities based on the prediction that securities prices will rise or fall next.

Whether it is investment or speculation, it is not simple. There are many participants in the secondary market, and each participant wants to make money from it. Everyone comes with the purpose of making money, and only those who have a competitive advantage can get excess returns from the secondary market.

Speculation is actually more difficult than investing, because in the speculative game, you need to know how other speculators (mainly Wall Street) play it, and do better than them in the speculative game, so you need to be smarter, more sensitive, more accurate, better stop-loss, more cold-blooded, but 99% of ordinary people can't do it.

Investment is different. Investment is actually about finding the wrong counterparty (often Wall Street) and asking the wrong counterparty to sell you a bargain, which is why many big American price investors especially like panic selling (Panic Selling) and "Blood in the Street" buying.

Two advantages that are easier for ordinary people to invest than speculators

It is much easier for ordinary people to find counterparties who make mistakes. First of all, let's take a look at Wall Street as a counterparty. Wall Street's main business is investment banking and trading.

1. Trading business:

As a dealer, a Wall Street firm is an agent, and you make money as long as you trade, whether you earn or lose. This also explains why Wall Street is always advocating short-term trading and repeatedly emphasizing the possibility of short-term sudden wealth.

2. Investment banking:

As investment banks, these companies help others arrange purchases and sales to the entire enterprise, underwrite newly issued securities, provide financial advice, and give fair advice on specific transactions, and so on. As underwriting companies, of course, they can't write a bad report and sell it to their clients, so just look at the stock reports of these investment banks and don't take them too seriously.

Based on the above understanding, ordinary people are more likely to gain two advantages for Wall Street as a counterparty:

1. Wall Street only focuses on large-cap stocks.

Wall Street's penchant for underwriting determines that Wall Street only cares about large-cap stocks, occasionally covering medium-cap stocks and almost no small-cap stocks. Including the OTC market, there are about 9000 stocks in the United States, of which only about 2000 are covered by Wall Street. The reason why Wall Street does not cover small and medium-sized stocks is also very simple, because the trading volume of these stocks is not active, and the underwriting business does not make much money. In addition, often a sell-side analyst covers many small and medium-sized stocks, but due to the stimulation of energy and money, these analysts cover these companies very little.

This characteristic that only cares about large-cap stocks determines that the real opportunity exists in small and medium-sized stocks, and the possibility of mispricing of real large companies is very low. When you focus on these stocks, you are likely to be more professional and know more about the company than Wall Street analysts do.

2. There are serious loopholes in Wall Street's valuation model.

Wall Street's favorite valuation model is the DCF model, that is, the discounted free cash flow model, in which the value of an enterprise is equal to the discounted value of free cash flow generated during the life of the enterprise in the future. This model has a serious loophole: the Terminal Value determines most of the target price.

The DCF model generally forecasts free cash flow in the next five years or so (this is also a serious problem, because many five-year forecasts are very incorrect), and then calculates a termination value based on the state of operation after five years, which is generally calculated in two ways. The first is to multiply the EBIT five years later by a multiple to get the enterprise value, and then calculate the equity value. The second is to give an assumption of sustainable growth rate (generally assuming that the sustainable growth rate is about 5%). On the basis of this assumption, we can get the final value of free cash flow in the state of sustainable operation. Then make a useless sensitivity analysis of the above figures. As a result, at least 60% of the value of a target price comes from Terminal Value.

The problem is that when a company's performance is bad, Wall Street analysts become more pessimistic and are likely to lower the future growth rate in the model, so the final value (TerminalValue) falls sharply, resulting in low target prices. When a company performs very well, Wall Street analysts become more optimistic and are likely to increase the growth rate in the model, so the final value (TerminalValue) rises sharply, causing the target price to be too high.

That's why many investment bank analysts always upgrade their investment ratings when share prices are high and downgrade them when stocks are low. Knowing this loophole, you can find some undervalued stocks.

Summary

There are too many myths about creating wealth on Wall Street. Whether it's speculation or investment, there are always people who earn buckets of gold. Most investors always enter the market with the dream of making money, but in fact, it is very difficult for most investors to make money in the stock market. If you want to be one of the few people who make money, you have to figure out what cards you hold. The advantage of being an ordinary investor is to understand Wall Street as a counterparty, seize the mistakes made by the counterparty, and seize the opportunity.

Disclaimer: The above content does not constitute any act of financial product marketing, investment offer, or financial advice. Before making any investment decision, investors should consider the risk factors related to investment products based on their own circumstances and consult professional investment advisors where necessary.

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