How to Make Money in the Stock Market Weighing Machine
by , Investment U Chief Investment Strategist
Friday, June 1, 2012: Issue #1786

These companies are likely to thrive – and deliver exceptional returns – to investors who are able to take the broader view, learn from the past and act unemotionally.

During a radio interview last week, I was asked by the host to explain how Europe’s fiscal problems will play out and the likely impact on the U.S. stock market.

This question is a fine example of why I don’t do many media interviews and why it’s largely a waste of your time to listen to most of the pundits who grant them.

The Eurozone is a mess. That much is clear. But as I told the audience, no one knows how the weak sisters in Europe will resolve their fiscal problems. (Although it’s bound to be instructive for everyone watching.) No one knows what the ultimate fate of the euro will be. No one knows what the fallout will be in world financial markets. And to the extent that someone is confident that they do know, history shows they are very likely to be wrong. Billionaire Ken Fisher doesn’t call the stock market “The Great Humiliator” for nothing.

Europe’s banking and public debt troubles – and their negative ramifications – have dominated world headlines for months. Only a rank novice (or a perpetual gloom-and-doomer, of which there are many) can believe these developments aren’t currently discounted in global stock and bond prices. That doesn’t mean financial markets won’t go lower. They might. And perhaps they will.

But they can also rally from here. Those who say they can’t imagine how are admittedly suffering from a poverty of the imagination – and I’ll bet took no advantage of fire-sale prices during the recent financial crisis (or even the mini-meltdown last fall).

Share Prices Ultimately Follow Just One Thing…

I’ve said it before but it bears saying again. Economies and world stock markets are affected by the complex interplay of government policies, geopolitical tensions (and war), economic growth, interest rates, inflation, commodity prices, currency values, human psychology (particularly fear and greed), consumer confidence, capital flows, pending elections and potential legislation governing everything from tax rates to corporate regulations.

If you really believe you have all these things figured out, you probably shouldn’t be investing your own money.

But here’s something you can take to the bank: Share prices follow earnings. I challenge you to look back through history and pinpoint even a single public company that increased its profits quarter after quarter, year after year, and the stock didn’t tag along.

As Warren Buffett’s mentor Benjamin Graham famously said, “In the short term, the market is a voting machine, but in the long term it is a weighing machine.” What it weighs, of course, is corporate profits. A company’s true value will in the long run be reflected in its stock price. Bank on it.

If you understand this, you recognize that the current market is handing you a boatload of opportunities. It may not feel that way, but that’s how it always works. You pay a premium to invest in stocks when the outlook is rosy and investors are complacent. The real bargains appear only when there is trouble on the horizon and skepticism is high. (It’s too bad that millions recognize this only in hindsight.)

Right now you should be searching for solid, recession-resistant companies with double-digit sales growth, sustainable profit margins, high returns on equity, and quarterly profits that are likely to surprise on the upside in the weeks ahead.

These companies are likely to thrive – and deliver exceptional returns – to investors who are able to take the broader view, learn from the past and act unemotionally.

Good Investing,

Alexander Green