Nick Sciple: Hey, I'm fool.com editor Nick Sciple, and on this episode of FAQ,
we're answering the question you've all been asking: how do you make money in the stock market?
People invest to make money, plain and simple. Except in special circumstances, like shorting
a stock, investors buy a stock with the hopes that it will increase in value, allowing him
or her to sell the shares later at a higher price and pocket the difference as profits.
But how do we know a stock is going to go up before we buy it? In the short term, stocks
go up or down for an endless number of reasons -- from military conflict and news releases
all the way down to individual tweets. However, there's only one reason a stock's price increases
or decreases over the long term: to match the value of a company's assets and cash flows.
As Ben Graham famously said, "In the short run, the market is a voting machine, vacillating
based on the news of the day. But in the long run, it's a weighing machine, measuring the
actual value of a business." Now that we know why a stock's value increases
over the long term, we can answer how to make money in the stock market. There are two ways
to make money in the stock market. You can either buy a company for less than it's worth,
or you can buy a company at fair value and hold it as it continues to grow over time.
Let's look at each of these in turn. Imagine I offered to trade you a $1,000 car
for $500. Would you take it? Most of you probably said yes. Free $500, right? Now, you can take
that car, and with patience and effort, find a buyer for the car's full value. Maybe the
seller didn't want to put in that effort, didn't know what the car was really worth,
or, for whatever reason, they needed the car gone quick, and they decided to sell it to
you for that reason. This same thing often happens in the stock market.
A stock falls out of favor, whether due to bad news around a company, market volatility,
or really a number of other reasons, and its price falls below what the company would be
worth to a reasonable purchaser based on its earnings and assets. Intelligent investors
can take advantage of these opportunities to purchase shares of a company for less than
it's worth, and just like with the car, sell the shares for a tidy profit once the market
realizes its mistake. Also like the car, it may take a long time to find a buyer,
because markets can remain irrational for a long period of time. However, this strategy has been among
the most successful in the history of investing. This approach -- buying shares of companies for
less than the resale value of the company as a whole -- is known as value investing.
It's been used for decades by famous investors like Warren Buffett and Benjamin Graham to
build incredible wealth. But that's not the only way to make money
in the stock market. Now, imagine I offered to sell you a grocery store in a small town
with only 100 people for its fair value. This grocery store is the only one in town.
Everyone in town shops there for all their food. And it's profitable. You know that in five years,
a new factory is going to be built in the town that's going to bring 500 new people
to the area, bringing the total population up to 600 people. Would you take my offer
to sell you the grocery store for fair value? Of course you would! You know that in five years,
the grocery store will have six times as many customers as it does today.
With a larger customer base, it should pull in even more money, making the store look extremely
undervalued in five years. This same phenomenon often occurs in the stock market.
For example, when Amazon went public in 1997, it enjoyed a market value of around
$450 million. However, over the ensuing 20 years, as consumer preferences shifted towards
e-commerce and the company wrangled emerging trends like cloud computing, streaming games,
and advertising, Amazon's earnings have skyrocketed by 34,000%, and it now holds a market value of
over three-quarters of a trillion dollars. For investors who were patient and confident
enough to hold the company for the long term, through 50%-plus sell-offs, competitive risks,
and probably some boredom, Amazon has provided life-changing returns. This investing style
-- buying companies with promise for future growth and holding for the long term to realize
the benefits of that growth -- is known as growth investing, and it's a strategy that's
been used by famous investors like Philip Fisher and The Motley Fool's own Gardner Brothers
to great success. Whether you decide to invest for value or growth,
or you shoot for some of both, successful investing requires knowledge and patience.
Knowledge of what a business is worth, and where a company has opportunities for growth
in the future. Patience to wade through many investment opportunities until you find one
where what you know about a company's long-term worth and what the market thinks it's worth
are out of sync; and finally, the patience to wait for the market to recognize that worth.
However, if you can master the patience and discipline it takes to stick to either of
these investing approaches, you'll be able to drive life-changing returns for yourself
and your family over the long term. Thanks for watching, guys! If you enjoyed
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