We’ve covered a ton in this course about how the stock market works, which stocks to buy, how to organize your portfolio, and much more.
In this lesson we want to pull it all together and walk you through what to expect when you invest in stocks.
There are certain events and situations that we haven’t discussed much so far, but we want to make sure you’re well aware of them.
We’ll add to this list over time based on feedback from our readers. So don’t hesitate to reach out if you’d like to see something added.
Let’s dig into what to expect once you start investing in stocks, beginning with analyst reports.
Analysts Estimates Can Move Your Stocks
Many stocks are covered by Wall Street analysts. This means that investment banks like Goldman Sachs, Merrill Lynch, and many others conduct detailed research on certain stocks and issue opinions on how they will perform.
Typically analysts will provide in their reports:
- A “target price”, which is where they think the stock price will be in a year
- A “Buy / Sell / Hold” recommendation for the stock
- An estimated forecast of upcoming quarterly / annual results
- A write-up of their opinion on the stock
For several reasons, these forecasts don’t tend to be very accurate, so we wouldn’t encourage you to rely on them. Plus, they’re usually only available to high end clients and investment institutions, not to us common investors.
Most importantly, changes in analyst opinions will often move the price of your stocks.
For example, you may login to your account and see your Best Buy (BBY) stock is up 6%. After browsing the news, you might see some headline like, “Best Buy Shares Rise on Goldman Upgrade to ‘Buy’.”
In that scenario, Goldman’s analysts upgraded their opinion of Best Buy stock to a “Buy”, which caused the price of the stock to increase.
Unfortunately, the same scenario often plays out to the downside as well, and you’ll sometimes see your stocks decline due to analyst downgrades.
We don’t pay too much attention to changes in analyst opinions, because they tend to have low accuracy.
But be aware they can move your shares up or down in the short term, usually just for a day or two.
It’s All About the Quarterly Earnings Report
Most companies (but not all) report their financial results every quarter.
This involves releasing their latest figures (through the end of the last quarter) before the market opens or after the market closes. This is typically followed by an earnings call where management talks about results and takes questions from shareholders.
While all stocks fluctuate in price nearly every day, it’s the earnings reports that really move stocks over time.
Benjamin Graham, a legendary value investor, once famously said:
“In the short run the market is a voting machine, but in the long run it is a weighing machine.”
He meant that stock prices tend to fluctuate daily based on the mood of the market, the latest analyst change, trending news coverage, and other short-term factors that act like a popular voting machine.
But over the long run, stock prices are moved by the growth or decline in the underlying value of the business behind each stock.
The short term is a popular vote. The long term is the weight of the underlying value of the company.
Because of this, during each quarterly earnings report, Wall Street analysts, investors, stock pickers, investment advisors, and many others scrutinize the company’s performance compared to their history and analyst expectations.
For example, if Starbucks (SBUX) reports $6.6B in revenue from last quarter, and the 20 Wall Street analysts who cover the stock had estimated just $6.5B, you’ll hear that Starbucks “beat consensus expectations on the top line.”
Simply put, they delivered higher sales than analysts had expected.
The same thing can happen on the bottom line, when a company earns more last quarter than analysts had expected.
Many companies also issue “guidance” on their upcoming quarter and year so that investors have a sense of what to expect. Just like their recent quarterly performance, a company’s guidance can be above or below what analysts had forecast.
When companies are performing very well, they tend to beat analyst expectations on the top and bottom line and raise their guidance for future earnings. This is called a “beat and raise”, and it’s a bullish sign that will often send the stock higher.
Rarely, companies will issue a “warning” before it’s time to release their quarterly earnings results. This is intended to warn investors that they’re going to miss their previously-shared targets by a meaningful margin.
When this happens, you’ll often see a swift decline in the stock’s price as investors bail out.
Finally, companies often announce their dividend and share buyback policy during their earnings call. Investors like to see dividend growth and generous share buybacks, so material news in these areas can also impact your stock’s price.
The market will watch earnings reports very closely because they’re a highly transparent opportunity to see how the company is currently performing.
Good performance will usually send your stocks upwards, while bad performance will send prices south.
While anything (good or bad) can happen for one quarter, a string of several very good (or very bad) earnings reports in a row are worth paying attention to.
Stocks Can Change Price During Extended-Hours Trading
While official market hours are Monday – Friday from 9:30am – 4:00pm EST, some brokerages allow extended-hours trading or after-hours trading. These are sometimes also called “pre-market” and “after-market” trading.
This allows investors to buy and sell shares for a few hours before and after the markets are open.
Since important stock news (such as earnings reports) is often released before and after market hours, you’ll sometimes see your stock move significantly up or down outside of typical trading hours.
For example, if a company reports fantastic earnings at 8:00am, you may see your stock is up +10% before the market even opens.
Or, if they issue an earnings warning after the market closes, you may see your stock decline after hours.
While we don’t see much value in placing trades after hours for most investors, it can be helpful to see how the market reacts to key news.
The Market Returns 7% – 10% Long-Term, but You’ll Rarely Earn That in Any Given Year
As we covered extensively in an early lesson, the market tends to return 7% – 10% per year, on average, over long periods of time.
However, it will rarely earn 7% – 10% in any given year.
Remember, that 7% – 10% figure is an average rate of return over long periods of time.
The actual year-by-year returns are all over the map, and they average out to the 7% – 10% range over time.
For example, here are the annual returns (including dividends) for the S&P 500 since 1988 (from YCharts):
As you can see, the returns vary a lot from year to year.
So, when you start investing, don’t expect to see your annual returns clock in at 7% – 10% each year, that’s just a long-term average.
But remember, if you can use you the skills you’ve learned in this course to earn just a few percentage points better than the market during the up years AND the down years, that will translate to long-term performance that beats the market’s typical 7% – 10% long-term average.
Losing to the Market for Stretches of Time Is Totally Normal
As savvy investors, we want to beat the market over the long term.
However, it’s important to remember that there will be long stretches of time where your performance trails the market. That’s OK!
Even the best, most legendary, investors only beat the market 60% – 70% of the time. The rest of the time, they underperformed their benchmarks.
Similarly, most high-performing investors only pick winning stocks 50% – 70% of the time. It’s not common to be right on all of your stock picks.
Keep in mind, “winning” means more than just a positive return. You have to consider the stock’s performance relative to the benchmark.
For example, if you buy a stock that loses money for five years before finally climbing back up and you sell it for a +1% gain, is that a winner?
Maybe. Maybe not.
What if the market crashed by -50% during that same period? I’d say a +1% gain is pretty good!
But what if the market gained +50% during the same period? It’s hard to call a measly +1% gain vs. a +50% gain for the market a “winning” stock.
As we’ve discussed in other lessons, remember to keep in mind it’s not just about always selling your stocks for a profit. You have to consider how the entire portfolio performs overall compared to a relevant benchmark.
The Stock Market Can Be Volatile
Sometimes market trading is calm, like a still lake during the early morning hours of sunrise.
And sometimes market trading is wildly turbulent, like a rough sea during a massive storm.
Ultimately, the market is driven by people making investment decisions. When people become emotional, afraid, greedy, risk-averse, risk-seeking, or other things, you will often see that reflected in the way markets trade.
The market can spend long stretches of time in states of high volatility, which is normal. It’s part of how stocks have traded for over 100+ years.
Volatility can provide wonderful opportunities to buy high-quality companies at discount prices. As investors panic and sell off stocks, you can pick up shares from your “wish list” for cheap.
A solid part of successful investing comes down to psychology; keeping your cool when markets are tanking and not getting greedy when markets are booming.
Corporate Actions Create Stock Splits, Dividends, Mergers and Acquisitions, Spin-Offs, and More
A corporate action is an event initiated by a public company that will bring a change to the securities issued by the company.
Common examples of corporate actions include stock splits, dividends, mergers and acquisitions, and spin-offs.
Most corporate actions, such as dividend payments, are a normal part of being a shareholder and there’s nothing you have to do.
Stock splits are when a company cuts its share price by “X” and then issues you “X” times as many shares. That way they can lower the price the stock is traded at, but keep everyone’s invested value the same.
For example, if a stock is trading at $100 and the company would rather it trade at $50, they might do a 2-for-1 stock split, cutting the price in half to $50 but doubling the number of shares you own.
During a stock split, there’s nothing you need to do. You’ll see the share price and quantity change in your brokerage, but the dollar amount of stock you own stays exactly the same.
Lesson Summary: What to Expect Once You Start Investing in Stocks
Hopefully this lesson will give you a sense of some key things to watch out for once you start trading.
Let’s review the main takeaways we covered:
- Investment banks conduct research on stocks and issue opinions on how they will perform. Their opinions can move your shares up or down, usually just for a day or two.
- Most companies (but not all) report their financial results every quarter.
- While all stocks fluctuate in price nearly every day, it’s earnings reports that really move stocks over time.
- During quarterly earnings reports, companies often discuss sales, profit, other financial metrics, dividend and share buyback policy, and provide estimates for future financial performance.
- While official market hours are Monday – Friday from 9:30am – 4:00pm EST, some brokerages allow extended-hours trading or after-hours trading. These are sometimes also called “pre-market” and “after-market” trading.
- The market tends to return 7% – 10% per year, on average, over long periods of time; however, it will rarely earn 7% – 10% in any given year.
- Even the best, most legendary, investors only beat the market 60% – 70% of the time. The rest of the time, they underperformed their benchmarks.
- Most high-performing investors only pick winning stocks 50% – 70% of the time. It’s not common to be right on all of your stock picks.
- The market goes through long and short cycles of volatility, and can spend long stretches of time in states of high or low volatility.
- A corporate action is an event initiated by a public company that will bring a change to the securities issued by the company. For example, stock splits, dividends, mergers and acquisitions, and spin-offs.