Exploring Your Investment Choices — A “Millennial’s” Perspective

Part 4 -
The Stock Market


This series is meant to address the commonly asked basic question:

What can I actually do with my money?

I’m going to hit each of the investment classes I see as potential choices (at least briefly) in broken up pieces so it’s a bit easier to digest — and in some sort of order and grouping so the concepts can grow on each other.

Generally, the list should also get more exciting / “risky” as you progress :)

Checking / Savings Accounts & CDs
Mutual Funds / ETFs
Fixed-Income / Bonds
Peer to Peer Loans
Equities / Stocks
Commodities
Real Estate
Sovereign Currencies
Digital Currencies
Startups
Derivatives


Part 4:
The Stock Market

Equities / Stocks


Uh oh, we just crossed over a crazy line. This “max yield” concept we’re familiar with from checking account interest rates, to “high yield” savings accounts, to CDs, to U.S. Treasury Bonds, to even super risky bonds like Puerto Rico Electric Power Authority Muni Bonds (ah!) — they all had posted “yields”, we could calculate the money we’d likely receive back for our investment.

In stock world and further, this concept falls apart — and whether this is exciting or frightening is up to you :)

So everyone talks about stocks and the all-popular “stock market”. The “stock market” generally describes the value of all the equity (ownership pieces) of a broad group of public companies. Public in this context means some of the equity is available to the general public to invest in versus private equity (equity in privately held companies) which the vast majority of the “general public” will not be able to invest in. Many refer to major stock indexes (in the U.S.) like the S&P 500, the Dow, and the Nasdaq when they mention the “stock market” — and these indexes are similar to mutual funds in that they represent just baskets with slightly different compositions — here with just the stock of major U.S. corporations.

Within these baskets are names we’re all familiar with, like McDonalds (MCD), Apple (AAPL), and Walmart (WMT). It’s also fairly common to own individual equities as a result of employer stock purchase programs/discounts.

But, as we discussed earlier, the big risk here is that one of these companies turns out to be a bad apple. In a simplified sense, a stock’s price reflects the “market’s” (buyers and sellers) future expectations of the underlying company financially. The price represents the anticipated translation of that corporate financial success into returns to you (in the form of: dividends — cash paid out to shareholders, funds due to a liquidation event — acquisition, etc., or selling the stock at a later point to someone else — basically hoping for simple price appreciation). The maximum stock price (or market cap) for any company is infinite, but is obviously bound by the reality of one company could ever be expected to return to it’s shareholders.

Nonetheless, the “unlimited” upside potential of equities makes it a very attractive investment class for those seeking large potential profits or appreciation on their investments.

Generally, larger, more mature companies in older industries will exhibit the least volatile price movement — and thus be seen as safer equities.

The market cap (or total value of all the outstanding stock) of a company is an important thing to look when analyzing an investment in a stock.

As another broad statement, a “large-cap” stock — or a stock with a large market cap (or value as implied by the price of the stock and number of shares outstanding) — as defined as over $10B has less upside potential than a “small-cap” stock — as defined as $300M — $2B.

Obviously the market sees a reason that a “large-cap” trades at a higher valuation than a “small-cap” stock, but because of the almost infinite yet realistic maximum stock market cap, a “small-cap” theoretically has the potential for higher returns (ignoring probability of course).

The choice of whether to chase these higher potential returns is of course just another decision of risk versus return, like every other investment :)

Let’s look at some real data points:

A public company has never had a $1T valuation or higher.

Exxon (XOM) — Market cap today = $341B.

Most of us are very familiar with Exxon (founded in 1870), the oil & gas giant (old & established industry). By our previous definitions, this is definitely a “large cap” stock, if not some exaggerated version of “large”.

Not to say that Exxon could never have a $1T market cap, but in the short — medium term let’s say it’s very unlikely that Exxon’ stock will appreciate this dramatically (but it’s probably near as unlikely it’d depreciate near as dramatically as well). This “very unlikely” price increase would yield you less than a 200% return. Not that a 200% return wouldn’t be amazing, but let’s look at similar logic in a “small cap” situation.

Instead of plugging a random “small-cap” stock, let’s talk about a hypothetical relatively new $500M software/biotech/pharma company (relatively new yet large industries). The potential returns here are obviously much larger, especially when you can optimistically look to other companies in the industry trading at market caps (and thus potential returns) of 10,000%+ the “similar” company you’re looking at.

With the increase in potential returns comes additional risk, and with investments in riskier stocks also comes increased downside potential.

A common strategy with equities, like we explored quantitatively with our bond portfolio example, is to allocate a smaller portion (or larger, or none, whatever you’re comfortable with) of one’s overall portfolio for more risky stocks while leaving the bulk in safer and less volatile equities. We can’t however really explore a “maximum yield” concept with a stock portfolio though, and that analysis in equities is totally subjective.


Alex Sunnarborg

Disclaimer:
All viewpoints are completely my own — nothing presented represents the viewpoints, opinions, etc. of any corporation or organization and all data/charts/analyses are for illustrative and discussion purposes only and should not be construed or interpreted as fact or advice.

As far as bias on the investments covered in this section — I currently own and have invested in many individual equities.