A subscriber to my weekly advice e-zine asked:
How to Separate Market Manipulation from Normal Market Movement?
To answer this question, we must define the two types of returns that investors may receive:
- Investment Return (EPS growth + dividend yields)
- Market Return (EPS growth + dividend yields + speculative return)
The difference between the two is speculative return, which is responsible for unpredictable short term movements within the stock market.
Most of the time, speculative return relies on changes in a stock’s Price to Earnings ratio (P/E ratio), or simply the price of a stock divided by its earnings per share over the last 12 months.
Understanding the difference between investment return and market return will allow you to understand why the stock market may jump up 100 points or down 100 points within days, yet continue to rise over the long term.
Historical Glance at Dow Jones Industrial Average from 1900 to 2006
As you can see from the Historical Dow Jones chart between 1900 and 2006, the stock market rises over the long term, period. That’s because the earnings of America’s corporations rise in the long term, thus reflected by the rising stock prices. The same principle applies to the stocks of foreign companies as well.
How to Avoid Being Crushed by Market Manipulation and Profit over the Long Term?
Don’t think of your stocks as numbers on a trading screen, but as shares of a real life company. If the business does well over the long term, then your shares will rise in value. On the other hand, if the company performs poorly, then the stock price shall decline over the long term.
Remember that a stock price can be manipulated over the short term by:
- rosy analyst recommendations
- one-time profitable events
- overanxious speculators
However, over the long term, a company’s earnings cannot lie, and its business gains will match the aggregate gains made by shareholders.
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