Lessons from “Why Does the Stock Market Go Up” by Brian Feroldi

Below are insights from Why Does the Stock Market Go Up by Brian Feroldi. See lessons and discussion questions below.

Part 1 Review: STOCK MARKET BASICS (p. 30)

• Stock represents partial ownership of a corporation.
• Stocks have value because the owner has a legal claim on a portion of the company’s profits and assets.
• The stock market is a place where businesses and investors can connect with each other in order to buy and sell stocks. 
• A stock exchange is a place where stocks are listed so they can be bought or sold by public investors. The two largest stock exchanges in the world are the New York Stock Exchange (NYSE) and NASDAQ Stock Exchange.
• A stock market index is a basket of stocks that are used to track the performance of the stock market as a whole. The three most popular stock market indexes in the U.S. are the Dow Jones Industrial Average, the S&P 500, and the NASDAQ Composite.

Part 2 Review: GOING PUBLIC (p. 45)

• The primary reason why companies go public is because they want to raise money from investors by selling new shares of stock.
• Companies can also go public because they want to create an easy way for existing shareholders to sell their stock. Other times, they just want to make the company more visible to the public.
• Most companies go public through an Initial Public Offering (IPO).
• Companies only get money from selling stock when new stock is created and sold to investors. When a stock is sold by an investor, the investor gets the money from the sale, not the company.
• The downside of creating new stock is that existing shareholders are diluted.
• Investors buy stock because they want to make money.
• Investors make money by owning stock from appreciation and dividends.
• Appreciation is when a stock goes up in value over time.
• Some companies give a portion of their profits back to their investors in the form of dividends.

Part 3 Review: VALUING A BUSINESS (p. 58)

• The price of a stock is determined by how much profit a business is expected to make in the future and how much investors are willing to pay now to own those future profits.
• Buyers want as low of a price as possible so they can earn a high return. Sellers want as high of a price as possible.
• The price-to-earnings (P/E) ratio is found by dividing the price of a stock by its earnings per share.
• A business that is growing is worth more than a business that is not growing.

Part 4 Review: VALUATION, INVESTOR SENTIMENT, AND LONG-TERM RETURNS (p. 83)

• The P/E ratio is not fixed; it changes all the time. 
• Good news makes investors more willing to buy stocks, increasing P/E ratios and stock prices. 
• Bad news makes investors less willing to buy stocks, lowering P/E ratios and stock prices. 
• In the short term, stock prices change based on how investors feel about a company. 
• Slight optimism leads to small gains; strong optimism leads to large gains. 
• Slight pessimism leads to small declines; strong pessimism leads to large declines. 
• Over the long term, prices move based on changes in earnings. 
• Over a one-year period, the odds that the S&P 500 rises are about 69%. 
• The longer the holding period, the higher the odds of making money. 
• There has never been a 20-year period in U.S. history in which the S&P 500 produced a negative return. 

Part 5 Review: MARKET CRASHES AND ECONOMIC DOWNTURNS (p. 96)

• Roughly every decade, the stock market experiences a major decline or crash. 
• Investors sell stocks when they anticipate a decline in earnings. 
• Stock market crashes are a normal part of investing. 
• Crashes are difficult to predict because they are heavily influenced by human emotions. 
• Difficult economic times push businesses, workers, and entrepreneurs to innovate. 
• Weak businesses often fail during downturns, allowing stronger competitors to gain market share. 
• Governments can help cushion downturns through spending, employment programs, and purchasing goods and services. 

Part 6 Review: WHY EARNINGS GROW OVER TIME (p. 118)

• Earnings grow through inflation, productivity, innovation, international expansion, population growth, acquisitions, and stock buybacks. 
• Inflation is the rise in the price of goods and services over time. 
• Productivity improves when people produce more with fewer inputs. 
• Innovation creates new products, services, and market opportunities. 
• International expansion allows companies to sell into new countries and markets. 
• Population growth increases demand for goods and services. 
• Acquisitions occur when one company purchases another company. 
• Stock buybacks occur when companies repurchase their own shares. 

Part 7 Review: COMPOUNDING AND DIVIDENDS (p. 135)

• Compounding occurs when investment proceeds are reinvested repeatedly to generate additional returns. 
• Compounding causes investment value to grow faster over time. 
• Stock market compounding occurs because returns are measured as percentages. 
• Annual gains and losses build upon prior years’ results. 
• Year-to-year returns vary widely and are rarely exactly 10%. 
• Over long periods, the average annual return of the U.S. stock market has been about 10%. 
• Dividend reinvestment uses dividends to purchase additional shares. 
• Dividends play an important role in long-term compounding. 

Part 8 Review: GETTING STARTED (p. 160)

• The first step to start investing is to open a brokerage account. visit brianferoldi.com/brokers for an up-to-date list of brokers. 
• There are two primary types of accounts: taxable accounts and retirement accounts.
• You can start investing with any amount of money. 
• There are two costs to investing: commissions and expense ratios.
• The most common ways to invest in the stock market are mutual funds, exchange-traded funds (ETFs), index funds, individual stocks, and target-date retirement funds. Each of them has pros and cons. 
• The vast majority of mutual funds underperform the stock market over time. This occurs because of misaligned incentives, career risk, fees, a short-term focus, size, and taxes. 
• If the idea of researching and buying individual stocks interests you, go for it. If not, just stick with index funds and target-date retirement funds. 

Part 9 Review: ALL ABOUT FINANCIAL ADVISORS (p. 177)

• A financial advisor is a professional who can assist you with many areas of your financial life. 
• Whether or not you should hire a financial advisor boils down to this question: are you ready, willing, and able to spend time learning how to become your own financial advisor? If not, consider hiring one. 
• Ask friends, family, accountants, tax professionals, and attorneys for a referral.
• Use websites like garettplanningnetwork.com, financialplanningassociation.org, and napfa.org to find a financial advisor. 
• Ask any financial advisor that you meet with if they are a fiduciary. If they say no, leave. 
• Make sure you understand how a financial advisor gets paid before you become their client. Ideally, they are fee-only.
• Robo-advisors provide automated investment advice. They have several benefits that might make them a good choice, but they are still new. 

Part 10 Review: AVOIDING BIG MISTAKES (p. 193)

• If you invest in both good times and bad, you should earn good returns over time. Don’t stop investing just because the economy is doing poorly. That can actually be the best time to invest. 
• There’s no magic signal that occurs at market tops or bottoms. Don’t try to time the market. 
• Remember, in the short-term, market prices are controlled by the collective emotions of investors. Does that sound like something you can predict?
• If a stock is trading below $5, there’s probably something wrong with the business. You’re better off avoiding it and looking for a better investment.
• Don’t be in a rush to sell an investment because it is going up. One of the worst mistakes that an investor can make is to sell a great investment early because they are in a rush to take a profit. 
• Don’t buy the highest dividend yielding stocks that you can find. A high dividend yield is usually a warning sign that the company can no longer afford to make its dividend payments. Dividends are not guaranteed. 

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