Stocks Are Companies, Not Governments

Distrust in governments may have created a better time to buy stocks in good companies.

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The last few months have been a wild ride in the markets. It was hard to avoid hearing about the ongoing debt-ceiling debate in congress or the downgrade of the U.S. sovereign debt credit rating. We all heard about the less-than-impressive GDP growth figures and the stubbornly high unemployment rate. On the other hand, the news media briefly mentioned that companies are setting earnings records and are well capitalized with plenty of cash on hand. So how did investors react when they were told that companies are in good shape and that loaning money to the U.S. government is not as safe as it used to be? By the masses, they sold their stock in companies and bought U.S. Treasury bonds, pushing the 10-year treasury rate below 2%.

So what determines the price of a stock? At any moment, it is determined by whatever price a willing buyer and a willing seller agree to. But over time, it’s price is generally determined by its profits. When a company has higher sales, new innovative products and services, and finds more efficient ways to create and deliver these goods, it’s price may go up. Of course taxes and government regulation play a role in how much profit a company makes, but it is not the overriding factor.

My experience over the past few months tells me that many investors are not happy with government, ours and others (I’m looking at you, Greece) and are using this as an excuse to dump stocks. They may also be unhappy with total economic figures like unemployment, but they are not really looking at companies. If they did, they would know that employment at the S&P 500 companies grew 10.6% between 2009 and 2010 while employment as a whole grew by only 0.7% over the same time period.* What this has created may be an even better time to buy, at a discount, stock in the companies of the world that are setting earnings records.

We should look at this as a wonderful opportunity, not a time to hang our heads.

* Don’t Let Fear Disrupt Your Investing,” Fidelity Viewpoints, July 26, 2011

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