INVESTINGIN

STOCKSCAN YOU BEAT THE MARKET?

CONCEPTS ADDRESSED• MARKET EFFICIENCY THEORY• BUY AND HOLD• MARKET TIMING• VALUE STOCKS• DIVERSIFIED PORTFOLIO• LONG-TERM INVESTMENT HORIZON• PRICE/EARNINGS RATIO• DIVIDEND YIELD• INTEREST RATE• DOW JONES INDUSTRIAL AVERAGE• INDEX FUNDS

A MARKET EFFICIENCY STORYAn elderly economics professor was walking down a busy street with one of his energetic students to the local café for lunch. Along the way, as he was explaining the concept of market efficiency to his student, the professor stepped right on a wadded up $20 bill and continued to stroll on. The student, who was looking down in studious thought at the time, was amazed at his good fortune and stooped down to pick it up. As the student rushed to catch up with the professor, he asked the professor whether he had seen the $20 bill. The professor quipped "My dear lad, haven't you been listening to anything I have been saying about efficient markets? Although I saw the $20, I knew my eyes must have been deceiving me. Efficient markets theory dictates that it couldn't possibly be there because if it had been, someone else would have already picked it up."

MARKET EFFICIENCY HYPOTHESIS

• All stock prices accurately reflect all historical and current information.

• Whenever you buy a stock, you are getting the best price based on available information.

DART THROWING MONKEYS• In A Random Walk Down

Wall Street, author Burton Malkiel convincingly showed that most investors lack consistent skill at timing markets or picking winning stocks over the long-term.

• His most controversial claim was that a monkey throwing wet paper towels at a stock chart on the wall could beat an expert armed with statistics and stock picking formulas.

TIMING THE MARKET• Somebody has to be the

first to notice the $20 bill on the street.

• Some investors believe they can identify under-valued stocks (Value stocks).

• The economic incentive for correctly timing the market can be huge, making market timing a tempting proposition.

BUY AND HOLD INVESTMENT STRATEGY

Buying a diversified stock portfolio and holding it long enough to benefit from its growth in value over time, regardless of short-term price fluctuations.

HERSHEY COMPANY (HSY)

Hershey makes candy and candy is popular at Halloween.

Should I buy shares of Hershey stock at the beginning of October and sell them in November?

• Gains from following the advice in the question over the last five October’s combined:

-7% (plus fees)• Gains from buying

HSY on 9/1/09 and holding it until 8/1/09:

+137%

INTERACTIVE ACTIVITYhttp://www.econedlink.org/interactives/EconEdLink-interactive-tool-player.php?filename=main.swf&lid=333

The link above will take you to three graphs showing actual price movements for several different stocks over a multi-year period.Decide what you would like to do.

KEY STATISTICS

Professional investment managers have a variety of statistics they examine in an effort to estimate the relative value of the stock market.

KEY STATISTICS

Price/Earnings (P/E) ratio: This ratio describes how much one is paying for every dollar a company earns. For example, if a company’s stock price is $15 per share and it earned $1 per share over the preceding year, its P/E ratio would be 15.

KEY STATISTICS• Dividend Yield: The DY is the dividend divided

by the share price. As an example, suppose you buy stock at $10 a share and the company is pays $1 per share in dividends. The dividend yield would be 10%. Ceteris paribus, the higher the yield the more attractive the stocks is.

• Interest Rate: How much you can expect to earn on bonds. Bonds are debt instruments that pay a fee for the temporary use of capital. The higher the interest rate on bonds the less attractive stocks will be because there is typically less risk with bonds.

INTERACTIVE ACTIVITYhttp://www.econedlink.org/interactives/EconEdLink-interactive-tool-player.php?filename=main.swf&lid=334

The link above takes you to an activity where you’ll start with $100 and attempt to accumulate as much wealth as you can by either investing in the stock market or setting your money aside safely in the bank.

SO…WHAT HAVE WE LEARNED?

• Outperforming the market by timing your transactions is extremely difficult.

• Advocates of the market efficiency theory suggest a long-term investment strategy of buying and holding a diversified group of stocks or an index fund that tracks a large basket of stocks.