After hearing the current events of the past week in the financial field it made me wonder if most people understand the concept of when profits are made with any form of investment. We saw stocks like Google, Amazon and Microsoft do very well after announcing quarterly results. Google (GOOG) shot up 14% in one day (Oct 18th) to close over $1,000 for the first time. The market value increase in Google stock in one day was greater than the total market value of most publicly traded companies. What changed from one day to the next that investors quickly decided that Google should be worth 14% more that day? Was Google stock really worth that much less only two days prior?
This question is at the heart of understanding what makes Wall Street tick. One would imagine that folks who invest money professionally do so in an unemotional way and only focus on facts and figures. If this were true, how do you explain a stock moving 14% in one day? Many stocks don’t move that much in months or a year. Is it possible that these professionals had no idea that Google would announce the numbers they did? Emotion made people take profits and other people jump on the bandwagon. Gordon Gecko would call it greed. There is only one way for you to have made a 14% profit on Google stock on that day…you would have had to purchase the stock at least the day before. Simple right?
What’s my point here? The profit on Google stock was not made on Oct 18th, the day it shot up so much. It was made on the day whoever bought the stock before October 18th. Profit in stocks is determined at the time of purchase rather than at the time of sale when the actual gain is realized. The calculation of your profit in any stock trade is dependent on the price you paid versus the price at which you sold. This is very similar to the market value of homes. Let’s assume the average house on your block is valued at $400,000 today. Who would you imagine would be a happier homeowner, the person who purchased the house at a cost of $300,000 many years ago or the person who purchased a house several years ago at a cost of $475,000? Both are worth approximately $400,000 today. The homeowner who paid $300,000 and sells for $400,000 realizes a $100,000 profit. The purchase price was key to this profit.
The next time you read or hear about a great real estate deal, a great stock, or any other great investment, just remember that every investor’s personal profit is determined based on the date of purchase. This is true of the market returns you hear about every night on the news or see on your smartphone. If you read Yahoo Finance after the market close today (10/25) you'll see that the S&P 500 Index is up 19.81% for 2013 year-to-date. Does this mean that everyone who was invested in a S&P 500 Index fund or ETF is up almost twenty percent? Sure, if you purchased the fund or ETF at the closing price of the last trading day in December of 2012. It is more realistic to assume that people buy investments at different times and sell at different times than the first day of the year.
None of this is rocket science. We are discussing basic investment facts and pretty easy math. But why do so many investors fall into the same trap time after time? Investors need to buy before the earnings announcement and sell after it if they want to book the profit. Buying a stock after it has already shot up in value isn't necessarily a great investment at that point in time. Others ask if this is a great investment; I ask is this a great investment now?