Rather than relying on stock market predictions, look for share value instead

In investing, it pays to avoid relying on stock market predictions. Successful predictions can pay off enormously, of course. But nobody can consistently or even frequently predict the future in individual stocks or the market. The more your investment success depends on predictions, the greater the risk you face.

On the other hand, it’s possible to assess investment conditions in a general sense. That way you may recognize when it’s a good time to buy stocks, if you can afford to hold them for the next couple of years or longer. If you do most of your buying in times like that, you’ll wind up making a lot of money over the course of your investing career. (If you follow our three-part Successful Investor strategy, you’ll make even more.)

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Stock market predictions and “a good time to buy”

Mind you, “a good time to buy” is an opinion on a long-term probability. It doesn’t mean the market will go up right away. For that matter, you may buy just prior to one of the market’s occasional downturns. You have to accept this risk if you want to profit from the stock market’s ability to turn middle-income people into well-off retirees over the course of a few decades.

The funny thing is that many people hurt their prospects by going at it backwards. Instead of looking for good times to buy, which are relatively plentiful, they fixate on avoiding the market’s relatively rare downturns. They try to do that by hunting for reasons to stay out of the market.

They want to invest in stocks. They believe in the market’s long-term growth potential. But they dread the thought of buying just prior to a downturn. So, if they see anything that they fear might provoke a market setback, they hold off on buying until the risk has passed.

A good way to buy stocks: Value stocks are a better focus for investors than stock market predictions

One of the sweetest and most profitable pleasures of successful investing is to buy a high-quality “value stock” (or a stock that’s reasonably priced, if not cheap, in relation to its sales, earnings or assets), then hold on to it as mainstream investors recognize the value and its share price moves up.

When you look for stocks that are undervalued, it’s best to focus on shares of quality companies that have a consistent history of sales and earnings, as well as a strong hold on a growing clientele.

High-quality value stocks like these are difficult to find, even when the markets are down. But when you know what stocks to look for, you can discover them. We employ three financial ratios as a useful guide to spotting them:

• Price-earnings ratios
• Price-to-book-value ratios
• Price-cash flow ratios

A bad way to buy stocks: Making stock picks by measuring volatility

Stock beta ratings are a commonly used measure of stock-market volatility. To calculate a stock beta, a market index like the S&P/TSX Composite Index is assigned a beta of 1.0. The historical volatility of different stocks relative to the index is then measured using either a 36-month or 60-month regression analysis.

If a stock has a beta of 1.0, it means the market and the stock move up or down together, at the same rate. That is, a 10% up or down move in the stock market index should theoretically result in a 10% up or down move in the stock. A beta of 2.0 implies the stock will tend to move twice as much as the market. That is, if the market moves up 10%, the stock should move up 20%. A beta of 0.5 indicates the stock will move one-half as much as the market, either up or down.

A negative beta indicates the stock tends to move in the opposite direction from the general market. That is, the stock price declines when the overall market is rising or rises when the overall market is declining.

As a measure of risk, beta has a number of limitations. It is based on past data, so its use in predicting the future assumes the company being charted remains unchanged—in other words, no major acquisitions, divestitures, or other company-altering events take place. In reality, a stock’s beta can rise or fall over a period of years or change abruptly.

To assess a company’s suitability for your portfolio, you are better off using more reliable measures of safety, such as steady earnings and cash flow, low debt and a secure hold on a growing market.

What stock market predictions have you heard, acted upon, and lived to regret?