Value investor with a deep passion for understanding and a desire to improve results over time.
The S&P 500 is made up of some of the biggest and best-run companies in the world, but each company doesn't make up an equal amount of the index. In a scenario where each company contributes the same weight, all 500 companies would contribute 0.2% to the index. This is generally referred to as an equal-weighted index, but the S&P is a market-weighted index. This means that each stock contributes in proportion to its market capitalization or what Wall Street thinks the company is worth. In other words, the size of the company matters a great deal.
Under a market-weighted scenario, a stock that makes up less than a hundredth of a percent can go bankrupt, and the index won't even budge noticeably since the price movement in the bigger stocks will more than bury this movement as mere background noise. The more concentrated the market is at the top, the more this phenomenon occurs.
Learn From the Biggest
There's a lot to be learned from the performance of very big companies like those at the very top of a market index. For one thing, you can often get important data points that are essentially leading economic indicators, telling you whether people are buying their products or using their services.
This sort of pulse check can tell you a lot about how the overall economy is doing, and since the companies at the top are industry leaders, they can tell you a lot about their respective industries too. Also, investing doesn't happen in a vacuum, so we can't completely ignore sentiment. Often, much of the rest of the market will often follow suit and rise or decline simply due to market psychology.
But Don't Miss Opportunities
It's not entirely true that within a market driven by a small handful of stocks, where the weight is concentrated in a handful of names, the only thing that the index number is going to tell you is how those few stocks are doing. Still, if you simply assume that all stocks in the S&P 500 must be ridiculously overpriced since the index itself is way up for the month or year, you might be missing a lot of opportunities at the bottom of the index.
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In other words, it's always worth a look at some of the more contrarian names or ignored, unloved stocks. You may be able to find some of the best deals of your life in a raging bull market, especially if it's raging because 5 or 6 companies are insanely popular right now. The author has continued to find bargains in great times simply by looking at sectors or areas of the market nobody is thinking about buying right now.
Time in the Market
While "it's a market of stocks..." is in the running for the most overused slogan in finance, another saying may have become even more of a truism:
Time in the market beats timing the market.
All you need to do is to take a look at the data, and it is overwhelmingly in favor of keeping your money invested as opposed to trying to jump in at the right time. As tempting as it may be to want to avoid losing days and just buy in at the right time, this strategy is not only unlikely to bear fruit; it's very likely to hurt your performance a great deal. Those who have tried this strategy have consistently underperformed largely because they miss some of the best days, the ones that make all the down days totally worth it.
This section might seem a little out of place in a piece about how individual stocks and the stock market aren't the same thing, but it's really important that you understand that when you aren't buying individual stocks simply because "the market" is expensive, you're actually participating in market timing. Don't fall into this trap.
By avoiding market timing and simply trying to buy if there's a good value on an individual stock, you are going to be able to remain invested more of the time, and you're more likely to participate in earnings growth. Take the time to uncover some of the forgotten names, or take a look at some contrarian plays.
Be sure to use a checklist to make sure you're buying things at the right price and with a margin of safety, and you can avoid dumb mistakes. Keep in mind that there are deals out there all the time, and all you have to do is find them.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.