Stocks and Their Valuation
by MaestriFrom slightly less than 4000 in early 1995, the Dow surged to 11723 in early 2000. To put this remarkable 7723-point rise in perspective, consider that the Dow first reached 1000 in 1965, then took another 22 years to hit 2000, then four more years to reach 3000, and another four to get to 4000 (in 1995). Then, in just over five years, it reached 11723. Thus, in those five years investors made almost twice as much in the stock market as they made in the previous 70 years!
That bull market made it possible for many people to take early retirement, buy expensive homes, and afford large expenditures such as college tuition. Encouraged by this performance, more and more investors flocked to the market, and today more than 79 million Americans own stock. Moreover, a rising stock market made it easier and cheaper for corporations to raise equity capital, which facilitated economic growth.
However, some observers were concerned that many investors did not realize just how risky the stock market can be. There was no guarantee that the market would continue to rise, and even in bull markets some stocks crash and burn. Indeed, several times during 2001 the market fell to below 10000 and surged above 11000. In fact, the market fell all the way to 8236 in the days following the September 11, 2001, terrorist attacks.
Note too that while all boats may rise with the tide, the same does not hold for the stock market—regardless of the trend, some individual stocks make huge gains while others suffer substantial losses. For example, in 2001, Lowe’s stock rose more than 108 percent, but during this same period Enron lost nearly 100 percent of its value.
While it is difficult to predict prices, we are not completely in the dark when it comes to valuing stocks. After studying this chapter, you should have a reasonably good understanding of the factors that influence stock prices. With that knowledge— and a little luck—you may be able to find the next Lowe’s and avoid future Enrons.
Taken From : Five-Minute MBA – Corporate Finance
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