The Motley Fool
Ask the Fool
Q: I observed a stock start trading one morning at a price very different from where it closed the day before. Can you explain that? — F.W., Greensburg, Pennsylvania
A: There may have been a stock split, or some big news (or rumors) may have broken after the market closed. If, for example, the company is being bought out or it posted an unexpectedly good or bad earnings report, that could have caused buy or sell orders to pile up overnight, resulting in big overnight price moves.
Stock prices simply reflect supply and demand, so if lots of people want to sell, the price will fall to a point at which some will buy — and vice versa. After-hours trading, which occurs before the market opens and after it closes, is another factor.
Q: Are share buybacks good for a company’s shareholders? — P.A., Tulsa, Oklahoma
A: It depends. If a company buys back shares when they’re overvalued, it’s wasting money that could have been spent in more productive ways (such as being paid out as a dividend or used to grow the business). But if it repurchases shares when they’re undervalued, that benefits shareholders.
The shares bought back on the open market are essentially retired, leaving each remaining shareholder owning a bigger piece of the company. For example, imagine that earnings at the Rubber Chicken Catering Co. (ticker: CHEWY) are $3 million and it has a million shares outstanding. Its earnings per share (EPS) are thus $3. If CHEWY buys back a tenth of its shares, leaving 900,000, then its EPS suddenly rises to $3.33 ($3 million divided by 900,000). Still, investors should prefer earnings to grow mostly due to business growth, not share buybacks.
What If Your Portfolio Tanks?
The stock market has experienced some big swings in recent months, and it’s got some investors jittery. Do you know what you would do if your stock portfolio suddenly took a dive? Here’s some guidance.
For starters, instead of fearing stock market drops, expect them. They will happen every few years, and some years can shrink your portfolio considerably. In 2008, for example, the S&P 500 plunged more than 36 percent. It dropped for three years in a row in 2000, 2001 and 2002, with 2002’s drop a hefty 22 percent. Those can be alarming, but know that there were plenty of years with double-digit gains before and after those years. The average annual gain over many years has been close to 10 percent.
So keep that perspective in mind whenever the stock market retracts or crashes. It shouldn’t hurt you severely if you’ve sensibly kept any money you might need in the next five (or even 10) years out of stocks. Your investments need time to recover after any downturn.
Another smart thing to do if the market drops is to go shopping! It can be hard, psychologically, to buy stocks when others are selling and the media is obsessing about market losses, but that’s often a great time to buy, as many terrific stocks will be temporarily sporting significantly lower prices.
EDITOR’S NOTE: The Motley Fool is an investment column created by brothers David and Tom Gardner and distributed by Andrews McMeel Syndication.