Have you ever watched a magic trick and were mesmerized by how the magician pulled it off?
For example, a common trick by magicians is to steal their subject’s watch, right off their wrist in plain sight. A good magician is so smooth. Even if you know it’s coming, it’s hard to detect the moment the watch is stolen.
Magicians are masters of misdirection.
They are able to control their subject’s attention – and that of the audience – to one thing while they simultaneously perform a covert action in the background. In short, magicians set you up to focus on the wrong thing. That distraction allows them to swipe a watch, wallet, or anything else in their subject’s possession.
Investors fall for similar tricks.
When it comes to stocks, earnings are the all-powerful engine that propels stocks higher. Earnings are simply the dollars left over after a company pays all its bills and obligations and reinvests for future growth. If earnings rise over time, the price of that company’s stock will follow suit. If earnings fall, well, you can guess what happens to the company’s stock price.
So it’s earnings that matter – and in particular, long-term earnings. That’s what we need to watch as investors.
But like a magician using misdirection, the media and other investors attempt to control your attention by getting you to focus on the stock price, instead of earnings. Why? Because that’s where the action and excitement is the greatest.
While earnings of a company tend to plod along, the stock price of a company can bounce around erratically. So if the market wakes up in an unusually pessimistic mood one day, it may hammer the price of particular stock or a whole group of stocks – or the entire market if its mood is particularly glum.
This action creates a distraction. And the news media play it up.
They pump out all kinds of content – television, streaming, radio, newspapers, and online. They trumpet the “bad news” of market prices. This catches investors eyes and causes them to watch, listen, or read about the latest happenings of stock prices.
Meanwhile, earnings may not have been impacted at all. Or perhaps short-term earnings may have taken a hit, but long-term earnings still appear rock solid.
But by focusing on prices – or your account value – you are tricked into setting your focus on the wrong thing.
When their focus is trained on prices, investors can become excessively concerned about their investment. We’re starting to see that now. Investors are beginning to obsess over how much money their accounts have declined. They take that as a signal to do something. But just because prices are dropping doesn’t mean you have a bad investment – or that you need to take action.
Again, the real question is, “What are the long-term prospects for earnings?”
But most investors don’t take their cues from earnings, they fall for the media’s misdirection and watch prices. That mistake can cause investors to sell low and buy high – the exact opposite of good investing.
Don’t fall for the media’s tricks.
The long-term track record of the U.S. stock market is undefeated. It has recovered from every loss. And it will this time, too. Why? Because over time, earnings will rise. And as a result, so will a broad-based investment in stocks.