To the uninitiated, the stock market may seem like a cacophony of jagged line graphs and endless fractions. A stock's price might seem as random as the temperature. But a simple understanding of investment principles makes the market far less intimidating.
Stock price, in theory, reflects the total value of a company, including sales it will have in the future. Suppose a company has free cash flow, approximated by revenue minus expenses, of $100 this year, and it expects to release a new product next year that will earn it $150 the first year, $100 the next and $50 the third [for simplicity, we will ignore all subsequent years]. The total value in those four years is $400. If the company has 100 shares outstanding, the price should be $4 per share. If the actual price on the market is less than that, a savvy investor would buy shares, profiting when the market catches up and brings the price to $4.
\Well, that's our theory, but stock prices don't always conform to theory. Sometimes they deviate from the expected, maybe substantially,"" said Howard Thompson, UW-Madison professor emeritus of business.
Anticipating future revenues is a game of educated luck, he cautions, so investing is not foolproof.
So what stocks might a novice investor consider buying?
Kevin Jeu, 29, a software engineer who has played the market for six years, prefers companies in the public eye such as AOL and GE.
""I tend toward businesses that are fairly easy to understand,"" he said.
Right now he favors Marvel Comics (MVL), a company that can earn revenue by simply licensing its comic characters even though it incurs no expenses.
""Four new movies [based on Marvel characters] are coming out in 2005, so I expect the stock will do decently well,"" he predicts.
