The origins of the UK stock market can tell us a great deal about the way this monolith operates today.
The trade of shares in London began at the end of the 17th century with the need to finance two great voyages - the Muscovy Company’s attempt to reach China via the White Sea north of Russia and the East India company’s exploration of India and the Far East.
Neither company was able to finance such expensive journeys privately so they turned to merchants who agreed to help fund these ventures in return for a portion or ‘share’ of any eventual profits.
Little has changed in the 21st Century with companies issuing shares or equity in their business to help fund growth and development. And just like those hopeful merchants back in the 1680s, investors buying shares today are aiming to secure a return from their chosen company’s future profits.
LOOK TO THE FUTURE
Markets, made up of a multitude of trades by individual investors, are therefore ‘forward-looking’ - a fact which should be imprinted on the brain of any investor in the stock market. Past performance offers only a partial guide to how a firm will fare going forward and rather than buying shares in a company which has already posted stellar numbers you should be aiming to get in ahead of such a catalyst.
Train yourself to always think of the market as a discounting mechanism which reflects a perception of the future ahead of time. Assets will be valued and priced according to this perception until reality - in the form of a trading update, set of results, macro-economic development or some other piece of news - intervenes to change the market’s view.
Valuation and prices will be reset by buying and selling activity as the news is swiftly digested or ‘priced in’. The stock market is not a crystal ball, it cannot predict the future, and it is from spotting examples where the market has got it wrong and mispriced a stock that investors can make real money.
If you think about it, every time you buy or sell a share, you are effectively saying that the market has made a mistake and that you expect this mistake to be rectified through a re-rating. Saying that you know better than the countless other investors that make up the market is no small claim and this should help focus the mind whenever you execute a trade.
RISK VS REWARD
Any investment involves balancing risk against reward. Using our earlier example, anyone buying a share in the Muscovy Company’s bold venture to open up a more accessible sea route to China would be taking on a number of very substantial risks.
The ships participating in the voyage could run aground in rough waters, be taken by pirates or simply fail to find a viable way of getting to China. At the same time the rewards of having a share of a monopoly on such a potentially active trading route would have been equally significant.
A company such as food service giant Compass (CPG) may not offer fast growth but its returns are ultimately pretty reliable and there is little risk of it suffering a massive collapse in sales or going out of business. As a result investors should expect a return of 8-10% in the best case scenario from investing in such a company.
At the other end of the scale, a bio-technology firm - which can often be wholly reliant on the success or failure of a previously untested technology - could quite easily see the value of its shares plummet 80 or 90% if it suffers a significant setback and anything less than a 25% return would not be commensurate to the level of risk involved.
