Yesterday I wrote about how Apple stock could be considered a dividend stock by some investors. Later that day, after the stock markets closed, Apple reported its first quarter results. (Apple, like many companies uses a fiscal year, instead of a calendar year. The first quarter for Apple runs from October to December.) The results were met with disappointment by the markets and the stock is down this morning. This triggered an email from someone asking if Apple was now a bad stock to own or buy, and that felt like the beginnings of an article I’ve been meaning to write for a while.
Remember you should not be buying individual stocks until your retirement plan, college plans, and savings plans are fully funded and on track.
What Happens When a Stock Price Falls?
One of the most difficult things for non-professional finance people to grasp is the difference between actual losses and paper losses. An example can be helpful.
Apple stock was trading at about $100 per share yesterday when I published the post about the dividend yield moving past the psychological 2 percent dividend yield mark. Although I didn’t buy any stock on that day, let’s pretend I did. Let’s say that I bought 100 shares of Apple stock at $100 per share. That means I invested $10,000 in Apple stock.
This morning, the stock is down, trading closer to $95 per share. How much money did I lose?
If my 100 shares are now worth $95 per share, then my total investment is now worth $9,500, which is down $500, or 5%. But, did I actually lose any money?
If this were my only holding, my account at my online discount brokerage would show a red (negative) return of minus $500. My rate of return might show minus five percent, but have I actually lost any money? The answer is not really, because I still own my stock. Until I sell, there is no actual loss.
This is what a paper loss is. On paper, my investment has lost $500. In reality, however, I bought 100 shares of Apple stock, and I own 100 shares of Apple stock. The value of that investment will continue to change until I sell it. Only when I sell my shares, do I have a real loss, or a real gain for that matter. (The latter is also hard for people to understand, but that’s a different article.)
That may sound like splitting hairs, but it isn’t. Almost everything you have in life varies in value over time. And those variations mean nothing to you because you aren’t buying or selling them. The difference, of course, is that there is no up to the second chart showing you what your assets are worth right this moment, so you don’t realize it.
Consider this thought. Is your home worth more or less than it was when you bought it? Assuming you didn’t just buy your house, you probably have a rough idea of whether it is worth more or less. However, there is no way for you to determine what your house is worth, right this second. So, the question of, is your house worth more or less than it was yesterday, or even last month, is impossible to answer, even though you could speculate.
If you want, you can go stick your own address into the Zillow website. Zillow attempts to make ongoing estimates about the value of homes by using the information of home sales from nearby to extrapolate what your house might be worth today. Don’t worry about how accurate it is (most experts agree it deliberately over-values houses to avoid upsetting realtors). But, scroll down and look at the chart of your home’s value. You may be surprised to see that, here at least, the value of your house also rises and falls. Yet, at no point in time did you worry that you “lost money” on your house.
The reality is that you don’t own your house because you expected to make a daily, or monthly profit. You bought it because you want to live in it. Now, obviously, you hope that it will be worth more than when you bought it some time down the line, and that you make a profit, but that is neither here nor there today.
Which brings me back to my hypothetical Apple shares, which I bought, not because I wanted to make a profit in 24 hours, but because I thought it was a good long-term investment that would also pay a dividend while I was holding it.
Like I said in yesterday’s article, the intriguing thing is that Apple currently pays $2.08 per year as a dividend, or 54 cents per quarter. That is like earning 2% interest on my stock. Now, there is the possibility that Apple will do awful in the future and my investment will continue to sink. On the other hand, what if the company pulled a Microsoft and basically stayed flat for the next 10 years?
In that case, I’m still earning 2%, which is much higher than I could earn in a savings account or money market account. So, as long as I can eventually sell my stock at $100, I’m coming out ahead. If I earn that 2 percent the whole time, and then can also sell my stock at a profit down the road, then I come out way ahead.
The interesting part here is what I like to call the McDonald’s affect. Every 10 years or so, sales at McDonald’s start to fall. Investors panic, shares fall, franchise owners show up in articles worrying about profits, and eventually, the CEO does something (anything). Eventually, sales recover. Why? Because it’s McDonalds. Barring a major shift in the world, or a major management blunder, McDondals is going to be pretty much the same this year, next year, and in 10 years.
What does this have to do with Apple?
Apple sells iPhone, iPad, laptops and computers. There are also some new gadgets like Apple Watch and Apple TV. Every few years or so, investors worry that Apple isn’t growing fast enough or isn’t’ innovative enough. Eventually, they release a new iPhone or iPad or whatever, and everything recovers. Why? Because it’s Apple. The company, may or may not have another blockbuster gadget sometime in the future. But, what we do know for sure, is that eventually the company will release the iPhone 7, and lots of people will buy it. Same with the next iPad and so on. Will their sales grow as fast as before? No, but based on everything we know right now, there is no reason to suggest a fall off either.
Did The Company Change?
The next thing people get wrong about investing is forgetting that daily, and even monthly, fluctuations in stock pricing have almost nothing to do with the company.
Consider this, is Apple (the company, not the stock) really worth five percent less today than yesterday? Of course, not. But, the stock price is down that much.
The stock price is a function of supply and demand for the people (or more likely the computers) that are buying or selling on that particular day, not a function of the actual company’s value.
So, when determining whether or not it is the right time to sell a company stock, you need to ask not what the stock price is, but whether your reasons for owning it in the first place have changed.
For example, with the Apple stock we have been talking about, I fully expect that the stock will race forward when the new iPhone 7 comes out. Remember, that there was a lot of doom and gloom about Apple before the iPhone 6 came out too. Even if I’m wrong, I still believe that Apple is a strong technology company that will continue to be profitable and dominant in certain areas of the market. That means that eventually, the stock price will rise. As long as I continue to believe that there is no reason for me to sell the shares of the stock. I’ll just keep collecting 2% a year until everyone else realizes the same.
Remember paper losses are not real losses. As long as your reason for investing in a company has not changed, neither should your investment. The only real exception to this rule is to reduce the volatility or risk in your portfolio (for example if this were money I was going to need soon), or in some cases to manage your taxes via tax-loss harvesting.
Remember, your investments are investments in the company, not in the stock price.
At the time of publication I did not own any shares in Apple stock. This is not an investment recommendation, nor an offer to buy or sell securities. This article is for general information only and is not financial or investing advice. Consult your financial and tax professionals for advice specific to your individual situation.