After a stock market crash it’s easy to forget why anyone would invest in shares in the first place.
When you buy shares in a company you become a shareholder. As an ordinary shareholder you are entitled to; a share of the distributed profits, this is known as the dividend, a vote on important company matters and if a company is wound up, you’re entitled to everything that’s left after all debts have been repaid. You can obviously also sell your shares in the future. Simply put, the two ways you make money from shares are by collecting the dividends and/or selling the shares on at a later date for more than you paid for them.
There are lots of models for how to value a company, over the years they have become increasingly complex. Ultimately though, they are all adding up the expected value of future profits. Profits in future years are “discounted” to take into account the time until you will actually receive them. Of course, different analysts will have different opinions on what those profits will be and they’ll frequently update their predictions.
Whilst that is all very sensible, people don’t act entirely rationally. In good times people tend to underestimate risks, overestimate future profits and share prices rise too high. When an event causes prices to fall they often fall too far as investors panic, forget about why they invested in the first place and try to cash in regardless of the cost. We saw this in March as markets fell in response to the unfolding pandemic. There are undoubtedly companies that will suffer in the short term and some may not survive. There are a lot of companies who may see this year’s profits wiped out but have enough money to survive even a prolonged shutdown before returning to “business as usual”. Logically, their share price should only have fallen by the profits they were missing out on in the short term but we’ve seen values plummeted well below this. Even companies that were likely to profit from the crisis saw their values fall.
It’s at times like these that smart long term investors make their money at the expense of those focussing on short term performance.