PSEi will always hit new high

Question: What do you predict the Philippine Stock Exchange composite index level will be by the end of 2017?—asked at “Ask a friend, ask Efren” free service available at www.personalfinance.ph and Facebook.

Answer: To answer your question, you need to understand two things: 1) what comprises the index; and 2) what the role of investors is in helping a company’ stock land in the index.

The Philippine Stock Exchange composite index (PSEi) is a fixed basket of thirty common stocks of companies listed on the stock exchange. These stocks are selected based on a specific set of criteria. Per www.pse.com.ph, the revised policy on index management requires that for a company’s stock to be included in the PSEi, the company should meet the following criteria: (the lineup of index component stocks is reviewed and updated periodically)

1. Have a free float level of at least 12 percent
2. Rank among the top 25 percent in terms of median daily value in nine out of the 12-month period in review
3. Ranking of the top 30 qualified companies based on full market capitalization.

While the first criterion relies solely on the action of the company, the next two will require the help of investors because they both involve the price of a company’s stock. It is said that the true value of a company is based on its market price because the latter is determined by the collective wisdom of investors trading at the stock market.

The question now is, what makes investors assign a high value to a company’s shares of stock?

There are two main reasons why people buy stocks. These are to profit from capital appreciation and from cash dividends. And both reasons rely on one thing, the earnings potential of a company. The higher the earnings potential, the higher the value investors will assign to a company’s stock. The higher the earnings potential of a company, the greater will be the number of investors trading its stock. Finally, the higher the value of a company’s stock, the greater will be its market capitalization since the latter is a mere product of price and outstanding shares.

Having said the foregoing, it is safe to say that the PSEi will always be on an overall upward trajectory, that it will always hit new highs. There will be pauses or consolidation phases and even downward movements when investors reassess earnings growth potentials. But since the PSEi will always have index component companies with the best earnings potentials, the index will once again resume its upward trend and hit new highs.

Your job as an investor is not to predict the PSEi level. Your job is to quantify your financial goals and compare them to what you need to start with and what you can add periodically given your time horizon to see what kind of return you need to make. And if that return is what stock investing can give you, given your risk preference, then you should be in the stock market.

Two more things to remember. First, please note that the value of stocks is the value of the companies they represent. Stocks by themselves have no value. Second, buy and hold as well as trading are mere tactics of a larger strategy called stock investing.

Happy investing.