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Long term investing is usually based on the principles of 'fundamental analysis', which attempts to determine whether a company's underlying strength justifies its stock price. To begin with, a stock is a 'share' of a company. If you own stock in Microsoft, for example, you have a real and legal claim to a percentage of the assets of that company. The assets might include land, machinery, profits from business operations and so on. Obviously, the more stock you hold, the more of the company you own. In one sense, therefore, the value of a stock should be tied to the value of the underlying assets. In the real world, other factors come into play, including the market's perceptions of the company's prospects. For
example, if the tiny imaginary company XYZ Pharmaceuticals, employing
just 100 people, and turning over less than $2 million a year is
currently valued at $4 million, what do you think would happen to
the share price if the company announced it had invented a cure
for cancer? That's right. No extra profits as yet, but suddenly
the share price zooms, because the market EXPECTS bigger things
in the future. This is one reason why the market is sometimes referred
to as the 'great expectation machine'.
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