Women and Money Series #2: The stock market is just like ordering pizza

Yes, it all ends up in pizza!

Image by Alexa from Pixabay

The Women and Money Series is back this week with issue #2, and my goal today is to show you that the stock market can be just like ordering pizza.

No, I'm not so naïve to truly think that the stock market is as simple as ordering a pizza, and I'm not underestimating your intelligence either. What I want to do is to create familiar associations to break down the barriers of understanding.

But first, let's acknowledge something: if you're reading this, you might be feeling a mix of emotions about money. Maybe you feel like you're "behind" where you should be, or guilty that you haven't figured this out yet, or anxious about making the "wrong" decision.

Here's the truth: most of us weren't taught this stuff, and feeling overwhelmed is completely normal. You're not broken, and you're definitely not alone.

Now, let's also address the elephant in the room: the fear of losing money. That knot in your stomach when you think about investing your hard-earned savings? I get it.

But here's some perspective: if you had invested $1,000 in a broad market index fund 10 years ago, it would be worth roughly $2,500-3,000 today, even after suffering multiple market crashes. Yes, there were scary moments where it dropped, but historically, the market has always recovered and grown over time.

The bigger risk? Leaving your money sitting in a savings account earning 0.5% while inflation eats away at its purchasing power. That's a guaranteed loss of buying power over time.

The pizza analogy

So let's think about the stock market as a pizza delivery business.

The pizzeria is the stock market itself, holding all possible types of pizzas.

The pizzas are different financial products, and in this pizzeria, you can choose to buy only a slice of a pizza.

The delivery person is your brokerage platform, giving you access to the stock market, aka, the pizzas in the pizzeria. Once the pizza is in your hands, it becomes your portfolio, something that you own.

Each slice of pizza is a stock, and the different flavors represent different sectors. We can think of cheese pizza as the tech sector, vegetable pizza as sustainable stocks, and so on.

If you buy an entire pizza of a single flavor, you're buying shares of a single company.

As we covered in issue #1 of this series, shares are parts of ownership in a company. Companies issue shares because they need money to finance ambitious projects without the obligation to pay it back. That's why it is risky for investors. But if the projects work and the company grows, investors own a part of something more valuable that can be sold for a higher price later.

This brings me to the first important point about buying your pizza: diversification. Betting all your money on a single company exposes you to unnecessary risk. Ideally, you should have shares of different companies, because if one ambitious project from one company doesn't work out, but another from a different company does, it balances out.

What to consider when deciding which flavors to choose

Your personal taste counts here, but to a lesser extent than when actually buying pizzas. That said, you should buy stocks from companies that you like and understand how they make money.

To help you decide, there are four main factors to consider. We're going to get a bit technical here, but it won't last long:

Beta (Markowitz, 1952): This measures how resilient a stock is relative to market volatility. For example, if the market goes down 10% and the stock loses 5% of its value, its beta is 0.5—making it a rather conservative stock. Beta explains about two-thirds of a stock's performance.

Company size (Banz, 1981): Smaller companies tend to outperform larger ones by about 3%, mainly because it's easier to make something smaller grow. However, they tend to be more volatile (25-30%) than larger companies (20%).

Value (Rosenberg, 1985; Piotroski, 2001): The P/E ratio (price-to-earnings ratio) indicates how much value a company creates relative to its stock price. Here's where the analysis gets counterintuitive: if a company's P/E ratio is over 14, it means it's creating great value, but it also means the stock price is expensive and might not be the best entry point. Companies with a P/E ratio below 14 are usually better investments, with an average return of 5% more per year.

Momentum (Jegadeesh, 1993; Weist, 2022): A company's stock that performed well in previous months tends to keep performing well in the following months, because good performance attracts new investors, creating a snowball effect. Of course, past performance doesn't predict future results, but the stock market is a psychological game with a lot of herd mentality.

Try this: Pick one company you know well, maybe Apple, Nike, or Starbucks. Look up its current stock price and try to find these four factors. Don't worry about making perfect sense of everything; just get familiar with where to find this information. Most financial websites like Yahoo Finance or Google Finance will show you these numbers.

Financial advisors typically recommend having at least 10 stocks from different sectors in your portfolio to benefit from diversification.

Personally, I find it hard to keep track of 10 different stocks, considering that all these factors need to be re-evaluated regularly to determine whether a stock should be kept or sold. It's like having to tell the pizza maker which types of flour and oil to use for each pizza.

So I prefer a different strategy.