Invest Like a Dealmaker

When many forces are working in your favor,amplifying and reinforcing each other, you get what is called a 'lollapalooza effect.' It's like critical mass in physics. Create enough concentration of mass and you'll set off a nuclear explosion.

The average investor has the wrong idea about how the stock market works. He thinks about the price of his stock in terms of its quoted stock price. But even then... he often misunderstands what that price represents.

A stock's quoted price represents only part of the stock's underlying value: the company's equity.

You can determine the total equity of a company by taking the quoted stock price and multiplying it by the total number of shares that are trading on the stock exchange (the shares outstanding, to use the trader's term). But then you need to add to that the company's total debt. The combination of debt and equity gives you the total worth of the company - its enterprise value, as stock experts like to call it.

Most investors focus on a company's P/E ratio - the relationship between the stock's market price and its earnings per share. That gives you an idea of how enthusiastic the market is about the company's growth potential. (In general, faster-growing and less-risky companies have higher P/E ratios.)

But a better way to make investment decisions is to invest like a professional trader. You always want to compare earnings to enterprise value, because this gives you the bigger picture - the kind of picture you'd have if you were investing personally in a company.