Investing in securities
What is a stock
Most investors buy a stock with the idea of selling it for a profit at a later date (or, in the case of day traders, in a few
hours). The result is that common stock prices
rise and fall primarily on investor confidence about future stock prices.
A share of common stock represents partial ownership of a corporation
(usually a very, very small part). You can calculate the percentage of the
company you own by dividing your number of shares by the total number of shares
of common stock issued by the company.
As a Stock holder (owner), you are entitled to: All the rights of
ownership. You share in the profit as well as vote your number of shares on all issues that the Board of Directors presents to
the owners as well as the directors themselves( assuming that you own voting stock, most share
are). You are also entitled to receive any dividends declared by the Board of Directors.
During the 90's the role of dividends has been minimized by investors in
search of capital gains, and dividend payout is currently at the lowest
rate of the twentieth century. According to Dow Jones & Company web
site dowjones historically dividends
have accounted for 40% of the total return on securities.
You are entitled to receive a portion of the remaining assets if the company
goes out of business. This sounds good in theory, but, all bondholders and preferred
stockholders are stand ahead of you in line to receive their share first.
Consider the fact that if a company is going out of business they are probably
bankrupt, so there is not much left for the stockholders.
There are other kinds of stock other than common; preferred, convertible,
restricted, but who cares! The important thing to remember is that you are
buying into a company not just swapping paper. Buy companies that you are
comfortable with, are willing to hold for a long period, and not stay awake nights
worrying about your investments.
How you make money owning stock
You can make money two ways: an investor may receive dividends and or profit
from an increase in the stocks price.
A dividend is a payout to the investor a share of the corporations
profit. Some companies and industries have a high dividend payout,
utilities and tobacco companies to name two. Some companies do not pay
dividends but use all of its profits to reinvest and grow the company, or use a
share of the profits to repurchase its own stock. By repurchasing its own
stock a company is making its remaining publicly traded stock more valuable and
increasing the percentage of ownership of the company among its
stockholders. Dividends are taxed at your normal marginal rate.
Share price growth is a capital gain. If a company is seen by investors
as having an a bright future they will bid the price up. Stock prices
follow over time the investors perception of the companies long term earning
prospects. Stock prices are not fixed and fluctuates according to the laws
of supply and demand. If you hold a stock longer than six months and you
sell at a profit, you will receive favorable capital gains treatment. Long
term capital gains are taxed at a very favorable rate.
Investment approaches to researching a stock
- Fundamentals -
- Fundamental investors are often called value investors.
They are concerned with finding and identifying value. Stocks with
good prospects that they believe, for some reason, is
selling below its true value usually defined as a low P/E ratio.
Value investors hope that sometime in the future the market
will recognize this and bid the stock up to its full value.
Fundamental investors consider what does the company do and how well does it do it
relative to the
other companies in its industry. Is it in an industry with great
prospects, or a commodity business steady but dependent on the economy
with little chance of innovation or greatness. What are the companies
financials, free cash flow, and its ability to spend on growth and research. What
about the current economy its future and how it will impact the companies
prospects. Value investors believe in buying low and selling
higher.
- This is the older more established investment approach. One interesting
observation is that price movement occurs more from expectations and
analysis reports than from actual earnings reports.
- The classic work in fundamental analysis is the Intelligent
Investor by Benjamin Graham
- Technical Analysis -
- Technicians are more concerned with price history and price fluctuations, relative strength, support and resistance,
relative price earnings, and volume than they are with current price and
price earnings ratios relative to the market. Technicians are
often active traders more interested in proper timing of an investment
than in the value of the investment itself. Many technicians use a chart i.e.
a picture of price volume patterns of stock and market performance and
try to predict future movement from the past. This is often criticized
as voodoo or a non-scientific procedure. I have found
technical analysis very useful
in helping to select entry and exit points. Chart reading is also
a useful way to screen a
large list of stocks to help identify interesting stock patterns to
further time consuming fundamental research. This kind of information
can be gathered from any number of chart books or internet sites such as
Daily Graphs, TC2000
and Big Charts. Technical
investors believe in buying high and selling higher. This is because one
of the most common techniques they use is to buy a stock as it is making
a new market high, believing that since everyone who owns the stock is
now making a profit and is less welling to sell it.
- The Classic work in technical analysis is titled Technical
Analysis of Stock Trends by Edwards and McGee.
These investment styles need not be mutually exclusive. Flipping
through a chart book or scanning charts or searching data basis for selected
criteria can allow you to review a great many stocks in a short period of
time. You can select a small handful to then do further in depth
analysis to identify the investment that best meets your needs.
Link to a good web address to learn the basics of investing learn about
investing Step
by Step.
The greatest asset an investor can possess is the ability to know the
difference between an investments price and value.
What is a bond
Bonds have been and will remain disappointing investments. Barron's
Allen Ableson once remarked "What distinguishes bonds from all other
investments is that they are a fool proof hedge against capital gains."
Bonds represent corporate or institutional (government) debt. They are essentially IOU's
. Companies can raise needed capital by selling stock ( shares of ownership) but also by
selling IOU's. Long term IOU's are called bonds short term IOU's are
called paper , notes. The issuing party promises to repay these instruments, with
interest, by a certain time. Bonds are seen as less risky than stocks because
they pay interest and at a pre determined date promise to return the face value
of a bond. Less risk for investors does not mean no risk — the possibility that an issuing company will
be unable to meet its payments to bondholders always exists. To assist
investors in assessing the risk of default — or not being paid back — several independent
agencies list debt ratings for various companies and their bonds.
The lower the rating, the riskier the bond — and the riskier the bond, the higher the yield tends to be to
investors.
Bond yield can be stated as current yield or yield to maturity.
Current yield - This is the yield you will see in the newspaper. This
is the dividend rate adjusted for the current price of the bond.
Yield to maturity - factors in the gain or loss you will receive when the
bond matures and you are paid the face value of the bond adjusted for the amount
of time remaining on the bond.
The value of bonds is largely dependent upon the market level of interest
rates. As interest rates rise the face value of the bonds fall. This
is necessary in order to increase the relative bond yield to competitive market
levels. If interest rates, fall the face value of the bonds rises as the
income stream the bond represents becomes more valuable. There are pocket
calculators that readily adjust price and yield of a bond under different scenarios.
My personal favorite is the Hewlett Packard model 12C.
Bonds are usually issued for periods of ten to forty years. In general
the longer the term of the bond the higher the interest rate should be to reward
the holder for the increased time risk. Risk is measured by commercial
rating services that issue a risk rating of AAA which is the highest rating
issued to the most credit worthy borrowers. The lowest rated borrowers are
given a D. these companies are in default on their financial obligations
and/or in bankruptcy with debt service in jeopardy.
Investors should avoid bonds where the issuer has the right to call the bonds
on a basis favorable to the issuer. This stacks the deck in the favor of
the issuer and deprives the investor of possible market rate gains associated
with the risk they have taken.. The investor commits for a twenty to forty
year period and accepts the risks (company and market) and if the market
turns in the investors favor the investor the issuer simply buys the bonds back
at a small premium. Bonds with an unattractive call feature sell at virtually
the same yield as bonds that do not have this feature.
Investors can also invest in bond mutual funds and receive professional management
and diversification.
What is a mutual fund
Mutual funds are pools of money that are invested is the various markets. the
Funds are professionally managed by a
portfolio manager or a management team. Purchasing shares of a mutual fund
can be an excellent savings vehicle for beginning investors. Many funds
allow you to invest with as little as fifty dollars with a automatic investment
plan. Mutual funds are traded much like
stocks and closed-end funds are even traded on the major exchanges. Mutual
funds can be good for the beginning investor because they can provide instant
diversification among many stocks and industries that the beginning investor may
not be able to afford. There are additional expenses associated with
funds, load, fees, and often commissions on top of the fees. Because there
are more funds than stocks on the New York Exchange, there is a lot of different
types with various investment goals i.e. growth, income, International, bond,
and even real estate funds some even further divided between mortgage
participation, and asset participation. I am not overly enthusiastic about
mutual funds comprising the majority of an experienced and knowledgeable
investor, because I do not like to turn my investment decisions
over to others. This is not to say that I do not invest in funds. I
find them very useful for diversification. I also find funds especially useful to invest in industry specific funds where I can invest in say
for example bio-technology or the communication industry, and let the managers who follow the
industry make the specific stock purchases while I trade the industry.
Remember that one of the most important strategic decisions investors need to
make is to be in the right industry at
the right time, and with funds I can diversify the company specific risk from
the industry risk for a small fee to the fund.
Following mutual fund purchases and sales is a useful source of information to
gain insight as to where
professional fund managers (the smart money) are placing their money. What industries and
specific companies are the successful managers buying and selling. The
funds are now so large that their purchases and sales can have major impact on
individual stocks and markets in general. Much
information can be gained from financial newspapers and from popular web sites
such as Morningstar and Microsoft
Investor.
The following table gives an average return for the major averages for the
past seventy years
| Asset |
Average Return (Arithmetic) |
|
Large company stocks |
13.2% |
| Small company stocks |
17.4 |
| Long-term corporate bonds |
6.1 |
| Long-term government bonds |
5.7 |
| U.S. Treasury bills |
3.8 |
| Inflation |
3.2 |
The most important advice I can give an investor here is: Think for
yourself. Learn, research and invest . Do not let anyone sell you
something, learn to make your own decisions. Set realistic goals.
Get started NOW.
Reading List:
How to Make Money in Stocks - William J. O'Neil
Intelligent
Investor - Benjamin Graham
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