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| What Are Stocks? Stocks represent ownership an investor’s ownership of the company that issued the stock. When entrepreneurs first start their companies they get money from their own bank account or from friends or relatives, or they borrow it from banks. With loans and hard work, they struggle to survive. After a company has been in operation for at least a few years, they become more stable and self-sufficient. They may be able to afford to operate at their current size, but the entrepreneur wants to expand. While the company may be making a profit at this point, the money needed to fund an expansion can not be generated from those profits. Or maybe it’s not an issue of expansion. Maybe the entrepreneur had deep pockets from the beginning and was able to build the company to a satisfactory size with his own money. But the entrepreneur has all his personal money in the operations of the company. If the company has a problem and fails, he will lose everything. Therefore, he wants to get some of his personal money out of the company and invest it elsewhere. When the entrepreneur decides to expand or to get some of his cash out of the company, he can go to a bank and borrow money. But maybe he just does not want to have debt to pay back. Maybe the bank won’t give him the amount of money he wants, or the interest rate he wants, or the length of time he needs on the loan. So instead of taking on debt, he sells part of the company. He may sell 20 percent, 40 percent, or 60 percent; it depends on how much money he wants to raise. He does that by issuing shares and selling them to the public. Investors buy the initial shares through a brokerage firm and, after the shares are all sold, they start trading over a public exchange. The price of the shares is then governed by supply and demand. The more people who think this company is a good investment and buy the stock, the higher the price will go. If you own the stock when the price increases, you have what is called a paper profit. Are the Stocks held in your name or Street name. Street Name: A Stock Broker account in which the brokerage firm, not the investor, is listed as the owner of the securities. If you register your securities in street name, you won’t have to deal with the physical receipt of stock certificates. Stock certificates are negotiable instruments and must be safeguarded. That probably means storing them in a safe-deposit box. Also, when you sell stock, due to T+3, you will have to give certificate to your broker within three days. That means getting the certificate, to the stockbroker using UPS or DHL to deliver it within three days. T+3: Stands for trade plus three days, which refers to a law enacted on June 7, 1995, that reduced the settlement time for buying and selling securities from five to three days. The Stock Broker then sends you a confirmation after each stock purchase or sale and also sends you a monthly statement depicting that month’s transactions and a listing of your complete portfolio holdings. When you register securities in street name, all of your dividends will be delivered to your broker, who will then credit them to your cash account. In addition, any reports, such as annual and quarterly reports, and proxies will be sent to your broker rather than to you. Your broker should forward those to you, but if he does not or if he forwards them to you long after receipt, you can solve that problem by calling the investor relations departments of the companies whose stock you own and ask them to add your name to their mailing list. That way, they will send company literature directly to you. Paper Profit: An investor’s unrealized difference between the purchase price and the increased price of a company’s stock. You receive no real profit (money) until you sell the shares. If investors decide the company is not a good investment, they will sell the shares and the stock’s price will decrease. If you own the shares when the price decreases, you have a paper loss. Paper Loss: An investor’s unrealized difference between the purchase price and the decreased price of a company’s stock. Again, you do not have an actual loss until you sell the shares. When the shares trade on a public exchange, the entrepreneur does not receive any more money. He already sold that portion of his company and got his money. It is as if you had a car and sold it. When you sold it. When you sold it, you got the money the buyer paid for it. But when that person sells it, you get nothing because you already received your money. Identifying Stocks to buy There are more than 8,000 stocks available for purchase on the New York Stock Exchange and the Nasdaq combined. But it is your job to choose just one. Impossible? Not at all. There are several ways you can identify stocks that may be good investments. As always, everyone is ready to give you suggestions. You can find stock recommendations in newspapers and magazines, on TV and radio shows, from friends, relatives, or from your full-service stockbroker. Of course, many of these recommendations you may hear will be the “stock of the day.” There always seems to be a stock that everyone is touting and that’s extremely popular with investors. Many times, those stocks have already risen to such highs that they end up being bad investments 4 rather than good ones. If you want to check out the most popular stock, however, you can certainly do that, but remember to remain somewhat skeptical. That’s why, if you are interested in a company on the list, it’s always important to research it to be sure it’s still at a price level that would warrant you buying it. Is there a product you use that you think is especially good? Are your children obsessed with a certain brand of clothing? Do you see a general trend in the economy, such as the aging of the population, which may point to a future boom in certain industries? Just by paying attention to your surroundings, you can identify trends and find good products that sell. Identifying those winning products is the first step in finding a good company and, therefore, a good stock to buy. DOING THE RESEARCH Of course, once you have identified what you believe is a good company, you have to do a little research to verify that it is indeed one you want to own. The first research step is obtaining written materials, such as the company’s annual and quarterly reports. Annual and quarterly reports: Publications written by public companies to communicate to the investment community the company’s operations for the past year or quarter. A company’s annual report is a great starting point to learn about the company, its products, and services. You can obtain an annual report and other publications directly from the company by calling its investor relations department or by visiting its web site. When obtaining information from the Internet, be careful. There are a lot of hot stock tips available on the Internet that are extremely fraudulent. Message boards abound, even in reputable web sites. As the survey on the credibility of investment information pointed out, you can never rely on any information you find on an Internet message board. For your own safety, stick to the web sites that belong to the companies you are researching, to government agencies, or to reputable third parties that make corporate information available. When you’ve gotten all the information, read through it. Start with the annual report, which is a report the company publishes each year to tell the investment community how they performed during the past year. An annual report is typically divided into five segments. 1. CEO’s Letter to Shareholders: This letter is a great opportunity for you to find out what plans the company’s chief executive officer has in store for the company. In addition to talking a little bit about future plans, the letter will also discuss the company’s past performance and any successes or failures the company had during the past year. 2. Business Segment Information: This section will tell you exactly what the company does. 3. Management’s Discussion and Analysis: These are the pages that will tell you how the company has been performing from a financial point of view. 4. Financial Statements: You’ll find at least three financial statements in this report. Balance Sheet: A financial statement that looks at a company’s financial status at a specific point in time, usually the last day of a quarter or fiscal year. Income Statement: A financial statement that uses income, expenses, and profit to describe how well the company performed during a specific period of time, usually one year or three months. Statement of changes in financial position: Also called a cash-flow statement, it explains the difference in the amount of cash and cash equivalents the company had at the beginning and end of the year. Footnotes: The section of the annual report that supports and explains the information found in the financial statements. Auditor’s Opinion: Outside accountants’ opinion as to whether the statements present fairly the financial position of the company and if the results of operations are in conformity with generally accepted accounting principles. There are four types of auditor’s opinion: 1. The unqualified opinion is the most common. 2. The qualified opinion. 3. The disclaimer opinion. 4. The adverse opinion. Chances are the only opinion you will ever find in an annual report will be the unqualified opinion. Typically, if the auditors have a problem with the reporting of any information, they will discuss it with the company and management will fix the problem so that the information does conform to generally accepted accounting principles. The final report is the proxy. This is the report the company the company sends to its shareholders when inviting them to attend the company’s annual meeting and to vote on certain issues. You’ll find a lot of good information here. The proxy is required to include a performance chart, which compares the company’s performance against its peers and certain indices, such as the S&P 500. The proxy will also tell you how many shares of the company’s stock management and the directors each own. If they own none of the company’s stock, that’s not a good sign. If they think their company’s stock is such a great investment for you, why do not they invest in it themselves? When you’ve finished reading through all of the company’s materials, you’re going to have a pretty good idea as to what this company is. You’ll know what their primary business is and what products or services they offer. You’ll have a feel for who their competition is and whether this company has competitive advantages or disadvantages. You’ll know what share of the market they have, who their customers are, how they distribute their products, and what their plans are for the future. Technical Analysis: Identifying trends and predicting a stock’s price movement through the study of its volume and price in the marketplace. Advance-decline theory: theory used in technical analysis to determine the general trend of the stock market by comparing stocks that are increasing in price to those that are decreasing in price. Bull Market: A market in which stock prices are increasing or are already very high. Bear Market: A market in which stock prices are declining or are already very low. Of course, that tells you absolutely nothing about a specific company’s stock. Technical analysis looks at the market as a whole to predict trends, rather than at individual companies. It involves dealing with lots of charts. Fundamental analysis: Predicting the future movements of a stock based on an analysis of the company’s financial statements, past performance, and current strategies. In fundamental analysis, we look at the fundamentals of the company. CURRENT RATIO Current assets divided by current liabilities The current Ration is a measure of a company’s liquidity. Current ratio: A ratio that determines how many times a company’s current liabilities could be paid with its current assets. WORKING CAPITAL Current assets minus current liabilities The working capital ratio is calculated by using the same numbers as the current ratio. It is current assets minus current liabilities. Working capital: Ratio that depicts a company’s available liquidity. DEBT TO EQUITY RATIO Total debt divided by shareholders’ equity With the debt to equity ratio, we’re looking at how much total debt the company has relative to its shareholders’ equity. Debt-to-equity ratio: A ratio that measures leverage by comparing a company’s total debt to its shareholders’ equity. EARNINGS PER SHARE (EPS) Net income divided by number of shares outstanding Earnings per share tells you how much money the company made in earnings during the year on a per-share basis. Consensus number: The number that a group of analysts agrees to as their projection for a specific public company’s earnings per share for a specific period of time. Whisper number: The earnings per-share number an analyst really wants a company to report, despite the analyst’s prediction of a lower number. Earnings per share is obviously an important number. Steadily increasing earnings are sign of good management and should drive the price of the stock steadily upwards. If earnings increase one year, decrease the next, then remain stagnant, management is having a problem with consistency. Look for the consistency of earnings over a five-to 10 year period. Price/Earnings Ratio (P/E) Price per share divided by earnings per share The price/earnings ratio tells you how much an investors is paying for every dollar of earnings the company makes. Price/Earnings Ratio: A ratio that depicts how many times a company’s annual earnings per share a stock is selling for in the marketplace. For example, if a company has a P/E ratio of 15, that means that the company’s stock price is 15 times its earning per share. P/E is calculated by dividing the company’s pershare stock price by its earnings per share. |