The stock and bond markets can be a great place to turn savings into wealth…or to lose your shirt. Here are some fundamentals of investing wisely.

Things to Know

Stocks aren't just pieces of paper.  When you buy a share of stock, you are taking a share of ownership in a company. As an entity, the company is owned by all shareholders, and each share represents a claim on assets and earnings.

There are many different kinds of stocks.  The most common way to divide the markets are by company size (measured by market capitalization), sector, and types of growth patterns.  Investors may talk about large-cap vs. small-cap stocks, energy vs. technology stocks, or growth vs. value stocks, for example.

Stock prices track earnings.  Over the short term, the behavior of the market is based on enthusiasm, fear, rumors and news. Over the long term, though, it is mainly company earnings that determine whether a stock's price will go up, down, or sideways.

It is unwise to place all of your eggs in one basket!

Stocks are your best shot for getting a return over and above the pace of inflation.  Since the end of World War II, through many ups and downs, the average large stock has returned close to 10 percent a year – well ahead of inflation, and the return of bonds, real estate and other savings vehicles. As a result, stocks have in the past been the best way to save money for long-term goals like retirement.

Individual stocks are not the market.  A good stock may go up even when the market is going down, while a stinker can go down even when the market is booming. 

A great track record does not guarantee strong performance in the future.  Stock prices are based on projections of future earnings. A strong track record bodes well, but even the best companies can slip.

You can't tell how expensive a stock is by looking only at its price.  Because a stock's value depends on earnings, a $100 stock can be cheap if the company's earnings prospects are high enough, while a $2 stock can be expensive if earnings potential is dim.

Investors compare stock prices to other factors to assess value.  To get a sense of whether a stock is over- or undervalued, investors compare its price to revenue, earnings, cash flow, and other fundamental criteria. Comparing a company's performance expectations to those of its industry is also common -- firms operating in slow-growth industries are judged differently than those whose sectors are more robust.

A smart portfolio positioned for long-term growth includes strong stocks from different industries.  As a general rule, it's best to diversify by holding stocks from several different industries. That way, if one area of the economy goes into the dumps, you have something to fall back on.  It is unwise to place “all your eggs in one basket.”

It's smarter to buy and hold good stocks than to engage in rapid-fire trading.  The cost of trading has dropped dramatically -- it's easy to find commissions for less than $10 a trade. But there are other costs to trading -- including mark-ups by brokers and higher taxes for short-term trades -- that stack the odds against traders. What's more, active trading requires paying close attention to stock-price fluctuations. That's not so easy to do if you've got a full-time job! And it's especially difficult if you are a risk-averse person, in which case the shock of quickly losing a substantial amount of your own money may prove extremely nerve-wracking.

What is a Stock? 
Check out this video and you’ll know!
Video: http://www.youtube.com/watch?v=-S0l0lHxOG0&feature=related

At some point, just about every company needs to raise money, whether to open up a West Coast sales office, build a factory, or hire a crop of engineers.  In each case, they have two choices…. Borrow the money or raise the money from investors by selling them a stake (issuing shares of stock) in the company.

When you own a share of stock, you are a part owner in the company with a claim (however small it may be) on every asset and every penny in earnings.

Individual stock buyers rarely think like owners, and it's not as if they actually have a say in how things are done.  Nevertheless, it's that ownership structure that gives a stock its value. If stockowners didn't have a claim on earnings, then stock certificates would be worth no more than the paper they're printed on. As a company's earnings improve, investors are willing to pay more for the stock and also if earnings decline, investors are less willing to bid up a stock and may “hammer” it.

Over time, stocks in general have been solid investments.. That is, as the economy has grown, so too have corporate earnings, and so have stock prices.  Since 1926, the average large stock has returned close to 10% a year even though the stock markets globally have lost ground since their peak in October 2007. If you're saving for retirement, that's a pretty good deal - much better than U.S. savings bonds, or stashing cash under your mattress.  Of course, "over time" is a general term. As any stock investor knows, prolonged bear markets can decimate a portfolio especially if you buy high and sell low.  Since World War II, Wall Street has endured several bear markets - defined as a sustained decline of more than 20% in the value of a stock or average such as the Dow Jones Industrial Average.  A trading range or a bull market where stocks surge upward sometimes follow these downturns, but again, the term "eventually" offers small comfort in the midst of the downdraft and unlike other investments, individual stocks sometimes do not recover their previous value. If a company’s product is replaced by a better item the company’s product and even the company can be eliminated which means you can lose your entire investment.

The point to consider, then, is that investing must be considered a long-term endeavor that you are watching carefully if it is to be successful.  And in order to endure the pain of a bear market, you need to have staying power and  a stake in the market when the tables turn positive.   The goal is to “buy low and sell high,” not let fear and greed overtake analysis, and have access to financial news to level the playing field.

How Much Should You Pay?

When times are good, investors think the happy days will last forever, and they are willing to pay exorbitant amounts for earnings.  When times are bad, they assume the world is ending and refuse to pay much of anything. In assessing how much a stock is worth, investors talk about "valuation," the stock price relative to a number of criteria.

Price/earnings (P/E) ratio

Video: http://www.youtube.com/watch?v=egOwMei2dP4

Everybody uses it, but not everybody understands it. The actual P/E calculation is easy: To get the P/E ratio divide the current price per share by the earnings per share. But what number should you use for earnings per share? The sum of the past four quarters? Estimates for next year?  There is no right answer. The P/E based on the past four quarters provides the most accurate reflection of the current valuation, because those earnings have already been booked.  But investors are always looking ahead, so most also pay attention to estimates, which also are widely available at financial web sites. 

Wall Street analysts generally compute earnings-per-share estimates for the current fiscal year and the next fiscal year and use those estimates to assign a P/E, though there is no guarantee that the company will meet those estimates.  The P/E can't tell you whether to buy or sell. It is merely a gauge to tell you whether a stock is overvalued or undervalued relative to other stocks. Assuming they have the same total shares outstanding, is a $100 stock more expensive than a $50 stock?  Perhaps but not necessarily as share prices  are dictated by expectations of future earnings. If the earnings of the higher-priced company are growing considerably faster, the higher share price may be justified.

What's an appropriate P/E?  Different types of stocks command different valuations. Generally, the market pays up for growth, consistency or enormous profitability. Consider a slow-growing industrial conglomerate and a tech company with fat profit margins and enormous growth potential. The market will typically reward the profitable, growth company with a higher P/E.

To quickly compare P/Es and growth rates, use the PEG ratio - the P/E (based on estimates for the current year) divided by the long-term growth rate. A company with a P/E of 36 and a growth rate of 20 percent has a PEG of 1.8.

In general, you want a stock with a PEG that's close to 1.0 (or lower), which means it is trading in line with its growth rate. But for a quality company, you can pay more.  Also, don't get excited by rock bottom P/Es - some companies are doomed to low valuations due to declining earning prospects. One group the market tends to penalize is cyclical companies whose performance rises and falls with the economy and the business “cycle.”

Price/Sales Ratio

Just as investors like to know how much they're paying for earnings, it's also useful to know how much they're paying for revenue (the terms "sales" and "revenue" are used interchangeably).  To calculate the Price/Sales ratio, divide the stock price by the total sales per share for the past 12 months. You could also use revenue estimates for the next fiscal year, which are published more frequently on financial web sites.  Like P/Es, Price/Sales ratios are all over the map, with faster growers tending to get the highest valuations.

Price/Book Value Ratio

Defined simply, book value equals a company's total assets minus its total liabilities and intangible assets. In other words, if you liquidated a firm, this is what the leftover assets would be worth after paying off all your creditors.

On the balance sheet, book value is represented as "shareholders' equity." (Dividing this aggregate total by the number of shares outstanding will give you a per-share book value).  This is a more conservative measure, which embraces a "bird-in-hand" philosophy of valuation. Investors use it to spot cases in which the market is overvaluing or undervaluing a company's true strength.  For example, a retailer that owns the buildings its stores are housed in might be sitting on unrealized real estate value.

Picking Stocks for Your Portfolio

Video: http://www.youtube.com/watch?v=Oj4obFbKZkc

Although there are more than 6,000 publicly traded companies, the core of your stock portfolio should consist of financially strong companies with above-average earnings growth.  Surprisingly, there are only about 200 stocks that fit that description. A well-balanced stock portfolio should consist of 15 to 20 stocks, across seven or more different industries - but you don't have to buy them all at once.

Since you want to be able to hold your stocks for a long time, they should offer a total return higher than the 10% historical market average.  You can estimate the likely return by adding the dividend yield to the projected earnings growth rate - a stock with 11% earnings growth and a 2%t yield could provide a 13% annual total return.  As a general rule, stocks with moderately above-average growth rates and reasonable valuations are the best buys. Statistically, high-growth stocks are usually overpriced and have a harder time meeting inflated investor expectations.

Video: http://www.thestreet.com/video/index.html#22632280001                      

The first thing to look at is the stock's price/earnings ratio compared with its projected total return.  Ideally, the P/E should be less than double the projected return (a P/E of no more than 30 for a stock with 15% total return potential).  A well-balanced portfolio might include a couple of industrials with 9% growth rates and 3% yields, selling under a 20 P/E, as well as consumer growth stocks with 13% growth rates and 1% yields, under a 20 P/E. Add a couple of tech stocks with 25% growth rates and high P/E over 20 but don't overdo it on those!  If you can average a 10% return over the next 10 to 20 years, you'll reach your financial goals - and probably outperform most pros as well!

How to Buy Stocks
Video: http://www.youtube.com/watch?v=Ns7zCnVTDJA

When you're looking for a broker, you have three distinct choices. From the most to the least expensive, they are: full-service brokers, discount brokers and online brokers. What distinguishes them is the advice they provide and the cost.

Full-service brokers will call with stock ideas and back this advice with reports from their firm's research department. They'll keep an eye on your picks and let you know when they think changes are necessary.

Discounter brokers do less of this. While there's typically plenty of research available on the best online brokerage sites, it's up to you to dig for it.  You may want to choose different kinds of brokers for different purposes. Full-service brokers should get paid for their stock ideas. That seems only fair. But if you've done your research yourself, there isn’t any reason to pay a hefty commission - discounters probably are fine.

Online brokers cost the least but hey all they do is execute the order.

The nice thing about the way the brokerage world is shaping up is that you may be able to have both of those things in one account at one firm.  Merrill Lynch and most other full service brokers have come around to the fact that they need an online component - and need to charge you lower commissions when you use it. Discounters like Schwab and Fidelity have both started offering a fuller range of services in recent years, while retaining their low-cost structure.

 If you decide to sign on with a full-service broker, you should make sure that person has a good track record. To get a report on any broker, call the National Association of Securities Dealers at 800-289-9999, or visit the broker's web site.

Full-service brokers

Cost: Commissions are typically based on a percentage of your purchase (or sale) price.

Discount brokers

Cost: Between $10 and $20 for a trade of 1,000 shares or less, and on average, discounters charge one-third the price of full-service brokers.

Online brokers

Cost: At $7 and up a trade, it doesn't get any cheaper than this!

Stock: Purchases, Sales & Price

When trying to place a buy or sell order, you'll be faced with all sorts of questions: Market or limit order? "Day only" or "Good 'till cancelled." Here's the vocabulary you need to know to place a trade.

If you place a market order with your broker, then you are saying that you're willing to buy at whatever happens to be the prevailing price for the stock. If you have a specific price in mind, you can set a limit order specifying the price you're willing to pay. If the stock dips down to that level, your order will be automatically filled. Limit orders can be left open for a single day (a day order) or indefinitely (good until canceled).

After you've bought a stock, you can instruct your broker to sell it if the price drops to a level you specify: a stop loss order. That's a kind of insurance; it means that no matter what happens to a stock's price you'll never lose more than a specified amount.  In a volatile market, however, setting a stop-loss order at 10% or 20% below the purchase price will sometimes cause you to cash out of the stock on a momentary dip - thus locking in a loss even though the shares may immediately head back up. 

Impact of Financial Crisis
Video: http://www.youtube.com/watch?v=_ZAlj2gu0eM&feature=related

Video: http://www.youtube.com/watch?v=edP787gzsMo&feature=channel

Equity investors are digesting an unwelcome cocktail of decelerating economic and corporate-profit growth and rising inflation, along with persistent concerns about the financial system stemming from the popping of the real estate bubble and the “deflation” that was sparked by the US subprime mortgage crisis that became a global real estate decline.

A consumer pullback in 2008 put a damper on US stock prices giving investors a reason to hammer the equity markets and stock prices declined on a percentage basis in 2008 the most since the Great Depression in the 1930’s.   Baby boomers especially are concerned about retirement income as their retirement investments declined significantly in 2008 and in early 2009.

Wall Street Journal wrote in March 2009:

 “Americans See 18% of Wealth Vanish” as follows: The wealth of American families plunged nearly 18% in 2008, erasing years of sharp gains on housing and stocks and marking the biggest loss since the Federal Reserve began keeping tack after World War II.”

Underperformance of Stocks
Video: http://www.youtube.com/watch?v=edP787gzsMo&feature=channel_page

Stocks, touted as the best investment for the long term, have been one of the worst investments over the recent ten-year period, trounced even by lowly Treasury bonds.  Over the past nine years, the S&P 500 is the worst performing of nine different investment vehicles tracked by Morningstar, including commodities, real estate investment trusts, gold and foreign stocks.

Barron’s, a weekly financial paper, interviewed Niall Ferguson, writer of “The Ascent Of Money” in May 2009 and he responded to, “Stocks haven’t done well since 1999” with, “You are back to square one if you had bought the ‘stocks for the long run’ story then.”

When adjusted for inflation but adding in dividends, the total return of the S&P 500 rose an average of just 1.3% a year over the past 10 years, well below the historical norm.  Big U.S. stocks were outrun even by Treasury bonds, which historically perform less well than stocks. Adjusted for inflation, Treasuries are up 4.7% a year over the past nine years, and 5.8% a year since the March 2000 stock peak. An index of commodities has shown about twice the annual gains of bonds, as have real-estate investment trusts.

Stocks for the Conservative Investor

Value stocks offer less gain in exchange for less pain.

Value stocks have far less downside risk than the broad market.  Their prices are relatively low compared to their fundamental value, as measured by factors as typical earnings and net worth.

What's the catch?  It's that value stocks typically don't outperform the broad market when it is gaining. So, in effect, value stocks offer us the prospect of not losing during bear markets, in return for gaining during bull markets at a below-market rate.  Value stocks offer less gain in exchange for less pain.

From a psychological point of view -- many people find it harder to gain less money than the market when it is going up than to lose money alongside the broad market when it is declining.  You need to determine your comfort level—if you are more conservative, go with value stocks.

Different Kinds of Stocks

There are thousands of stocks to choose from, so investors usually like to put stocks into different categories: size, style and sector.

“Stock Size” is the total value of the shares outstanding or the company “capitalization.” 

It is simply the number of shares outstanding times the value of each share.  Those in the know refer to it as the stock “cap.”  Stocks are categorized by their size or “cap.”

 

 

 

 

 

 

 

 

 

 

 

 

 

Video: http://www.youtube.com/watch?v=STNJlYdUUrE&feature=P
layList&p=ED9B03E14CB2C3B1&index=1

A company's size refers to its market capitalization, which is the current share price times the total number of shares outstanding. It is how much investors think the whole company is worth.  XYZ Corp., for example, may have 2 billion shares outstanding, and a stock price of $10. So the company's total market capitalization is $20 billion. (Technically, if you had an extra $20 billion lying around, you could buy each share of stock, and own the whole company!)

Is $20 billion a lot or a little? No official rules govern these distinctions, but here are some useful guidelines for assessing size.  Large-cap companies tend to be established and stable, but because of their size, they have lower growth potential than small caps.  Over the long run, small-cap stock shave tended to rise at a faster pace. It's much easier to expand revenue and earnings quickly when you start at $10 million and not $10 billion. When profitability rises, stock prices typically follow.

There is a trade-off, though.  You need to determine your comfort level with risk.  With less developed management structures, small caps are more likely to run into troubles as they grow - expanding into new businesses and beefing up staff too soon are examples of potential pitfalls that small-caps face. But even corporate titans get into trouble.  Think about AIG, Citibank and General Motors.  Ouch.

“Stock Style” generally refers to the rate of growth or potential growth  as reflected in the company’s valuation.  Is the company stock multiple greater, the same or less than the typical stock?

A “growth” stock is shares in a company that is expanding at an above-average rate, much as tech companies did in the 1990s.  Catch a successful growth stock early on, and the ride can be spectacular. But the greater the potential, the greater the risk. Growth stocks race higher when times are good, but if growth slow or the stocks valuations outpace the earning prospects those stocks can “tank” like during the” dotcom boom” of the late 1990s.

Video (Time to Buy “Busted” Growth Stocks): http://www.thestreet.com/video/index.html#22884895001                                        

The opposite of growth is “value.” There is no one definition of a value stock, but in general, it trades at a lower than average earnings multiple than the overall market.  Maybe the company messed up, causing the stock to plummet - a value investor might think the underlying business is still sound and its true worth is not reflected in the depressed stock price, or maybe fundamental changes diminished the company’s prospects such as the “nifty fifty” in the 1970’s.

And of course, some companies ride the economic “cycle” and are known as “cyclical” companies.  Their prospects are strongly influenced by the business cycle.  A cyclical company makes something that isn't in constant demand or the demand increases during an upturn in the business cycle. For example, steel makers see sales rise when the economy heats up, spurring builders to put up new skyscrapers and consumers to buy new cars.  But when the economy slows, their sales can decline rapidly. Cyclical stocks bounce around a lot as investors buy and sell depending on whether the economy is expanding or contracting.

“Stock Sector” is the grouping the stock belongs to such as industrial, consumer, financial, utility and so on.

Standard & Poor’s breaks stocks into 10 sectors and dozens of industries. Generally speaking, different sectors are affected by different things. So at any given time, some are doing well while others are not.  In the past, finance, healthcare and technology were the fastest growing sectors, while consumer staples and utilities offered stability with moderate growth. Other sectors tend to be cyclical, expanding quickly in good times and contracting during recessions.  But occasionally, a sector will undergo an unexpected long-lasting change in their outlook.  The financial sector is a recent example of a sector that has recently experienced a significant fundamental change unrelated to the business cycle of growth and recession.

The Basics of the Stock Market

 Stocks may be designated as common stock, the most widely known form, or preferred stock. When investors buy stock, they become owners of “shares” in the company.   Many U.S. businesses are privately owned, but investors can buy shares in more than 10,000 corporations that are publicly traded on a stock exchange such as the New York Stock Exchange ( NYSE) or the Over The Counter Exchange (OTC) via “market makers” who make a market in the stock. Millions of people in the United Stock own stock in publicly traded companies and in equity mutual funds that invest in stocks.  Also known as stock mutual funds, equity mutual funds invest pooled amounts of money in the stocks of public companies.  Individuals own “units” in the equity mutual fund that represents the ownership of stocks held in the fund itself.

Video: http://www.youtube.com/watch?v=ns4VaoExDJY&feature=
PlayList&p=ED9B03E14CB2C3B1&index=2

Generally, stocks are traded in blocks or multiples of 100 shares, which are called round lots. An amount of stock consisting of fewer than 100 shares is said to be an odd lot. On an exchange, an order that involves both a round lot and an odd lot, say 175 shares will be treated as two different trades and may be executed at different prices. Your broker will charge you a different commission on each trade, and will confirm each of them separately. These distinctions are not generally involved in trades executed in the OTC market.

Some stocks are "restricted" or "unregistered," so designated because they were originally issued in a private sale or other transaction where they were not registered with the Securities Exchange Commission (SEC). Restricted or unregistered securities may not be freely resold unless a registration statement is filed with the SEC or unless an exemption under the law permits resale. 

If a company is successful, the price that investors are willing to pay for its stock will go up and shareholders who bought stock at a lower price make a profit or a “capital gain.” If a company does not do well, its stock may decrease in value and shareholders can lose money and have a “capital loss” or even lose the entire investment.

Stocks have more potential upside opportunity and also more downside risk than quality bonds.

Stocks have more potential upside opportunity and also more downside risk than quality bonds.  Generally, bondholders are paid before stockholders in a liquidation or bankruptcy.  As owners, shareholders generally have the right to vote on electing the board of directors and on certain other matters of particular significance to the company. Under the federal securities laws, most companies must send to shareholders a proxy statement providing information on the business results and compensation of nominees to the board of directors and on any other important matter submitted for shareholder vote. This information is required so that shareholders can make informed decisions; however, this is usually done once a year and much can change in a business before shareholders have the opportunity to weigh in.

Issuing Shares in the Stock Market

There are two major subdivisions to the stock market.  They are the primary market and the secondary market.  The primary market is for “new issues” while the secondary market is for traded shares.  When the company issues new shares, the shares are said to be offered in a primary offering.  After the initial issue in the primary market, the company receives no proceeds from any sale of the same shares.  For example, investor A buys the shares from the company for $10 each in the primary offering. Two years later he sells the same shares to investor B for $15 each, making a profit of $5 per share.  Investor B then sells the shares to investor C for $7 each, taking an $8 per share loss. The original issuing company neither gains nor loses from the sales to other investors.

You are the Market

The “market” for each individual stock determines what a purchaser will pay on a given date.  For example, the DJIA composite (Dow Jones Industrial Average)  in October 2007 peaked above 14,000 and today it trades around 8,000 (about a 40% drop in less than two years).  The sole determinant of market value of the shares or a composite of shares (DJIA) is the price that potential buyers are willing to pay or “trade” at and that prospective sellers are willing to sell or accept.  Every trade of a stock involves a “winner” and a “loser” unless of course the stock stays at the same price.

Two Ways to Profit:  Stock Dividends and Capital Gains

Stock Dividends

Stock ownership pays a return through dividend payments, the portion of a corporation's earnings that is paid to stockholders. To determine a stock's dividend yield, divide the amount of the annual dividend by the current price per share.  For example, if a stock is priced at $10 a share and the annual dividend is $0.50 a share, the dividend yield is $0.50/$10.00, or 5%.

 Many common stocks and preferred stocks pay dividends. Most companies make their dividend payments on a quarterly basis. The amount and timing of dividend payments are at the discretion of the corporation's board of directors. There is no law that states a company must pay a dividend on its common shares, even if the company is profitable. The board of directors can raise, reduce or even eliminate a company's dividend rate; however companies try to maintain a fairly even flow of dividends, increasing the dividend when the company enjoys growth in net earnings. 

The expected receipt of dividends is sometimes justification enough for investing in stocks, particularly if the yield on the investment exceeds the return afforded by saving accounts or safe treasury securities that are guaranteed by the US government; however, the dividend is not guaranteed and interest on treasury securities is guaranteed. Stocks that pay out a generous dividend are known as income stocks.   

Capital Gains

When buying stock, an investor is typically hoping that the perceived value of the company will rise, producing a capital gain when the shares are sold at a higher price. Trading for such buy-low, sell-high profits over a short time span is a speculative activity known as short term trading. Companies that are expected to grow in share value are known as growth stocks.  Investors buy such stocks in anticipation that their per-share value will increase as the company prospers and investors often purchase securities primarily for the “potential” capital gain.

Many growth stocks pay out very little in dividends, or no dividends at all.  These stocks are bought for their “growth” or “capital gains” potential.   Balanced portfolios have a balance between income stocks paying dividends and growth stocks with capital gains potential. Some investors achieve this by buying a package of securities with dividend and non-dividend paying stocks such as those found in growth income mutual funds.

Tax Treatment of Dividends and Capital Gains

Tax laws generally require a greater payment for dividend income, depending on the individual’s tax bracket, than for capital gain returns.  However, capital gains are only realized on investments held for at least one year (see www.irs.gov).

Stock Types:  Common and Preferred Stock

When they hear the word "investing", most people think of common stock. A share of common stock represents a proportional ownership interest in the corporation. In other words, common stocks are a type of equity security. The total number of shares that investors (both individuals and institutions) own at any one time is known as the outstanding shares. If a corporation has 1000 shares of common stock outstanding, and you own 100 of those shares, then you are a 10 percent owner of the corporation. 

Characteristics of Common Stock include: limited liability, voting privileges, low priority of claims in bankruptcy, and dividends, although not all stocks pay dividends.

Limited Liability   

One of the principal benefits of common and preferred stock is that investors cannot lose more than 100% of their investment. No matter how much the company loses or how many bills of the company go unpaid, the common stockholders cannot be held personally liable. The reason is that a corporation is a separate legal entity under the law. 

Voting Privileges

Common Stockholders have the right to vote. Stockholders vote for the selection of directors, elected so that the corporation is operated according to the wishes of stockholders. Stockholders vote on mergers and acquisitions, changes in the company's capitalization, stock splits and other unusual actions.

Voting is usually conducted either on a statutory basis or on a cumulative basis. Under the statutory basis, if four different directors are up for election and you have 100 shares of voting right, you could cast 100 votes for each seat or directorship. Stockholders with more 50% voting shares have absolute control over the company.

Under cumulative voting, you may save up all your voting shares and split them up any way you like. Given the same four directorships, you may choose not to vote for the first three and vote your 400 shares for the fourth candidate. Thus, cumulative voting gives minority stockholders their best chance of gaining representation on the board of directors. 

Priority of Claims in Bankruptcy

Common stock is the most "junior" security that a company offers. In other words, if the company falls on hard times, the first expense that is cut back is the dividend payments to the shareholders. If the company goes bankrupt, the company's creditors, all of the bondholders, and all of the company's managers are paid off before the common stockholders. The shareholder is the last to get paid. 

Dividends 

Common stockholders have the right to receive dividends when declared by the Board of Directors. They decide whether the company can distribute profits with a dividend payment and the amount. Companies make their dividend payments quarterly or once every 3 months and there are four relevant dates.  These dividend payment dates are public information.

On the declaration date, the board of directors announces the dividend, its amount and the day it is to be paid. 

The ex-dividend date is the first day the stockholder is not entitled to the dividend if stock ownership changed. 

On the record date, the company reviews the list of stockholders. To receive the dividend, you must be on the company's list as a stockholder. If you are not, you do not receive the dividend. 

On the payment date, about two weeks after the record date, the company makes payment. 

Preferred Stock 

Preferred stock entitles its holders to priority over owners of common stock regarding dividends and in the distribution of assets if the company is liquidated or reorganized in bankruptcy.

Preferred stock, which not all companies have, generally entitles the stockholder to receive a fixed dividend before any payment can be made to the holders of common stock. Owners of preferred stock also carry a superior claim against assets if the corporation is liquidated. Some preferred issues are convertible into common stock at fixed exchange rates.  The conversion rate is public information.

Two factors largely determine the value of a preferred stock: the price at which it is convertible into common stock and the amount of its fixed dividend.

Because the amount of a preferred stock's dividend typically does not change, these shares generally have many of the characteristics of fixed-income securities. Typically, there is less downside price swings with preferred stock than with common stock as the dividend is more secure.  Common stock, however, provides a better way to maximize participation in the potential growth of a company. Preferred stockholders do not have voting rights like common stockholders unless the company is financially unable to make its dividend payments. 

Preferred stock is largely owned by institutions and corporations  because provisions in the tax laws allow dividends that they receive from preferred stock to be largely tax-exempt. In contrast, dividends on preferred stock received by individual investors are fully taxable (although recently the tax rate has been less on preferred dividend income than on common stock dividend income). Since most of the demand for preferred shares comes from buyers who can benefit from the tax treatment of preferred dividends, such stock is typically less attractive to most individuals. 

Short Selling Stock can be Profitable Too
Video: http://www.youtube.com/watch?v=PvoGvQ5HvZc&feature=PlayList&p=
ED9B03E14CB2C3B1&index=0&playnext=1

Video: http://www.youtube.com/watch?v=opaaKIcCiZ8&feature=channel

Most of us think of making a "killing" by buying something at a low price and selling it at a much higher price. The buy-low, sell-high principle is, after all, the essence of making capital gain by “going long” s but individual stocks can be sold short which is essentially a “sell high buy low” principle where the investor profits by “going short.”

Investors who believe a stock is selling at a bargain price will purchase it in anticipation of later selling the security at a higher price. They are bullish on the stock and expect it to increase in value while those who think that a stock is overpriced and that it will decline, are bearish on the stock.

When stocks are in a prolonged “uptrend” the bulls are in charge but when stocks are in a prolonged slump or decline, the bears are in charge.  So it goes on Wall Street where the sentiment is either bullish (rising stock prices) or bearish (declining stock prices.)

The mechanics of short selling is interesting. Short sellers are “bearish” on a stock. When you sell the stock short, where does the stock come from? Since you do not own the stock being sold, it must come from someone who owns it. This borrowed stock is then used to complete the transaction. Since the stock is borrowed, the borrower is obligated to return the stock eventually and therefore, must buy it back. 

On the whole, short selling is very risky and is normally not practiced by the individual investor. The amount the short seller can lose is the entire value of the stock. That is the inherent danger in short selling - the potential losses as the stock must be repaid at a certain date.   

During 2009, limitations on short sales were imposed by the government due to the substantial losses in the stock market and possible market “manipulation” through short selling.

Stock Prices

To streamline the trading process, the securities industry has adopted the convention that stock prices are to trade in eighths of a point. For stocks, each point is $1, and each eighth is $1 divided by 8, or 12.5 cents. The stock prices are quoted as 1/8, 1/4, 3/8, 1/2, 5/8, 3/4 and 7/8. 

For example, a stock is currently trading for $20 per share and it starts to rise. It may trade at 20 1/8, 20 1/4, 20 3/8, 20 1/2, 20 5/8, 20 3/4, 20 7/8 and 21. If the stock is rising quickly, it may bypass certain of these multiples, rising from $20 to 20 3/8 in one trade. 

While a stock can move by more than an eighth of a point, it cannot move by less than an eighth. For example, if you want to buy a stock that is selling at $20 a share, you can buy it for $19.875 or $19 7/8. However, you cannot bid $19.95. The only exception is stocks that are traded for less than $2 per share, which usually trade with minimum price increments of a sixteenth of a point.

Mutual Funds, Exchange Traded Funds (ETF) and Stock Ownership

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When you purchase a share of stock, you purchase ownership in a company whereas when you purchase a share of a mutual fund, you purchase a share of a collection of stocks and perhaps bonds, and other securities with a group of investors These shares are managed by an investment company or mutual fund manager that takes a fee for providing this service.  Diversification or owning a collection of different stocks or securities is the reason to invest in a mutual fund rather than in individual stocks.  If you have the time to research and manage your investment every day, you may find that individual stocks work best for you; however, if you rather leave the day-to-day management of your investments with experienced managers and have a more diversified portfolio, a mutual fund that fits your tolerance for risk may be more appropriate. 

Fees charged by mutual fund companies vary greatly and can significantly affect the value of a mutual fund over the long-term.

Diversification

By owning many individual stocks, you can certainly diversity your portfolio.  But, again, this will take research and daily management and to achieve diversification one must have a meaningful amount of money. A mutual fund provides diversification with a smaller amount of money.  A mutual fund can include just stocks, stocks and bonds, stocks, bonds and commodities, stocks, bonds, commodities, real estate and so on.

Mutual Funds and Convenience

When you own shares in a mutual fund, the recordkeeping of transactions is handles for you and, at least annually, you will receive a statement of the mutual fund’s holdings.  Stock transactions can be a more complicated experience.  For example, you will need to keep track of your buys and your sells—this can be time consuming and complicated—especially at tax time.

Basically, those who purchase mutual fund shares do so because they want the diversification that mutual funds can often provide and the convenience of leaving the investing—and reporting—up to the pros.  They are willing to pay the fee the mutual fund company charges on the assets invested to select, manage, trade, and report on the results.  For those that like the excitement of individual stock ownership and who don’t mind the “paper trail,” individual stock ownership is a viable option.

High Yield Stocks

A high yield stock is a stock whose dividend yield is higher than the yield of any benchmark average such as the 10-Year US Treasury Note.  The classification of a high yield stock is relative to the criteria of any given analyst. Some analysts may consider a 2% dividend yield to be high, while other may consider 2% to be low. There is no set standard for judging whether a dividend yield is high or low. Many analysts do however use indicators such as the previously mentioned comparison between the stock's dividend yield and the 10-Year US Treasury Note.

A high dividend yield indicates undervaluation of the stock because the stock's dividend is high relative to the stock price. High dividend yields are particularly sought after by income and value investors. High yield stocks tend to outperform low yield and no yield stocks during bear markets because many investors consider dividend paying stocks to be less risky; however, dividends can be reduced or eliminated so dividend yields need to be evaluated and the company’s cash flow and future prospects should be carefully monitored.

Tax Considerations of High Yield versus Low Yield (or No Yield) Stocks

Low yield stocks (which pay a small dividend or none at all) are expected to appreciate.  The tax on capital gains has been much less than on income, but this depends on your individual tax bracket.  To qualify for capital gains tax treatment (often less than dividend income tax treatment) the stock must be held for a year a day to qualify as a “capital gain” rather than a return of income through a dividend payment.

Recent and Historical Performance of Stock Market
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From the mid 1970’s to 1982, there was generally no equity market appreciation of stock market averages..  However, from 1982-2008, there was a significant appreciation of stocks.  Since October 2007, when stock markets peaked, stocks have declined dramatically.  Over the long term, stocks have historically outperformed all other investments.  From 1926 to 2008, the S&P 500 returned an average annual 9.6 percent gain. The next best performing asset class is bonds. Long-term U.S. Treasury notes returned, on average, 5.9 percent over the same period.

Short Term Stock Market Performance

Over the short term, stocks can be hazardous to your financial health.  On Oct. 19, 1987, stocks experienced the worst one-day drop (in percent terms) in stock market history by declining 22.6 percent in a single day! Recently, the shocks have been prolonged and painful.  If you had invested in a Nasdaq index fund around the time of the market's peak in March 2000 you would have lost three-fourths of your money over the next three years. And in 2008, stocks overall lost a whopping 37 percent. Ouch.

The Bond Market and Bull & Bear Stock Markets

When interest rates go up, bond prices fall. Why? Because bond buyers won't pay as much for an existing bond with a fixed interest rate of, say, 5 percent because they know that the fixed interest on a new bond will pay more.

But, when interest rates fall, bond prices go up and the effect is greatest on bonds with the longest term, or time, to maturity. That is, long-term bonds get hit harder than short-term bonds when rates climb, and gain the most when rates fall.

In the short run, changes in interest rates can be more important than earnings. When rates go up, all other things being equal, investors tend to pull money out of stocks and put it into bonds and other fixed-income investments because the returns are so attractive and the risks are less with high quality bonds such as Treasury “paper” backed by the US government. Stock prices go down as bond yields go up. When interest rates come down again, all other things equal, then investors tend to shift money into stocks, reversing the previous trend.

Note, however, the phrase  "all other things equal." In real life, other things are rarely equal, and so this relationship - while true in general terms - is hardly perfect.  Inflation expectations can actually cause bond prices to decline as interest rates start to rise and stock prices to increase as well if investors believe that the stock they are buying will benefit from a rise in prices as the company will (be able) to raise prices for their products for things like natural resources or commodities.

Inflation may be the biggest threat to your long-term investments.  While a stock market crash can knock the stuffing out of your stock investments, so far, the market has always bounced back and eventually gone on to new heights. However, inflation reduces your buying power as things cost more when the price level rises. That's why it's important to put your retirement investments where they'll earn the highest long-term inflation-adjusted or “real” returns.

At an average annual growth rate of 9.6 percent a year, stocks will double your money about in a little more than seven years. Factor in inflation, which has historically run at about 3.1 percent annually, and it will take more than 10 years to double your actual buying power.  Likewise, bonds, which have historically grown at roughly 5.9 percent annually, will double your money every 12 years. After inflation, however, it will take 26 years.

If your money is in cash, you'll have to wait 23 years for the nominal value of your account to double, assuming the cash earns the historical 3.1 percent annual return. But even your grandchildren won't see the real value of your money double.  That's why, whenever you add up your gains or losses for a given period of time, you have to add in the effects of inflation to understand how much further ahead or behind you really are in real terms (the buying power of your money).

Bull Stock Market of the 1990’s

If you're looking to invest money you may need in a year or two, the stock market can be downright dangerous.

The 1990s enjoyed the biggest bull market in U.S. history. During the decade the Dow more than quadrupled.  While stocks, as represented by the S&P 500, have not always performed so extraordinarily, they have usually been the best performing asset class over time.

Since 1926, stocks have returned an annual average of 9.6 percent through 2008 -- and that included the most recent horrendous bear market. Over the same period, government bonds returned 5.9 percent, and "cash," the term used to describe Treasury bills and other short-term investments, returned just 3.7 percent. In other words, if you're investing for the long-term, history says stocks are the place to be.

But if you're looking to invest money you may need in a year or two, the stock market can be downright dangerous. Look no further than the Dow's 554-point drop - a 7.2 percent loss - on Oct. 27, 1997, and the 508-point drop on Oct. 19, 1987 - a harrowing 22.6 percent loss - to see what a difference a day can make.

Bear Stock Markets Too

Then there are those bloody” bear” stock markets, like 1973-74, when the Dow fell 45 percent. or 2008 when the stock “averages” lost 37 percent.

To cite a severe example, if you had bought the stocks in the Dow Jones Industrial Average at the peak in early 1966, you wouldn't have made any significant profit until mid-1983 - more than 17 years later. Even that was better than if you'd bought in the pre-crash peak of 1929. After that, it took until 1954 for the market to regain all it lost in the Depression. As for the market woes of the early 2000s, it would take more than five years (or until 2005) using an historical average rate of return, for the Dow to return to its glory-day levels from its October 2002 low.

Volatility of Stocks versus Bonds

Stocks do not always outperform bonds.  It is only in the post-World War II era that stocks so widely outpaced bonds in total-return. Stock and bond returns were about even from about 1870 to 1940. And, of course, bonds were well in front in 2000, 2001 and 2002 before stocks once again took charge in 2003 and 2004.  And, in 2008, the bond market had far outperformed the stock market once again.

You can lose money in bonds.  Bonds are not turbo-charged CDs. Though their life span or duration and interest payments are fixed -- thus the term "fixed-income" investments -- their returns are not, unless you buy only bonds that are high quality guaranteed with no credit risk and hold the bond to maturity when the principal of the bond is repaid in full.

Analyzing Analyst Recommendations

Research analysts make recommendations on the stock and bond securities of those companies. Most specialize in a particular industry or sector of the economy. Their recommendations are watched carefully. Analysts' reports can influence the price of a stock especially when the media promotes the analyst’s stock picks or pans. The mere mention of a company by a popular analyst can temporarily cause its stock to rise or fall—even when nothing about the company's prospects or fundamentals has changed.  Analysts use a variety of terms—buy, strong buy, near-term or long-term accumulate, near term or long term outperform or underperform, neutral, hold—to describe their recommendations. But the meanings of these terms can differ from firm to firm. Rather than make assumptions, investors should carefully read the definitions of all ratings used in each research report. They should also consider the firm's disclosures regarding what percentage of all ratings fall into either "buy," "hold/neutral," and "sell" categories.  Typically, analysts rarely rate stocks a sell.

While analysts provide an important source of information in today's markets, investors should understand the potential conflicts of interest. For example, some analysts work for firms that underwrite or own the securities of the companies the analyst covers. Analysts themselves sometimes own stocks in the companies they cover—either directly or indirectly, such as through employee stock-purchase plans in which they and their colleagues participate.

As a general matter, investors should not rely solely on an analyst's recommendation when deciding whether to buy, hold, or sell a stock. Instead, they should also do their own research—such as reading the prospectus for new companies or for public companies, the quarterly and annual reports filed with the Securities & Exchange Commission ( SEC)—to confirm whether a particular investment is appropriate for them in light of their individual financial situation. Individual investors can also do their own research by visiting a store or company or listening to a company’s earnings report in a webcast.

Potential Conflicts of Interest

Many analysts work in a world with conflicts of interest and competing pressures. On the one hand, sell-side firms want their individual investor clients to be successful over time because satisfied long-term investors are a key to a firm's long-term reputation and success. A well-respected investment research team is an important service to customers.

At the same time, however, several factors can create pressure on an analyst's independence and objectivity. The existence of these factors does not necessarily mean that the research analyst is biased. But investors should take them into account before making an investment decision. Some of these factors include:

Investment Banking Relationships

When companies issue new securities, they hire investment bankers for advice on structuring the deal and with the actual offering called an “underwriting.”  Underwriting a company's securities offerings and providing other investment banking services can bring in substantial money. Here's what an investment banking relationship may mean:

The analyst's firm may be underwriting the offering—if so, the firm has a substantial interest both financial and in the firm’s “ranking” to have a successful offering.  Analysts are often an integral part of the investment banking team for initial public offerings—assisting with "due diligence" research into the company, participating in investor road shows, and helping to shape the deal. Upbeat research reports and positive recommendations published after the offering is completed may "support" new stock issued by a firm's investment banking clients.  The firm underwriting the stock offering collects a fee which can be significant…even many millions of dollars.

Client companies prefer favorable research reports and unfavorable analyst reports may hurt the firm's efforts to nurture a lucrative, long-term investment banking relationship. An unfavorable report might alienate the firm's client or potential client.  A firm’s incentive to “win” the investment banking relationship may compromise their objectivity and even their honesty.

Brokerage Commissions

Brokerage firms usually don't charge for their research reports. But a positive analyst report can generate more stock purchases which results in additional brokerage commissions.

Analyst Compensation

Brokerage firms' compensation arrangements can put pressure on analysts to issue positive research reports and recommendations. For example, some firms link compensation and bonuses—directly or indirectly—to the number of investment banking deals the analyst lands or to the profitability of the firm's investment banking division.

Ownership Interests in the Company

An analyst, other employees, and the firm itself may own significant positions in the companies an analyst covers. Analysts may also participate in an employee stock plan that invests in companies the firm covers. Or, in a new trend "venture investing," an analyst's firm or colleagues may acquire a stake in a start-up by obtaining discounted, pre-IPO shares. These practices allow an analyst, the firm he or she works for, or both to profit, directly or indirectly, from owning securities in companies the analyst covers which compromises the firm’s and analyst’s objectivity.