Chapter 1
IN THIS CHAPTER
Using stock exchanges to get investment information
Applying accounting and economic know-how to your investments
Keeping abreast of financial news
Deciphering stock tables
Understanding dividend dates
Recognizing good (and bad) investing advice
Knowledge and information are two critical success factors in stock investing. (Isn’t that true about most things in life?) People who plunge headlong into stocks without sufficient knowledge of the stock market in general, and current information in particular, quickly learn the lesson of the eager diver who didn’t find out ahead of time that the pool was only an inch deep (ouch!). In their haste to avoid missing so-called golden investment opportunities, investors too often end up losing money.
For the best approach to stock investing, build your knowledge and find quality information first so you can make your fortunes more assuredly. Before you buy, you need to know that the company you’re investing in is the following:
Where do you start, and what kind of information do you want to acquire? Keep reading.
Before you invest in stocks, you need to be completely familiar with the basics of stock investing. At its most fundamental, stock investing is about using your money to buy a piece of a company that will give you value in the form of appreciation or income (or both). Fortunately, many resources are available to help you find out about stock investing. Some of our favorite places are the stock exchanges themselves.
Stock exchanges are organized marketplaces for the buying and selling of stocks (and other securities). The New York Stock Exchange (NYSE; also referred to as the Big Board ), the premier stock exchange, provides a framework for stock buyers and sellers to make their transactions. The NYSE makes money not only from a cut of every transaction but also from fees (such as listing fees) charged to companies and brokers that are members of its exchanges. In 2007, the NYSE merged with Euronext, a major European exchange, but no material differences exist for stock investors. In 2009, the American Stock Exchange (Amex) was taken over by (and completely merged into) the NYSE. The new name is NYSE Amex.
The main exchanges for most stock investors are the NYSE and NASDAQ. Technically, NASDAQ isn’t an exchange, but it’s a formal market that effectively acts as an exchange. Because the NYSE and NASDAQ benefit from increased popularity of stock investing and continued demand for stocks, they offer lots of free (or low-cost) resources and information for stock investors. Go to their websites to find useful resources such as the following:
www.nyse.com
www.nasdaq.com
Stocks represent ownership in companies. Before you buy individual stocks, you want to understand the companies whose stock you’re considering and find out about their operations. It may sound like a daunting task, but you’ll digest the information more easily when you realize that companies work very similarly to the way you work. They make decisions on a daily basis just as you do.
Think about how you grow and prosper as an individual or as a family, and you see the same issues with businesses and how they grow and prosper. Low earnings and high debt are examples of financial difficulties that can affect both people and companies. You can better understand companies’ finances by taking the time to pick up some information in two basic disciplines: accounting and economics. These two disciplines, which we discuss in the following sections, play a significant role in understanding the performance of a firm’s stock.
Assets minus liabilities equals net worth. In other words, take what you own (your assets ), subtract what you owe (your liabilities ), and the rest is yours (your net worth )! Your own personal finances work the same way as Microsoft’s (except yours have fewer zeros at the end).
A company’s balance sheet shows you its net worth at a specific point in time (such as December 31). The net worth of a company is the bottom line of its asset and liability picture, and it gives you a gauge as to its solvency (whether it has the ability to pay its debts without going out of business). The net worth of a successful company grows regularly. To see whether your company is successful, compare its net worth with the net worth from the same point a year earlier. A firm that has a $4 million net worth on December 31, 2015, and a $5 million net worth on December 31, 2016, is doing well; its net worth has gone up 25 percent ($1 million) in one year.
Income minus expenses equals net income. In other words, take what you make (your income ), subtract what you spend (your expenses ), and the remainder is your net income (or net profit or net earnings ) — your gain.
A company’s profitability is the whole point of investing in its stock. As it profits, the business becomes more valuable, and in turn, its stock price becomes more valuable. To discover a firm’s net income, look at its income statement. Try to determine whether the company uses its gains wisely, either by reinvesting them for continued growth or by paying down debt.
Do a comparative financial analysis. That’s a mouthful, but it’s just a fancy way of saying how a company is doing now compared with something else (like a prior period or a similar company).
If you know that the company you’re looking at had a net income of $50,000 for the year, you may ask, “Is that good or bad?” Obviously, making a net profit is good, but you also need to know whether it’s good compared to something else. If the company had a net profit of $40,000 the year before, you know that the company’s profitability is improving. But if a similar company had a net profit of $100,000 the year before and in the current year is making $50,000, then you may want to either avoid the company making the lesser profit or see what (if anything) went wrong with the company making less.
Accounting can be this simple. If you understand these three basic points, you’re ahead of the curve (in stock investing as well as in your personal finances).
Economics. Double ugh! No, you aren’t required to understand “the inelasticity of demand aggregates” (thank heavens!) or “marginal utility” (say what?). But a working knowledge of basic economics is crucial (and we mean crucial) to your success and proficiency as a stock investor. The stock market and the economy are joined at the hip. The good (or bad) things that happen to one have a direct effect on the other. The following sections give you the lowdown.
Cause and effect: If you pick up a prominent news report and read, “Companies in the table industry are expecting plummeting sales,” do you rush out and invest in companies that sell chairs or manufacture tablecloths? Considering cause and effect is an exercise in logical thinking, and logic is a major component of sound economic thought.
When you read business news, play it out in your mind. What good (or bad) can logically be expected given a certain event or situation? If you’re looking for an effect (“I want a stock price that keeps increasing”), you also want to understand the cause. Here are some typical events that can cause a stock’s price to rise:
Because most investors ignored some basic observations about economics in the late 1990s, they subsequently lost trillions in their stock portfolios during 2000–2002. During 2000–2008, the United States experienced the greatest expansion of total debt in history, coupled with a record expansion of the money supply. The Federal Reserve (or the Fed ), the U.S. government’s central bank, controls both. This growth of debt and money supply resulted in more consumer (and corporate) borrowing, spending, and investing. The debt and spending that hyperstimulated the stock market during the late 1990s (stocks rose 25 percent per year for five straight years during that time period) came back with a vengeance afterwards. When the stock market bubble popped during 2000–2002, it was soon replaced with the housing bubble, which popped during 2005–2006.
Of course, you should always be happy to earn 25 percent per year with your investments, but such a return can’t be sustained and encourages speculation. This artificial stimulation by the Fed resulted in the following:
In the end, spending started to slow down because consumers and businesses became too indebted. This slowdown in turn caused the sales of goods and services to taper off. Companies were left with too much overhead, capacity, and debt because they had expanded too eagerly. At this point, businesses were caught in a financial bind. Too much debt and too many expenses in a slowing economy mean one thing: Profits shrink or disappear. To stay in business, companies had to do the logical thing — cut expenses. What’s usually the biggest expense for companies? People! Many companies started laying off employees. As a result, consumer spending dropped further because more people were either laid off or had second thoughts about their own job security.
Because people had little in the way of savings and too much in the way of debt, they had to sell their stock to pay their bills. This trend was a major reason that stocks started to fall in 2000. Earnings started to drop because of shrinking sales from a sputtering economy. As earnings fell, stock prices also fell.
Reading the financial news can help you decide where or where not to invest. Many newspapers, magazines, and websites offer great coverage of the financial world. Obviously, the more informed you are, the better, but you don’t have to read everything that’s written. The information explosion in recent years has gone beyond overload, and you can easily spend so much time reading that you have little time left for investing. In the following sections, we describe the types of information you need to get from the financial news.
Check out the following resources as a starting point for gathering financial news:
www.wsj.com
) and Investor’s Business Daily
(
www.investors.com
). These excellent publications report the news and stock data as of the prior trading day.www.marketwatch.com
), Yahoo! Finance (
http://finance.yahoo.com
), Bloomberg (
www.bloomberg.com
), and Investing.com (
www.investing.com
). These websites can give you news and stock data within minutes after an event occurs.Before you invest, you need to know what’s going on with the company. When you read about the company, either from the firm’s literature (its annual report, for example) or from media sources, be sure to get answers to some pertinent questions:
Knowing how the company is doing, no matter what’s happening with the general economy, is obviously important.
As you consider investing in a stock, make a point of knowing what’s going on in that company’s industry. If the industry is doing well, your stock is likely to do well, too. But then again, the reverse is also true.
Yes, we’ve seen investors pick successful stocks in a failing industry, but those cases are exceptional. By and large, it’s easier to succeed with a stock when the entire industry is doing well. As you’re watching the news, reading the financial pages, or viewing financial websites, check out the industry to ensure that it’s strong and dynamic.
No matter how well or how poorly the overall economy is performing, you want to stay informed about its general progress. It’s easier for the value of stock to keep going up when the economy is stable or growing. The reverse is also true: If the economy is contracting or declining, the stock has a tougher time keeping its value. Some basic items to keep tabs on include the following:
Being informed about what public officials are doing is vital to your success as a stock investor. Because federal, state, and local governments pass literally thousands of laws, rules, and regulations every year, monitoring the political landscape is critical to your success. The news media report what the president and Congress are doing, so always ask yourself, “How does a new law, tax, or regulation affect my stock investment?”
As odd as it sounds, trends in society, popular culture, and entertainment affect your investments, directly or indirectly. For example, a headline such as “The Graying of America — More People Than Ever Before Will Be Senior Citizens” gives you some important information that can make or break your stock portfolio. With that particular headline, you know that as more and more people age, companies that are well positioned to cater to that growing market’s wants and needs will do well — meaning a successful stock for you.
Keep your eyes open to emerging trends in society at large by reading and viewing the media that cover such matters (Time magazine, CNN, Fox News, and so on). What trends are evident now? Can you anticipate the wants and needs of tomorrow’s society? Being alert, staying a step ahead of the public, and choosing stocks appropriately gives you a profitable edge over other investors. If you own stock in a solid company with growing sales and earnings, other investors eventually notice. As more investors buy your company’s stock, you’re rewarded as the stock price increases.
The stock tables in major business publications such as The Wall Street Journal and Investor’s Business Daily are loaded with information that can help you become a savvy investor — if you know how to interpret them. You need the information in the stock tables for more than selecting promising investment opportunities. You also need to consult the tables after you invest to monitor how your stocks are doing.
Looking at the stock tables without knowing what you’re looking for or why you’re looking is the equivalent of reading War and Peace backward through a kaleidoscope — nothing makes sense. But we can help you make sense of it all (well, at least the stock tables!). Table 1-1 shows a sample stock table. Each item gives you some clues about the current state of affairs for that particular company. The sections that follow describe each column to help you understand what you’re looking at.
TABLE 1-1 A Sample Stock Table
52-Wk High |
52-Wk Low |
Name (Symbol) |
Div |
Vol |
Yld |
P/E |
Day Last |
Net Chg |
21.50 |
8.00 |
SkyHighCorp (SHC) |
3,143 |
76 |
21.25 |
+0.25 |
||
47.00 |
31.75 |
LowDownInc (LDI) |
2.35 |
2,735 |
5.9 |
18 |
41.00 |
–0.50 |
25.00 |
21.00 |
ValueNowInc (VNI) |
1.00 |
1,894 |
4.5 |
12 |
22.00 |
+0.10 |
83.00 |
33.00 |
DoinBadlyCorp (DBC) |
7,601 |
33.50 |
–0.75 |
If you just can’t wait to know how a stock performed over the last few hours, you can go online to find up-to-date data. Check out Book 6, Chapter 2 for financial websites we recommend that will keep you abreast of the market’s ups and downs.
The column in Table 1-1 labeled “52-Wk High” gives you the highest price that particular stock has reached in the most recent 52-week period. Knowing this price lets you gauge where the stock is now versus where it has been recently. SkyHighCorp’s (SHC) stock has been as high as $21.50, whereas its last (most recent) price is $21.25, the number listed in the “Day Last” column. (Flip to the later section “Day last ” for more on understanding this information.) SkyHighCorp’s stock is trading very high right now because it’s hovering right near its overall 52-week high figure.
Now, take a look at DoinBadlyCorp’s (DBC) stock price. It seems to have tumbled big time. Its stock price has had a high in the past 52 weeks of $83, but it’s currently trading at $33.50. Something just doesn’t seem right here. During the past 52 weeks, DBC’s stock price has fallen dramatically. If you’re thinking about investing in DBC, find out why the stock price has fallen. If the company is strong, it may be a good opportunity to buy stock at a lower price. If the company is having tough times, avoid it. In any case, research the firm and find out why its stock has declined.
The column labeled “52-Wk Low” gives you the lowest price that particular stock reached in the most recent 52-week period. Again, this information is crucial to your ability to analyze stock over a period of time. Look at DBC in Table 1-1 , and you can see that its current trading price of $33.50 in the “Day Last” column is close to its 52-week low of $33.
The “Name (Symbol)” column is the simplest in Table 1-1 . It tells you the company name (usually abbreviated) and the stock symbol assigned to the company.
Dividends (shown under the “Div” column in Table 1-1 ) are basically payments to owners (stockholders). If a company pays a dividend, it’s shown in the dividend column. The amount you see is the annual dividend quoted for one share of that stock. If you look at LowDownInc (LDI) in Table 1-1 , you can see that you get $2.35 as an annual dividend for each share of stock that you own. Companies usually pay the dividend in quarterly amounts. If you own 100 shares of LDI, the company pays you a quarterly dividend of $58.75 ($235 total per year). A healthy company strives to maintain or upgrade the dividend for stockholders from year to year. (We discuss additional dividend details later in this chapter.)
The dividend is very important to investors seeking income from their stock investments. For more about investing for income, see Book 3, Chapter 3 . Investors buy stocks in companies that don’t pay dividends primarily for growth. For more information on growth stocks, see Book 3, Chapter 2 .
Normally, when you hear the word “volume” on the news, it refers to how much stock is bought and sold for the entire market: “Stocks were very active today. Trading volume at the New York Stock Exchange hit 2 billion shares.” Volume is certainly important to watch because the stocks that you’re investing in are somewhere in that activity. For the “Vol” column in Table 1-1 , though, the volume refers to the individual stock.
Volume tells you how many shares of that particular stock were traded that day. If only 100 shares are traded in a day, then the trading volume is 100. SHC had 3,143 shares change hands on the trading day represented in Table 1-1 . Is that good or bad? Neither, really. Usually the business news media mention volume for a particular stock only when it’s unusually large. If a stock normally has volume in the 5,000 to 10,000 range and all of a sudden has a trading volume of 87,000, then it’s time to sit up and take notice.
The main point to remember is that trading volume that is far in excess of that stock’s normal range is a sign that something is going on with that stock. It may be negative or positive, but something newsworthy is happening with that company. If the news is positive, the increased volume is a result of more people buying the stock. If the news is negative, the increased volume is probably a result of more people selling the stock. What are typical events that cause increased trading volume? Some positive reasons include the following:
Some negative reasons for an unusually large fluctuation in trading volume for a particular stock include the following:
In general, yield is a return on the money you invest. However, in the stock tables, yield (“Yld” in Table 1-1 ) is a reference to what percentage that particular dividend is of the stock price. Yield is most important to income investors. It’s calculated by dividing the annual dividend by the current stock price. In Table 1-1 , you can see that the yield du jour of ValueNowInc (VNI) is 4.5 percent (a dividend of $1 divided by the company’s stock price of $22). Notice that many companies report no yield; because they have no dividends, their yield is zero.
In the P/E ratios reported in stock tables, price refers to the cost of a single share of stock. Earnings refers to the company’s reported earnings per share as of the most recent four quarters. The P/E ratio is the price divided by the earnings. In Table 1-1 , VNI has a reported P/E of 12, which is considered a low P/E. Notice how SHC has a relatively high P/E (76). This stock is considered too pricey because you’re paying a price equivalent to 76 times earnings. Also notice that DBC has no available P/E ratio. Usually this lack of a P/E ratio indicates that the company reported a loss in the most recent four quarters.
The “Day Last” column tells you how trading ended for a particular stock on the day represented by the table. In Table 1-1 , LDI ended the most recent day of trading at $41. Some newspapers report the high and low for that day in addition to the stock’s ending price for the day.
The information in the “Net Chg” column answers the question, “How did the stock price end today compared with its price at the end of the prior trading day?” Table 1-1 shows that SHC stock ended the trading day up 25 cents (at $21.25). This column tells you that SHC ended the prior day at $21. VNI ended the day at $22 (up 10 cents), so you can tell that the prior trading day it ended at $21.90.
Reading and understanding the news about dividends is essential if you’re an income investor (someone who invests in stocks as a means of generating regular income; see Book 3, Chapter 3 for details). The following sections explain some basics you should know about dividends.
To understand how buying stocks that pay dividends can benefit you as an investor, you need to know how companies report and pay dividends. Some important dates in the life of a dividend are as follows:
For typical dividends, the events in Table 1-2 happen four times per year.
TABLE 1-2 The Life of the Quarterly Dividend
Event |
Sample Date |
Comments |
Date of declaration |
January 15 |
The date that the company declares the quarterly dividend |
Ex-dividend date |
February 8 |
Starts the two-day period during which, if you buy the stock, you don’t qualify for the dividend |
Date of record |
February 10 |
The date by which you must be on the books of record to qualify for the dividend |
Payment date |
February 27 |
The date that payment is made (a dividend check is issued and mailed to stockholders who were on the books of record as of February 10) |
As an example, say that you want to buy ValueNowInc (VNI) in time to qualify for the quarterly dividend of 25 cents per share. Assume that the date of record (the date by which you have to be an official owner of the stock) is February 10. You have to execute the trade (buy the stock) no later than February 8 to be assured of the dividend. If you execute the trade right on February 8, the closing date occurs two days later, on February 10 — just in time for the date of record.
But what if you execute the trade on February 9, a day later? Well, the trade’s closing date is February 11, which occurs after the date of record. Because you aren’t on the books as an official stockholder on the date of record, you aren’t getting that quarterly dividend. In this example, the February 8–10 period is called the ex-dividend period.
Psssst. Have we got a stock tip for you! Come closer. You know what it is? Research! What we’re trying to tell you is to never automatically invest just because you get a hot tip from someone. Good investment selection means looking at several sources before you decide on a stock. No shortcut exists. That said, getting opinions from others never hurts — just be sure to carefully analyze the information you get. Here are some important points to bear in mind as you evaluate tips and advice from others:
Consider the source. Frequently, people buy stock based on the views of some market strategist or market analyst. People may see an analyst being interviewed on a television financial show and take that person’s opinions and advice as valid and good. The danger here is that the analyst may be biased because of some relationship that isn’t disclosed on the show. Analysts are required to disclose conflicts of interest on business channels.
It happens on TV all too often. The show’s host interviews analyst U.R. Kiddingme from the investment firm Foollum & Sellum. The analyst says, “Implosion Corp. is a good buy with solid, long-term upside potential.” You later find out that the analyst’s employer gets investment banking fees from Implosion Corp. Do you really think that analyst would ever issue a negative report on a company that’s helping to pay the bills? It’s not likely.
Gather data from the SEC. When you want to get more objective information about a company, why not take a look at the reports that firms must file with the SEC? These reports are the same reports that the pundits and financial reporters read. Arguably, the most valuable report you can look at is the 10K. The 10K is a report that all publicly traded companies must file with the SEC. It provides valuable information on the company’s operations and financial data for the most recent year, and it’s likely to be less biased than the information a company includes in other corporate reports, such as an annual report. The next most important document from the SEC is the 10Q, which gives the investor similar detailed information but for a single quarter.
To access 10K and 10Q reports, go to the SEC’s website (
www.sec.gov
). From there, you can find the SEC’s extensive database of public filings called EDGAR (Electronic Data Gathering, Analysis, and Retrieval system). By searching EDGAR, you can find companies’ balance sheets, income statements, and other related information so you can verify what others say and get a fuller picture of what a business is doing and what its financial condition is.