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Investing in theStock Market

By C. Edward Gilpatric

IN THIS BOOK

■ Learn what it takes to be a successful investor

■ Get up to speed on stock market terminology

■ Research and select promising stocks

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CliffsNotes™ Investing in the Stock MarketPublished byIDG Books Worldwide, Inc.An International Data Group Company919 E. Hillsdale Blvd.Suite 400Foster City, CA 94404www.idgbooks.com (IDG Books Worldwide Web site)www.cliffsnotes.com (CliffsNotes Web site)Copyright © 1999 IDG Books Worldwide, Inc. All rights reserved. No part of this book, including interior design, cover design, and icons, may be repro-duced or transmitted in any form, by any means (electronic, photocopying, recording, or otherwise) without the prior written permission of the publisher.Library of Congress Catalog Card No.: 99-64592ISBN: 0-7645-8518-5Printed in the United States of America10 9 8 7 6 5 4 3 2 11O/TR/QY/ZZ/INDistributed in the United States by IDG Books Worldwide, Inc.Distributed by CDG Books Canada Inc. for Canada; by Transworld Publishers Limited in the United Kingdom; by IDG Norge Books for Norway; byIDG Sweden Books for Sweden; by IDG Books Australia Publishing Corporation Pty. Ltd. for Australia and New Zealand; by TransQuest Publishers PteLtd. for Singapore, Malaysia, Thailand, Indonesia, and Hong Kong; by Gotop Information Inc. for Taiwan; by ICG Muse, Inc. for Japan; by NormaComunicaciones S.A. for Colombia; by Intersoft for South Africa; by Eyrolles for France; by International Thomson Publishing for Germany, Austria andSwitzerland; by Distribuidora Cuspide for Argentina; by LR International for Brazil; by Ediciones ZETA S.C.R. Ltda. for Peru; by WS Computer Publish-ing Corporation, Inc., for the Philippines; by Contemporanea de Ediciones for Venezuela; by Express Computer Distributors for the Caribbean and WestIndies; by Micronesia Media Distributor, Inc. for Micronesia; by Grupo Editorial Norma S.A. for Guatemala; by Chips Computadoras S.A. de C.V. forMexico; by Editorial Norma de Panama S.A. for Panama; by American Bookshops for Finland. Authorized Sales Agent: Anthony Rudkin Associates for theMiddle East and North Africa.For general information on IDG Books Worldwide’s books in the U.S., please call our Consumer Customer Service department at 800-762-2974. Forreseller information, including discounts and premium sales, please call our Reseller Customer Service department at 800-434-3422.For information on where to purchase IDG Books Worldwide’s books outside the U.S., please contact our International Sales department at 317-596-5530or fax 317-596-5692.For consumer information on foreign language translations, please contact our Customer Service department at 1-800-434-3422, fax 317-596-5692, or e-mail [email protected] information on licensing foreign or domestic rights, please phone +1-650-655-3109.For sales inquiries and special prices for bulk quantities, please contact our Sales department at 650-655-3200 or write to the address above.For information on using IDG Books Worldwide’s books in the classroom or for ordering examination copies, please contact our Educational Sales depart-ment at 800-434-2086 or fax 317-596-5499.For press review copies, author interviews, or other publicity information, please contact our Public Relations department at 650-655-3000 or fax 650-655-3299.For authorization to photocopy items for corporate, personal, or educational use, please contact Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, or fax 978-750-4470.

LIMIT OF LIABILITY/DISCLAIMER OF WARRANTY: THE PUBLISHER AND AUTHOR HAVE USED THEIR BEST EFFORTS INPREPARING THIS BOOK. THE PUBLISHER AND AUTHOR MAKE NO REPRESENTATIONS OR WARRANTIES WITH RESPECT TOTHE ACCURACY OR COMPLETENESS OF THE CONTENTS OF THIS BOOK AND SPECIFICALLY DISCLAIM ANY IMPLIED WAR-RANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. THERE ARE NO WARRANTIES WHICH EXTENDBEYOND THE DESCRIPTIONS CONTAINED IN THIS PARAGRAPH. NO WARRANTY MAY BE CREATED OR EXTENDED BY SALESREPRESENTATIVES OR WRITTEN SALES MATERIALS. THE ACCURACY AND COMPLETENESS OF THE INFORMATION PROVIDEDHEREIN AND THE OPINIONS STATED HEREIN ARE NOT GUARANTEED OR WARRANTED TO PRODUCE ANY PARTICULARRESULTS, AND THE ADVICE AND STRATEGIES CONTAINED HEREIN MAY NOT BE SUITABLE FOR EVERY INDIVIDUAL. NEITHERTHE PUBLISHER NOR AUTHOR SHALL BE LIABLE FOR ANY LOSS OF PROFIT OR ANY OTHER COMMERCIAL DAMAGES,INCLUDING BUT NOT LIMITED TO SPECIAL, INCIDENTAL, CONSEQUENTIAL, OR OTHER DAMAGES.

Note: This book is intended to offer general information on investing in the stock market. The author and publisher are not engaged in rendering legal,tax, accounting, investment, real estate, or similar professional services. Although legal, tax, accounting, investment, real estate, and similar issuesaddressed by this book have been checked with sources believed to be reliable, some material may be affected by changes in the laws and/or interpretationof laws since the manuscript in this book was completed. Therefore, the accuracy and completeness of the information provided herein and the opinionsthat have been generated are not guaranteed or warranted to produce particular results, and the strategies outlined in this book may not be suitable forevery individual. If legal, accounting, tax, investment, real estate, or other expert advice is needed or appropriate, the reader is strongly encouraged toobtain the services of a professional expert.

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is a registered trademark or trademark under exclusive license to IDG Books Worldwide, Inc. from International Data Group, Inc. in the United States and/or other countries.

About the AuthorC. Edward Gilpatric earned a Ph.D. from theUniversity of Chicago. He is a former regis-tered stock representative and spent manyyears as an audit manager and director for theState of Illinois.

Publisher’s AcknowledgmentsEditorial

Senior Project Editor: Mary GoodwinAcquisitions Editor: Mark ButlerCopy Editor: Linda S. StarkTechnical Editor: John C. Eisenbarth

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Table of Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

Why Do You Need This Book? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1How to Use This Book . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2Don’t Miss Our Web Site . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

Chapter 1: Determining Your Financial Needs and Goals . . . . . .5

Doing a Reality Check: Are You Free of Major Debt? . . . . . . . . . . . . . . . . . . . .5Sizing up credit card debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6Considering other kinds of debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

Setting Your Goals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8Deciding how much money and time you need . . . . . . . . . . . . . . . . . . . .10Developing an investment plan to meet your goals and time frames . . . . .11

Making a Commitment to Work for Your Goals . . . . . . . . . . . . . . . . . . . . . .14Using payroll deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14Exercising discipline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15Practicing patience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

Are You Ready? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

Chapter 2: What You Need to Know about Stocks . . . . . . . . . . .17

The Many Varieties of Stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18Legal classification: Common or preferred stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18Descriptive classification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

Total Market Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20Anticipated performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22Industry Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24

The Stock Market and Exchanges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25Understanding IPOs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27

Chapter 3: Investing in the Stock Market: Rewards and Risks .28

Different Ways of Investing in the Stock Market . . . . . . . . . . . . . . . . . . . . . .28Investing as part of a group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29Investing in stocks on your own . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30

The Rewards of Investing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30Greater growth potential . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31Better accessibility to your money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31Greater control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

The Risks of Investing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32You could lose a substantial part of your investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33You can’t see into the future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34There is no money-back guarantee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34You don’t have total control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34

Chapter 4: Finding the Tools to Research Stocks . . . . . . . . . . . .36

Narrowing Your Choice of Stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36Narrowing the field . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37Determining your investment strategy . . . . . . . . . . . . . . . . . . . . . . . . . . .37Devising a screening technique . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39

Understanding the Limits of Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41Finding Your Level of Comfort with Research . . . . . . . . . . . . . . . . . . . . . . . .41Exploring Sources of Reliable Information . . . . . . . . . . . . . . . . . . . . . . . . . . .42

Printed daily stock updates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43Televised daily stock updates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44Online daily stock updates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45Weekly and other reports on stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46

Chapter 5: Selecting Stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

Using Your Experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50Using Your Intuition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51Reaching beyond Intuition: What Are the Experts Doing? . . . . . . . . . . . . . . .52Picking Stocks: Some Criteria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .56

1: EPS: Earnings per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .572: P/E ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .573: ROE: Return on stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . .584: Beta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .585 and 6: 5-year sales and earnings history . . . . . . . . . . . . . . . . . . . . . . . . .597: Company size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .598: Relative industry strength . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59

Practicing the Business of Real Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . .60Playing the Paper Game . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60

Chapter 6: Taking the Plunge: Making the Purchase . . . . . . . . .62

Buying Stocks with a Broker . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63Choosing a broker . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63Setting up an account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65Types of accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .66Deciding what to do with dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67Deciding what to do with certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . .69Types of orders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .70

iv CliffsNotes Investing in the Stock Market

Buying Stocks on the Internet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71Buying Directly from a Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73Maintaining Your Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75

Chapter 7: Tracking Your Stocks . . . . . . . . . . . . . . . . . . . . . . . . .78

Setting Up Your Tracking Timetable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79Tracking the Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82Tracking a Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86

Chapter 8: Making Mid-Course Adjustments . . . . . . . . . . . . . . .88

Diversifying Your Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88Purchasing Additional Stocks by Dollar-Cost Averaging . . . . . . . . . . . . . . . . .90Handling Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .92Living with Market Downturns and Stock Losses . . . . . . . . . . . . . . . . . . . . . .93Knowing When to Sell a Loser . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95Knowing When to Sell a Winner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .96

Chapter 9: What to Do If Things Go Badly . . . . . . . . . . . . . . . . . .98

Your First and Best Line of Defense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98When Do You Have a Legitimate Complaint? . . . . . . . . . . . . . . . . . . . . . . .100Investor Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .102What to Do If You Have a Legitimate Complaint . . . . . . . . . . . . . . . . . . . .103

CliffsNotes Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .106

Q&A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .106Scenarios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107Consider This . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .108Practice Projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .108

CliffsNotes Resource Center . . . . . . . . . . . . . . . . . . . . . . . . . . .110

Books . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110Internet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .111Magazines and Newspapers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113Send Us Your Favorite Tips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .115

Table of Contents v

vi CliffsNotes Investing in the Stock Market

INTRODUCTIONThe stock market is probably not a completely foreign con-cept to you, but you may not know enough to buy and sellsstocks with confidence — and a commitment to long-terminvesting. You need this book because

■ You’re interested in the stock market, and you want tolearn the essentials quickly.

■ You want to invest for your lifetime goals, but you worryabout the risk.

■ You’ve heard that you can potentially make more moneyin the stock market than the interest you receive on yoursavings and checking account from the bank.

Your first trip to the bookstore or your public library can bean overwhelming and dismaying experience. So manychoices, so little guidance. The value of this book is that ithas everything to get you started investing in the stock mar-ket — except the specific stocks that you are going to select.

Why Do You Need This Book?

Can you answer yes to any of these questions?

■ Do you need to learn about investing your money in thestock market fast?

■ Don’t have time to read 500 pages on the stock market?

■ Do you need to get more return on your money than the2% that your bank offers?

■ Do you need help figuring out what all those confusingterms like IPO, total market value, and preferred stockmean?

If so, then CliffsNotes Investing in the Stock Market is for you!

How to Use This Book

You’re the boss here. You get to decide how to use this book.You can either read the text from cover to cover or just lookfor the information you want and put the book back on theshelf for later. Here are a few ways that I recommend yousearch for a topic of interest:

■ Use the index in the back of the book to find what you’relooking for.

■ Flip through the book looking for your topic in the run-ning heads at the top of the page.

■ Look for your topic in the Table of Contents in the frontof the book.

■ Look at the In This Chapter list at the beginning of eachchapter.

■ Look for additional information in the Resource Centeror test your knowledge in the Review section.

■ Or, flip through the book until you find what you’relooking for — since I organized the book in a logical,task-oriented way.

Also, to help you find key information quickly in the book,you can look for icons strategically placed in the text. Hereis a description of the icons you’ll find in this book:

If you see a Remember icon, make a mental note of this text — it’s worth keeping in mind.

If you see a Tip icon, you’ll know that you’ve run across ahelpful hint, uncovered a secret, or received good advice.

2 CliffsNotes Investing in the Stock Market

The Warning icon alerts you to something that could be dan-gerous, requires special caution, or should be avoided.

Don’t Miss Our Web Site

Keep up with the fast-paced world of investing by visitingthe CliffsNotes Web site at www.cliffsnotes.com.Here’s what you find:

■ Interactive tools that are fun and informative.

■ Links to interesting Web sites.

■ Additional resources to help you continue your learning.

At www.cliffsnotes.com, you can even register for anew feature called CliffsNotes Daily, which offers younewsletters on a variety of topics, delivered right to youre-mail inbox each business day.

If you haven’t yet discovered the Internet and are wonderinghow to get online, pick up Getting On the Internet, new fromCliffsNotes. You’ll learn just what you need to make youronline connection quickly and easily. See you atwww.cliffsnotes.com!

Introduction 3

CHAPTER 1

DETERMINING YOURFINANCIAL NEEDS ANDGOALS

IN THIS CHAPTER

■ Deciding whether to pay outstanding debts or investyour money

■ Setting your investment goals

■ Committing to a savings and investment plan

Anyone who can earn the money to start an investment pro-gram can successfully invest in stocks. In this chapter, I walkyou through some personal issues you need to resolve beforeyou begin investing. Should you invest your money or payoff your debts? What are your specific financial goals? Canyou commit to an investment plan? Get ready to do someserious thinking — and acting — but don’t worry, this chap-ter can help put you on the path to achieving your personalfinancial goals.

Doing a Reality Check: Are You Free of

Major Debt?

Before you consider any type of investment plan, make anhonest appraisal of your overall financial situation. You maywant to pay off some outstanding debts before you begin asavings and investment program.

Because this is a book on investing, I suggest that you lookat debt as “reverse investing.” When you owe money, whether


to a person or an institution, the lender is making money offof you. If you’re constantly paying more in interest to somelender than you’re making on your savings and investments,you’re going backward in your hopes of building your nestegg for a secure and comfortable future.

Not all debt or borrowing is bad, however. You may have bor-rowed money for your education. You probably got a lowerinterest rate because of government subsidies. You expect thatyour enhanced earning power will more than compensate forthe interest you pay on your loan. In many cases, thisassumption is true.

The bottom line regarding debt is that it is a drag and a bur-den until it is paid off. Unless you can convincingly showthat borrowing money now will increase your ability to earnmoney in the near future, get rid of your debt as soon as youcan so that you can start building up your net worth for thefuture you dream of.

Don’t make the mistake of borrowing money to buy stocks.Don’t buy the sales pitch that a particular investment is theopportunity of a lifetime. If you borrow to invest, you incurreal debt with no guarantee of possible future gains.

Sizing up credit card debt

Carrying credit card debt is one of contemporary life’s easierentrapments. Credit card companies make getting credit andrunning up big balances simple and alluring. By adding extrafees, some credit cards penalize users who do not carry bal-ances on their card. Credit card companies want you to carrybalances — the bigger the better from their point of view.And why not? Credit account interest really pays off for com-panies issuing cards.

Credit card debt can carry interest charges in the 18 to 22%range. Clear up credit card debt before you even think ofinvesting. No reliable way exists for you to earn more onstock investments, even in the short run, than the rate ofinterest you’re paying on your credit card debt.

Paying off your credit card balances — even a little at a time— is a form of savings. Look at it this way: By paying off only$1,000 a year from a debt of $10,000, you save about $220at typical credit card interest rates, and your net worth, eventhough still in negative territory, rises proportionately.

Considering other kinds of debt

If you’re fresh out of college or even a few years into your firstjob after graduation, you may be carrying a heavy load of stu-dent loans that require repayment. The federal governmentsubsidizes and underwrites these loans. Check your interestrates. If you’re paying in the single digits (below 10%), don’tconsider these loans as urgent to pay off as credit card debt.Some investments can produce earnings higher than 10%.Therefore, using your money to purchase these investmentsis wiser than paying off your student loans; you can makemore from the investment than you will pay in interest onthe loans.

You may also be better off by putting your money into invest-ments rather than paying off your installment loan debt (forexample, your car loan) — if you can earn more on theinvestment than you would pay in interest on the loan.

You can view interest on home mortgages and home equitylines of credit differently. This kind of interest is generallytax-deductible, whereas credit card and installment loan inter-est is not.

Chapter 1: Determining Your Financial Needs and Goals 7

Don’t succumb to the temptation to use your home equityline of credit to finance your investments. Can you afford tolose your home? If not, don’t borrow against it — even foran “opportunity of a lifetime.”

Setting Your Goals

Setting goals sounds easy. “I want to be rich and retire by thetime I’m 50.” But is this statement a goal or a fantasy? Morethan likely, most statements of this sort are fantasies ordreams. Dreaming is fine, but looking forward to a brightfuture is not goal-setting. As you begin to formulate yourgoals, ask yourself three basic questions:

1. Can I break down my general goals into specific objectives?

2. What must I do to realize these specific objectives?

3. Is this a short-term or a long-term goal?

I provide a place in Figure 1-1 for you to list your goals. Con-sider the following examples. Suppose that your goal is to

■ Retire with financial security. What does security meanto you? Does it mean that you stay in the home that youhave lived in for 30 years? Or does it mean that you cansell that big, old house and move to a luxury condo inBoca Raton? Do you want to retire at 60, 65, or 75? Howmuch money will you need to save every year in order toretire at the time and to the place you prefer? What areyour savings options, for example a 401(k) plan?

■ Start your own business. Do you want to start an inde-pendent business or buy a franchise? Can you work outof your home, or do you need to purchase or build a site?How will you pay your bills until the business shows aprofit? Can you get a loan from the Small Business


Administration? How much money will you need inorder to purchase and establish the business (acquire thesite, buy inventory, hire personnel, purchase insurance,and so on)?

■ Put your child through college. Do you want to sendyour child to a state school, or do you want him or herto have the option of attending a more expensive, pri-vate college? Will you be able to take advantage of stu-dent loan or grant programs? How old is your child?How much money will you need to save each year untilhe or she graduates from high school? Can you takeadvantage of college savings plans to help you save themoney?

■ Buy a home. When do you want to move into a newhome? How much do you want to borrow? How muchmoney do you want to put down on your home? Do youwant to put at least 20% down to avoid paying for amortgage insurance policy?

Figure 1-1: A place for you to list your short and long-term goals.

Short-term goals $$$ Time frame

Long-term goals $$$ Time frame


Deciding how much money and time you

need

When you set specific investment goals, consider two essen-tial factors:

■ The amount of money you plan to accumulate

■ The time frame for saving that amount of money (keepin mind whether your goal is a short- or long-term)

Specifying a time frame is an important part of goal-setting.How do you come up with a time frame that makes sense forthe amount of money you plan to accumulate?

For example, if you’re saving for retirement, your specific goalmay be to maintain a standard of living comparable to whatyou achieved during your working years. Although you needa comprehensive retirement planning program to take intoaccount all the factors unique to your situation, a basic truthremains: You hope to have annual purchasing power equiv-alent to your current annual income.

You can forecast a time frame by considering when you hopeto retire and by reviewing the significant transitions in yourlife and family history. Look at yourself and what you wantout of life. Do you want to retire at 50? What kind oflongevity runs in your family? Does your employment or pro-fession define who you are, that is, would you feel empty orlose self-esteem if you gave up your career? After you arriveat a projected retirement year, determine whether you cansave enough money to retire at that age and maintain yourcurrent standard of living. Consider the following factors:

■ Your projected annual income between now and yourpreferred retirement age


■ The annual rate of inflation

■ Anticipated income you will be able to draw duringretirement: Social Security, pension, 401(k) funds, andpersonal savings

If you can afford to retire at your projected year, your timeframe is valid. (If you need help with the numbers, contacta professional retirement advisor.)

To make your investment plan work for you, you not onlyneed to design well-founded, long-term goals, but you alsohave to project realistic time frames for your plan. If yourgoals are mushy, or if your targets in time are ever-moving,you will never muster the discipline to achieve the financialsecurity you seek.

Developing an investment plan to meet

your goals and time frames

After you calculate a realistic monetary goal and a reasonabletime frame to achieve it, work backward to determine howmuch money you need to invest on a regular basis to accom-plish your goal.

You’re bound to quickly realize that the sooner you get startedon a systematic savings and investment plan, the more likelyyou are to realize your dream.

You need to save money in order to have funds to invest. Togive you some incentive, Table 1-1 is an illustration of a hypo-thetical investment plan that shows the impact of com-pounding the interest on your savings and investments.Compounding interest means that you leave all the interestyou have earned on your savings or investments in youraccount and add it to your principal.


Suppose that you save $100 a month for a year. After youhave accumulated $1200, you invest that amount in the stockmarket. Every month you save another $100, Each year onJanuary 1, you add another $1,200, and you do this for 25years. Your total investment over 25 years is 25 × $1,200, or$30,000.

If your investments provide you a steady return 8%, you willhave accumulated $1,296 by the end of the first year, towhich you add an additional $1,200 for a total of $2,496.

If this pattern continues year after year, by the end of thetwenty-fifth year you will have accumulated $99,945.27. Ifyou use 12% for the compounded annual rate of return, your25 years of investment grows to $180,400.67.

The Rule of 72 is a handy and reliable way of calculating com-pounded growth. Suppose that your investment yields a solidannual return of 8%. Divide 8 into 72, and you get 9. Aninvestment that yields 8% annually will double in value in 9years. Doing the math: If your annual return is 12%, yourmoney will double in 6 years.

Don’t be misled by the numbers used in Table 1-1. A rocksolid, unvarying annual return of 8% or 12% is very unlikely.Some years you may do better. Some years not as well. How-ever, an average annual return ranging from 8 to 12% is quitepossible — and many investors have achieved even betterreturns over long periods.

Table 1-1: $100 Per Month Compounded

for 25 years

End of Year 8% Interest 12% Interest

1 $2,496.00 $2,544.00

2 $3,895.68 $4,049.28

3 $5,407.33 $5,735.19


End of Year 8% Interest 12% Interest

4 $7,039.92 $7,623.42

5 $8,803.11 $9,738.23

6 10,707.36 $12,106.81

7 $12,763.95 $14,759.63

8 $14,985.07 $17,730.79

9 $17,383.87 $21,058.48

10 $19,974.58 $24,785.50

11 $22,772.55 $28,959.76

12 $25,794.35 $33,634.93

13 $29,057.90 $38,871.18

14 $32,582.53 $44,735.65

15 $36,389.13 $51,303.93

16 $40,500.26 $58,660.40

17 $44,940.28 $66,989.65

18 $49,735.50 $76,127.61

19 $54,914.34 $86,462.92

20 $60,507.49 $98,038.47

21 $66,548.09 $111,003.08

22 $73,071.94 $125,523.44

23 $80,117.69 $141,786.25

24 $87,727.11 $160,000.60

25 $99,945.27 $180,400.67

Before moving on, take one last look at the 12% column inTable 1-1. Your money will double every 6 years if the rateof return is 12% a year compounded. In the illustration,however, doubling of the investment occurs about every 5years because you’re adding another $1,200 every year. Thatmeans that the $180,400.67 total for the end of year 25 cangrow to about $360,000 in another 5 years.


As you play with these figures, you can see why an early starton a systematic and disciplined investment program is so crit-ical. Five years can make a big difference. Another 5 years ofgrowth under the same assumptions can yield another$360,000.

Making a Commitment to Work for

Your Goals

The key to success in the stock market centers on your com-mitment to achieving your goals. Saying that you’ll giveinvesting a try won’t do the job. You have to begin with a pro-gram that takes some money right off the top of yourmonthly income. Otherwise, you may be tempted to useyour investment money for other purposes. Refer to Table1-1 for a look at what $100 a month can do for you in thelong run. If your goal is more ambitious, plan a higher invest-ment amount, but make the sum doable.

Spelled out another way, investment in the stock market isdeferred gratification. You put off today’s pleasures — eatingout, extra rounds of golf, the luxury car that has to befinanced, the trip to New Zealand, whatever — for the antic-ipated return of future security. If you’re ready to make thatcommitment, your next move is to settle on a systematicpayment schedule for your investment dollars.

Using payroll deduction

The easiest approach to meeting your financial goals is tomake your savings/investment program automatic. Perhapsyour company has a credit union or other program thatenables you to use payroll deduction for depositing directlyto your savings account. When the time comes for yourannual investment, you take your $1,200 or whatever sum


you settled on and invest it wisely. If you don’t have access tothis type of program, your friendly banker can help you setup a savings account with automatic transfers from checking.

Exercising discipline

Much of the discipline you have to apply to reach your finan-cial goals has to do with controlling your spending. You livein a consumer economy. Every day you face pressures andappeals to spend for this or that, and sometimes for worthycauses. You need a budget and a mindset that will keep youfrom spending the money earmarked for your savings andinvestment program.

Follow the first rule of every savings program: Pay yourselffirst. This discipline isn’t as much fun as blowing all your cashthe second it lands in your pocket. Just imagine, however,the excitement you can enjoy watching your investmentsgrow.

Practicing patience

Beyond discipline, you need patience. No law suggests thatstocks only go up. As the legendary financier J.P. Morganallegedly responded when asked to predict stock market per-formance, “The market will fluctuate.”

If you panic and sell the first or second time your carefullyresearched stocks take a hit in the market, you will nevermake much money. In fact, you may not make any. You haveto have the patience to ride out inevitable market declines.

Don’t expect guarantees. Some of your stocks are going tofall. Some will fall sharply. Most will come back. Be patient.Over the long haul, stocks produce a return greater thanalmost any other investment.


Are You Ready?

Here is your final checklist of decisions you need to havemade in order to get started in investing in the stock market.

1. Have I set my goals and objectives?

2. Have I determined the amount of money I need to real-ize my goals?

3. When will my goals be realized?

4. Do I have a strategy for implementing my goals?

5. Have I calculated the required rate of return on my sav-ings and investments?

6. Am I willing to bear a risk?


CHAPTER 2

WHAT YOU NEED TOKNOW ABOUT STOCKS

IN THIS CHAPTER

■ Differentiating between common and preferred stocks

■ Understanding other labels that are given to stocks

■ Exploring the major trading markets for stocks and otherfinancial instruments

One of the biggest challenges of investing in the stock mar-ket is just understanding what writers, brokers, commenta-tors, and other investors are saying because so many of theterms are unfamiliar.

You will hear a fair amount about brokers in this book. If youchoose to use professional help with your investments, yourfirst point of contact very likely will be a broker, a licensedintermediary between buyers and the stock market. With fewexceptions, all stock purchases must be handled by stock-brokers — even on the Internet. For more info on brokers,check out Chapter 8.

As a beginning investor, you may hear statements like, “Mul-tiples are way too high,” or “It’s time to get out of cyclicals.We’re due for a recession.” How do you make sense out ofthis jargon? By the time you finish this chapter, you will knowmore than enough to begin sorting intelligently through themany choices that face new investors.

You may be asking, “Why should I bother myself with all thisterminology?” The answer is straightforward: You need abasic investing vocabulary so that you understand what youread and so you can eventually make intelligent choices whenyou’re ready to invest in stocks.

The Many Varieties of Stocks

A stock is a share in the ownership of a company. Stocks canbe divided into a variety of classifications. You should befamiliar with two classifications in particular: legal (or formal) classifications, and descriptive (or popular) classifications.

Legal classifications define your rights as a shareholder.Descriptive classifications do not have specific, legal meaningbut are convenient terms that brokers, financial writers, andothers use to explain different types of stock.

Legal classification: Common or

preferred stocks

In formal or legal terms, the two main classes of stocks arecommon stocks and preferred stocks.

■ Common stock is, well, the more common type. Owner-ship of common stock usually entitles its holders to ashare of the company’s dividends and voting rights atcompany meetings based on the number of shares held.Owners of common shares are also entitled to a propor-tionate share of the company’s assets, if the organizationis liquidated. However, common stocks offer no guar-antee that any dividend will be paid.

■ A stock is designated as preferred when it gives its ownerpreference over the holders of common stock in receiv-ing dividends and also in being paid a share of the com-


pany’s assets, if the company is liquidated. Preferredstocks generally do not confer any voting rights. Allcompanies offer common stock. Relatively few also offerpreferred stock.

Most preferred stocks have fixed, or stated, dividend pay-ments. A few preferred stocks have a varying dividend andare called adjustable rate preferred.

A preferred stock is a more conservative, that is, less riskyinvestment than common stock. The downside of preferredstock is that the holders receive only the stated dividend anddo not participate in the company’s growth in the same waycommon stock shareholders may. Table 2-1 shows the prosand cons of common and preferred stock.

Table 2-1: Common and Preferred Stock

Stock Type Pros Cons

Common Owner shares in Owner is at risk if success if company falterscompany profits

Preferred Dividend payment Dividends don’t is guaranteed increase if company

prospers

The stock reports printed every day in The Wall Street Jour-nal, Investor’s Business Daily, and other larger publicationsidentify when a stock is preferred. Because the large major-ity of stocks are common stocks, there are no listing noteswhen a stock is common.

Descriptive classification

After you get past the legally correct terminology used to cat-egorize shares of a corporation (common and preferredstock), you come to a great variety of additional ways to label

Chapter 2: What You Need to Know about Stocks 19

or talk about stocks outside of common and preferred.Descriptive is a broad term that encompasses all of the otherlabels you can put on stocks. In the rest of this section, I tellyou about some of the other labels or categories you will runacross when researching stocks.

Three basic descriptive categories are widely used to classifystocks:

■ Total market value: Stocks are categorized by size, basedon the total market value of company stock

■ Anticipated performance: Categorized by perceivedinvestment potential of the stock

■ Industry group: Categorized by the nature of the com-pany’s business

Total Market Value

A widely used category to classify stocks descriptively is basedon the total market value of the shares of the company whosestock is being traded. Total market value or market capital-ization is a number derived by multiplying the current mar-ket price of one share of the company’s stock times the totalnumber of outstanding stocks. For example:

Current market price × number of outstanding shares =Total market value.

$50/per share × 100,000,000 outstanding shares of stock= $5,000,000,000 Total market value

Stocks of companies whose total market value is under $1.5billion are referred to as small cap (see Figure 2-1). Companieswhose share value totals between $1.5 and $5.0 billion arecalled mid cap, and those above $5.0 billion are referred toas large cap.


Figure 2-1: Total market value determines the cap size of a stock.

Actually, you don’t need to calculate the total market valueof any company on your own because the work has alreadybeen done for you. The best place to get this information ison the Web. Heavy-duty publications like Value Line andStandard & Poor’s Stock Reports also give this information,and so will company quarterly and annual reports.

Almost all the Web sites that provide stock prices will alsogive constant updates on total market value because this willchange every time the market price of the stock changes (seeCliffsNotes Resource Center for a list of Web sites). It is notimportant to know the precise total market value of a com-pany at any given moment, but you should be aware ofwhether you are looking at the stock of a small company, alarge company, or something in between.

0

1.0

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4.0

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6.0

Various Cap Stocks

Billi

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of D

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SmallCap

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LargeCap

Stock

MidCap

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Please note that no universal agreement on the preciseboundaries of these cap categories of stocks exists. Moreover,the numbers that define category boundaries are constantlybeing revised.

Why is it important to know whether the companies whosestock you’re considering is considered to be small, mid, orlarge cap? The labeling of stock by dollar size provides use-ful clues to risk and to growth possibilities. The smaller thecompany, the more risky its stock is likely to be. Conversely,large cap stocks tend to be less risky, to be more likely to paydividends, and to grow steadily but not rapidly.

If you’re looking for stocks that are less risky than the smallcap but with greater prospects for rapid growth than themature, large cap companies, you would do well to concen-trate your search on mid cap stocks.

Anticipated performance

Another common way of describing stocks is based on theanticipated performance of the company over time. Here are afew anticipated performance labels placed on stocks:

■ Growth stocks: Stocks of relatively new and rapidlyexpanding companies

■ Income stocks: Stocks of established companies thathave a history of paying good dividends

■ Cyclical stocks: Stocks that rise and fall with the busi-ness cycle

The labels applied to stocks such as “growth” or “income”refer to the past performance of a stock. So, when a stock islabeled “growth” or “income”, these companies have eitherbeen a relatively new or rapidly expanding company in thepast or have paid good dividends in the past. These labels are


an educated guess of what the stock is likely to do based onlooking back at past history but do not offer any guaranteeof future results.

Here are a few examples of how knowing whether a stock isa growth or an income stock can help you make investmentdecisions.

■ New investors presumably want long-term growth. Forexample, a young person with years to build up a nestegg, there is little point in investing in a stagnant com-pany with steady but small dividends. A young investoris usually in a position to take greater risks in a growthstock in order to earn greater overall returns.

■ Retired investors on the other hand are more likely toseek current income, so they move toward stocks thatproduce a higher level of current income while main-taining or modestly increasing their value. After retire-ment when income from employment is no longeravailable, the mature investor can begin to take dividendsin cash rather than reinvesting them in additional shares,making income stocks a good choice.

You may wonder who would want to buy cyclical stockswhich rise in good economic times and fall back in times ofrecession or depression. Knowing that a stock is cyclical pro-vides useful clues about how the stock will likely perform. Ifyou’re inclined to try to maximize your return by buying lowand selling high, you may have a strong interest in the cycli-cals. You buy them when you think the economy is about tocome out of recession or depression, and you sell them whenyou think the economy is peaking.

This book does not recommend an investment programbased on constantly trading cyclical stocks. Any strategy thatcalls for constant trading carries high risks along with possi-ble higher gains. You should know, however, which stocks are


more likely to fluctuate with the business cycle so that youdon’t mistakenly buy them in good economic times and sus-tain heavy losses in even mild recessions.

Industry Group

Industry group is another categorization of stocks. An indus-try group is a way of lumping like businesses together. Forexample, all Internet stocks, computer hardware manufac-turers and software producers can be grouped together astechnology stocks. These categories are helpful if you’re seek-ing to diversify your stock investments.

Diversification — putting your eggs in more than one basket— is a recommended approach to reducing the risk of rely-ing on the performance of stock in one company or indus-try (something I’ll return to in Chapter 8). For example,having all your investments in one category, like technologystocks, is probably not a good idea because if the entire mar-ket takes a downturn, then all your investments will beaffected negatively.

The industry groups designated by the Dow Jones Corpora-tion (publisher of The Wall Street Journal and many otherfinancial-related publications) are the following:

■ Basic materials (mostly metals)

■ Conglomerates

■ Consumer/Cyclical (includes companies that provideproducts and services that vary with economic good andbad times)

■ Consumer/Noncyclical (includes basics like food, med-icine, and tobacco)

■ Energy (coal and oil)


■ Financial (banks and insurance)

■ Industrial

■ Technology (generally high-tech but also includesbiotechnology)

Analysts have devoted years of study to determine how dif-ferent businesses perform. For example, pharmaceutical com-panies have produced consistently high returns on investmentover the years. Basic consumer goods such as food have muchlower profitability.

Stocks are also commonly analyzed by comparing them interms of growth, earnings, and volatility with other compa-nies in the same category. A familiarity with these terms canhelp you translate the financial pages of your favorite news-paper and sort through the data involved in the process ofselecting a few stocks for investment.

To better understand the practical application of industrygroup categories on the real world of investing, buy a copyof Investor’s Business Daily and check out its SmartSelect Cor-porate Ratings. These ratings include an Industry Group Rel-ative Strength Rating, which tells how any stock ranks interms of price compared to other stocks in the same indus-try group. This rating can help you figure out whether a par-ticular stock is a strong performer compared to others in thesame industry.

The Stock Market and Exchanges

As an investor, you really don’t need to know the internalworkings of the New York Stock Exchange, Nasdaq, Ameri-can Stock Exchange, or any other exchange. Licensed stock-brokers can do all the work for you by locating theappropriate exchange for your trade.


All three major exchanges (NYSE, Nasdaq, and AMEX) havetheir own requirements for listing a stock on their exchange.The specifics of these different requirements are not impor-tant for you to know, but the fact that a stock is listed on amajor exchange is a valuable piece of information.

All listed stocks have been scrutinized and must file a widerange of reports with the Securities & Exchange Commis-sion (SEC), which regulates exchanges. The SEC does notassure you that the stock of any listed companies will serveyour investment needs, but it does provide some assurancethat the company is reputable.

You can access all SEC mandatory company reports onlineby visiting the SEC Web site at www.sec/gov/edgarhp.htm. The Web site is known by its acronym,EDGAR, which stands for Electronic Data Gathering, Analy-sis, and Retrieval (see Figure 2-2).

Figure 2-2: The EDGAR Web site for SEC reports.


You need to be very cautious if you choose to purchase stocksbeyond those listed on the NYSE, Nasdaq, and AMEX. Youalmost certainly will be getting into lightly traded stocks —called a “thin market.” Brokers take little interest in theseshares and do not actively try to sell in these markets.

Understanding IPOs

Another term you may see or hear is IPO. When companiesare added to the listings of the major exchanges, they willbegin to issue stock for trading on the exchange on whichthey are listed. This first offer of shares for trading is calledan Initial Public Offering or IPO. IPOs get a lot of attention,and some even generate trading excitement.

When a company goes public and offers its first shares, var-ious brokerages get an allocation of shares that are offered ata price determined by discussions between the company andthe various brokerages.

The brokers then let some of their customers know of thisnew IPO and what the initial offering price will be. Favoredcustomers of brokerages may have an opportunity to makesome quick money if the market price of IPO shares risessharply.

As a new investor you won’t be getting too many chances toget in on IPOs. In fact, unless you’ve worked with a full-serv-ice broker for a while, you’re not going to have a chance tobuy the IPO shares at the set offering price.

The important thing for you is not to get beguiled by all thehoopla about IPOs and wish you could be in the deal. MostIPOs, after an initial surge, drop quickly in price, below eventheir initial offering price.

Chapter 2: What You Need To Know About Stocks 27

CHAPTER 3

INVESTING IN THESTOCK MARKET:REWARDS AND RISKS

IN THIS CHAPTER

■ Looking at the different ways of investing your money

■ Discovering the risks and rewards of investing

The fact that you’ve picked up this book and read this farmeans that you are more than a little interested in gettingsome real returns on the money you’ve saved. Before youjump in to the stock market with both feet, read this chap-ter to get a sense of the risks and rewards involved in invest-ing in the stock market.

Different Ways of Investing in the

Stock Market

You have many ways of investing in the stock market. Thisbook deals with only one of those ways, namely, buyingstocks on your own for your own personal portfolio.

Investing in stocks for yourself is perhaps the most challeng-ing form of stock investing, but it can also be the most sat-isfying and possibly the most rewarding.

You have to decide for yourself whether investing on your ownis the way to go for you. To help you decide, I list some of theother ways to invest in stocks. You may be surprised — I hope,pleasantly — to learn that you may already be an active par-ticipants in the stock market.

Investing as part of a group

There are three principal ways in which you may already beinvested in the stock market:

■ As an owner of life insurance. If you own life insur-ance, your insurance company very likely has investedsome of its reserve funds into various safe investments,including high-quality stocks.

■ As a participant in a company pension plan. If you’repart of a pension plan at work, that pension system willtake your dollars along with the dollars of thousands ofother employees and invest them in stocks, bonds, andthe like.

■ As a participant in a company 401(k) program. If youwork for a company that offers its employees a 401(k)option and you’ve bought into it (generally a good idea),you almost certainly will be invested in a mutual fund,which has a stock component.

A mutual fund usually consists of a collection of stocksand bonds, but the fund may also contain other types ofsecurities such as mortgages, cash accounts, and so forth.(I go into more detail about the pluses and minuses ofmutual funds later in this chapter.)

If you’re a bit hazy on what’s going on with your 401(k)plan, I recommend that you pick up CliffsNotes Invest-ing for the First Time that deals with these plans or talkto a qualified representative from your company.

Take a minute to think about funds you may have investedin these ways. If you don’t already know the details aboutthese investments, ask the people who administer these fundsfor you to supply you with some background information onthese investments. Doing so is a wonderful way to get a firstpeak at the stock market.

Chapter 3: Investing in the Stock Market: Rewards and Risks 29

Investing in stocks on your own

There are two basic ways to buy stocks on your own.

■ Buy stocks in one or several companies and assembleyour own personal portfolio. Almost all the remainderof this book is devoted to this way of investing in stocks.

■ Purchase a package of stocks that someone else hasassembled and manages for you. This package of stocksis a mutual fund.

I give you a quick overview of mutual funds here but if youare interested in this form of investing, pick up CliffsNotesInvesting in Mutual Funds. A mutual fund is not restricted toowning only stocks but most likely will also have some bondsand cash reserves among its assets. An important aspect of allmutual funds is that they are professionally managed.

Mutual funds offer you a portfolio of carefully selected stocks,a diversified investment option (see Chapter 8 for why thisis important), professional management, and the opportu-nity to invest with minimal cash.

Mutual funds can play an important part of a balancedinvestment plan, but you need to do careful research to finda fund that will provide a return equal to the stock market asa whole.

The Rewards of Investing

There are many good reasons to invest in the stock marketon your own. Among the more common reasons:

■ You gain the potential for substantially greater growthand income in stocks than in many other types of sav-ings and investments.


■ Your money is available to you as you need it.

■ You have greater control of your assets than in a mutualfund.

Greater growth potential

Keeping your money in a regular savings account does pro-vide some return on your money, but you certainly don’t getmuch of a return.

When you receive your next bank statement, be sure to checkthe interest rates that your bank is paying on your money.Rates of interests under 2% are common. These pitifully lowrates of return offer almost no incentive to systematicallyaccumulate assets. Investing your savings or a portion of yoursavings in stocks can offer the potential for greater growththan placing your money in an average savings account.

If the rate of return you receive on your savings account isclose to or below the current inflation rate, you can actuallybe losing value on bank savings accounts.

Better accessibility to your money

The money that you invest in stocks that you purchase onyour own — that you do not place in an IRA or 401(k) —is available to you whenever you want or need that money.You can simply sell your stock when you’re ready to make amajor purchase, such as making the down payment on yourfirst home.

While you can cash in stocks or other securities in whichyou’ve invested whenever you want, doing so isn’t always yourbest choice. Unless you’re facing an emergency, early sale ofany investment — including stocks — works against yourlong-term savings goals.


Greater control

You also gain greater control over your investments by pur-chasing stocks on your own. For example, you may be will-ing to take greater risks to earn greater rewards than manymutual fund managers.

Even at the same level of risk, you have at least a good pos-sibility that you can do better than many fund managers withthe research techniques that I introduce in Chapters 4 and 5. Regardless of your performance compared to profes-sional fund managers, you will be free of the 2 to 5% man-agement and other fees which mutual funds commonlycharge and which diminish your overall returns.

The Risks of Investing

Anyone who has even a passing interest in getting into stockinvestments has very likely heard the conventional wisdomthat with patience everybody can make big money in stocks.

It is a well-established fact that for the past 75 years the stockmarket has averaged a compound gain of more than 15%.There have been some good years, some bad years, and somegreat years. When averaged out, whatever money you put inthe stock market should double in five years or less, or so itwould seem.

Despite the impressive historical record of steadily upwardtrending performance in the stock market as a whole, youhave good reasons to be at least a little bit cautious. Eventhough the stock market has broken into record territory,there’s no certainty about how high — or how low — it maygo in the future (see Figure 3-1).


Figure 3-1: The Dow Jones performance in the 1990s.

You could lose a substantial part of

your investment

The big and overriding risk in investing is loss of some or —in extreme cases — all the money you’ve invested. In theworse case scenario, you can lose everything you invest andincur additional losses in the process!

If the thought of losing any of your money at all is more thanyou can bear, please do not consider investing in the stockmarket. If you’re inclined to worry a lot about your moneyand its safety, invest only in financial instruments of mini-mal or no risk, such as insured CDs.

11000

10000

9000

8000

7000

6000

5000

4000

3000

20001990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Dow Jones Averages for 1990-1999


You can’t see into the future

What makes stock investing both maddening and fascinat-ing is that in the long run, with patience and discipline, youcan make some real money, perhaps as much as a consistent10 to 12% return on your investments. But what nobodyknows is when the inevitable downturns will come and howlong they will last.

Most of the 1990s has been very profitable for investors.Along the way some stocks have had explosive gains, espe-cially high-tech stocks. Other solid, well-managed, and prof-itable corporations have shown relatively little gain. Somehave even lost ground.

Some losses are short-lived and are quickly recouped, butother sharp drops in the overall stock market can last foryears. The most famous was the market crash in October1929. The market took more than three years to recoverlosses from that crash.

There is no money-back guarantee

Risk is inherent in stock investing. No federal agency orwealthy corporation insures the money you invest in stocks.You make your choices, and you live with the outcomes.

You don’t have total control

Today’s economy is a global economy. Events happening onthe other side of the planet — events that are totally beyondyour control — can influence the stock market. For exam-ple, the Gulf War in 1992 led to fears about crude oil sup-plies, and the stock markets reflected those anxieties.


If the Federal Reserve Board or its Chairman decides thatinflation is beginning to rise and that the economy is over-heating, investors begin to worry about rising interest rates.Sometimes, these concerns cause a decline in stock values.

Information moves quickly these days because of the remark-able advances in communications technology. Even hints thata company’s profits may not be up to Wall Street’s expecta-tions can lead to sharp losses in the value of individual stocks.

Even the biggest brokerage firms on Wall Street and the largemutual funds managers with all their research and analyticcapabilities cannot successfully anticipate every large move-ment in the market as a whole, and much less, the swings invalue of individual stocks.

The first and last rule for the new investor: Learn how to livewith the risks of investing. If you want bigger gains, you mustaccept more risk. The good news is that there are ways to con-trol and manage your risk (see Chapter 8).


CHAPTER 4

FINDING THE TOOLS TORESEARCH STOCKS

IN THIS CHAPTER

■ Narrowing the range of stocks to research

■ Understanding the limits of research

■ Finding your comfort level with research

■ Locating reliable sources of information on stocks

■ Developing a sense for investing in stocks

Enough of the preliminaries, you know the risks of invest-ing, and you’re willing to live with them. What comes next?

Now is the time to begin researching your stock investmentoptions. You have over 10,000 listed stocks to sort throughand narrow your choice to maybe 25 to 50 to take a closerlook at.

Before you begin to feel a bit overwhelmed, there are twothings to keep in the forefront of your mind. First, there isno magic or correct number of stocks to research. You mayfind two or three very promising stocks in your first hour onthe Web or in the library. Second, researching stocks is notlike solving a math problem. You should be looking for a fewgood or very good stocks to invest in, not the perfect stock.

Narrowing Your Choice of Stocks

With so many stocks to invest in, you need to narrow yourfocus down to a manageable number of stocks to research.

Why do you need to do this research? You will want to makesure you have all the information at hand to make the mostinformative decisions on where to invest your hard earnedmoney.

Early in your investment career you learn that researchingand finding a few good stocks to invest in is a process thatnever stops. For now, you should narrow your search to 100stocks if you’re working on the Web or 50 if you’re workingwith print media sources. If 50 seems too many, settle for 25stocks.

Begin narrowing the field by deciding that you’re only goingto buy stocks in companies that you understand. This is akey rule to follow. In order to invest in pharmaceutical com-panies, you don’t have to be a biochemist, but you do needto have enough knowledge about what the company does —what its main products or services are — to have a real senseof whether it is likely to be profitable in the long run.

Narrowing the field

With 10,000 stocks to sort through, narrowing the list toonly 100 (or whatever other number you want to work with)means that you select only 1% or fewer of all stocks as wor-thy investment candidates. To get anywhere in this process,you need to settle two issues:

■ What will your investment strategy be?

■ What screening techniques will you use?

Determining your investment strategy

Review what you learned in Chapter 3 on rewards and risk.Review your investment goals you compiled in Chapter 1.Now ask yourself, “What will it take to get me to my goals?”

Chapter 4: Finding the Tools to Research Stocks 37

Don’t just plan your investment strategy in your head. Putyour answers on paper. That will bring a much better focusto the task of settling on a strategy so that you can start mak-ing choices.

I can’t walk you through every investment strategy out therebecause the options are endless. However, having a sense ofwhat you want financially and how much risk you are will-ing to take considerably narrows down your choices.

■ More conservative strategies focus on the mature, verylarge companies that make up the Dow Jones indexes ofindustrial companies, utilities, and transportation com-panies. Nothing is wrong with this strategy, and it hasworked well for many people. Check with your libraryor the Web for the names of the 65 companies that makeup the Dow. You may find just what you’re looking for.

■ A less conservative but not totally adventuresomeapproach may be to check stocks of large cap compa-nies but exclude very large stocks (for example, those over$5 billion in market capitalization). You can use an Inter-net stock screener to select stocks only in the $1 to $5billion range using techniques that I describe in detaillater in this chapter.

■ More adventuresome strategies include mid cap or evensmall cap companies (refer to Chapter 2 for definitions)whose growth is likely to be more rapid. Again, nothingwrong with these strategies as long as you understand therisks.

If you’re working on the Web, using a stock screener can helpyou locate companies within a specified range of market cap-italization. You simply enter a value or range, and the Website comes up with a list of potential stocks. I explain usingstock screeners later in this chapter.


If you’re working with print media, a shortcut that is not pre-cise but good enough is to consider companies listed onNYSE as large cap, and companies on the Nasdaq nationalmarket list as mostly mid cap. Most papers also present adaily list of Nasdaq small cap stocks.

Stock selection is what systems analysts call an iterative process.You are going to go back over this subject many times in yourinvestment career. What you learn on each trip back may leadyou to modify — and improve on — decisions you madepreviously.

Devising a screening technique

You have two ways to screen stocks. You can do it manuallyor you can do it on the Web. Doing your first screening man-ually, despite the time investment it takes, can have some pos-itives. You get a real sense of the range and diversity of stockofferings. Your search may raise some questions such as, whyare so many investors paying huge sums for companies withno earnings?

Immersing yourself in detail helps bring clarity to your think-ing. You may, for instance, quickly decide that you only wantto look at companies that report earnings, or better, a risingtrend in earnings. Reading Barron’s, a weekly stock marketnewspaper, makes it very easy to identify which companiesare earning money, and whose earnings are rising (or likelyto rise).

You can also get a lot of valuable information from review-ing SmartSelect Corporate Ratings listed in Investor’s Busi-ness Daily. Companies are ranked on the basis of theirearnings per share and several other measures.


To make the process of manually sorting stocks to find the50 or so best for you, buy a copy of Investor’s Business Dailyand Barron’s. Don’t subscribe to these publications — just geta copy of each to use and mark up during your research.Make sure you have a highlighter to mark those stocks thatyou want to take to the next level of analysis (see Chapter 5).

Screening stocks by using one of the many programs avail-able on the Web takes a lot less time and, for many, is thepreferred way to go.

Several Web programs can do the screening job for you. Ifyou want to look for yourself, begin by visiting Yahoo!Finance at www.yahoo.com for plenty of links and infor-mation for the beginning investor.

Or to cut to the chase, visit Hoover’s Online StockScreener.To use StockScreener:

1. Go to the StockScreener Web site at www.stockscreener.com.

2. Click the Exchange drop-down list and select a specificexchange to search. You can also select the All Exchangesoption to search all available exchanges.

3. Click the Industry Group drop-down list to select a spe-cific industry or select the All Industries Groups optionsto search all industries.

4. Supply up to 20 different criteria in the appropriate areasprovided and click the Search button to begin the searchprocess. If you need any help, click the More Informa-tion link at the top of the page.

5. After the search is complete, a results screen lists com-panies that fit your search criteria.


At the end of your screening process, try to get your list downto something manageable like 50 stocks as potential candi-dates for purchase. In Chapter 5, I give you further instruc-tions on how to cut your options down further.

Understanding the Limits of Research

In an information age, you may believe that if you just workhard enough, you can find reliable and accurate answers toall your investing questions.

Unfortunately, nobody knows with certainty how the stockmarket as a whole, or individual stocks in particular, are likelyto fare tomorrow — let alone years down the road. Theglobal economy is volatile, and this constant flux has a directand unpredictable impact on the stock market’s upward anddownward momentum.

Anybody can pick winners from a field of past performances.With a computer and a database on stocks, you too, canassemble a portfolio that, looking back, would have doubledyour money every six months. The trick is to pick the win-ners, the better performing stocks, beforehand.

The bottom line for you is this: No amount of research caneliminate all the uncertainties and risks that go into stockmarket investing. All that research can accomplish is to shiftthe odds in your favor.

Finding Your Level of Comfort

with Research

Unless you have absolutely nothing to do except dig throughdata on stocks, a reasonable approach to spending time onresearch should bear some relationship to the dollar amountthat you plan to invest. For example, an investment of$10,000 warrants more research than an outlay of $1,000.


Restrain yourself if you’re tempted to get carried away withyour fact-finding. With so many competing theories, so manyavailable stocks, so many data bits, so much of everythingstock-related, keeping your goal in focus can be a challenge.

You’re trying to locate a few — certainly no more than 10 —different stocks that are going to provide above-averagereturns for the long run. Are you likely to miss some stocksthat could have done even better? Yes, but you will only knowthat after the fact.

Exploring Sources of Reliable Information

Lots of quality information about an astonishing array ofstocks is readily available in print and on the Web. In fact,you may feel overwhelmed until you’re able to focus yourresearch amidst the sea of resources.

In this section, I present a quick guide to sources and thevarying levels of information and analysis available at each ofthese levels.

Stock information of all kinds is available via two majormedia vehicles.

■ The oldest, of course, is the print medium, the dailynewspaper.

■ Ongoing information also appears on a wide variety ofonline sources. While many Web sites are free; some sitesrequire subscriptions for access.

Better-quality updates provide more than just opening andclosing stock prices. More in-depth updates may cost you,but you can also find out things like the extent of change inthe stock price, the volume of shares traded, 52-week highsand lows in the stock prices, current dividends, yields, andother bits of information.


Don’t get caught up in daily or minute-by-minute stock mar-ket reports. Market fundamentals do not change by theminute or hour. Stay in focus. You’re invested for the long run.

Printed daily stock updates

The daily newspapers in large cities provide the closing pricesof stocks for the previous business day along with severalother useful bits of data about each stock. The newspapersin smaller cities often restrict their coverage to a small num-ber of heavily traded stocks and/or those of local interest. Tomake sure that you get at least a reasonable minimumamount of useful information about stocks, stay with the bigcity dailies.

National circulation dailies are a step up from your localpaper. The most prominent of these are The Wall Street Jour-nal (WSJ), The New York Times (see Figure 4-1), and Investor’sBusiness Daily (IBD). USA Today also provides adequate cov-erage, but not with the depth of either the WSJ or the IBD.

The best way to get a feel for the kind of information avail-able in print is to occasionally buy a copy of Investor’s Busi-ness Daily (IBD) and spend at least an hour reading it in somedetail. The quality and depth of information in its pagescomes close to meeting all your information needs aboutstocks.


Figure 4-1: Sample stock listing from The New York Times.

Copyright © 1999 by The New York Times. Reprinted by permission.

Televised daily stock updates

If you want to check the stock market in progress, you cantune into many larger cities’ televised stock market coverageor on cable programming (channels like CNN and CNBC)across the country. What you typically see is the stock mar-ket ticker for the NYSE and Nasdaq, and maybe for theAMEX, moving across the lower half of the screen.

This ever-moving electronic version of the original stock mar-ket ticker tape, usually displays at short intervals various stockmarket averages, showing their daily gains and losses. Boththe market averages and individual stock quotations run 20minutes behind the actual stock trades they report.


The big problem with TV coverage of the stock market isthat you can sit in front of the screen for an hour and neversee stocks that you’re watching or investing in. Generally, TVcoverage is good for a quick overview of market conditions.Look for shows that provide commentary on the stock mar-ket in general and breaking news that can affect the markets.

Online daily stock updates

Daily stock updates via the Internet are impressive. Manyfree Web sites display stock averages using a 20-minute delay.If you need even more instantaneous information, you cansubscribe to special Web sites. A few of the many free andsubscription Web sites are listed in CliffsNotes Resource Cen-ter at the end of this book.

As a beginning investor, however, you rarely need this kindof up-to-the-minute information. When the time comes foryou to place an order to buy or sell stock, your broker cangive you the current market value of each stock.

Web sites, besides providing an abundance of informationon an ongoing basis, also offer an array of long-term data onindividual firms. By clicking a few buttons, you can obtainrecent news stories about a stock, charts showing fluctuationsin the price of shares over varying time periods, some ana-lytic reports, and brokers’ recommendations for the stock,among other things.

A good place to start your Web search is to visit a gateway sitethat provides links to many other sites that provide infor-mation on stocks. One of the most popular gateway sites iswww.yahoo.com.


Weekly and other reports on stocks

As you move from daily to weekly or longer reporting, youcan expect to gain better balance and perspective. You alsowiden your view to more trend analysis.

Among the more reputable and truly impressive sources ofstock information is Barron’s, a weekly tabloid that containseverything you ever wanted to know about stocks and a fewother things besides. Reading highly specialized papers likeBarron’s or the IBD can lead to information overload. Exer-cise caution, and tackle your reading and research indigestible bites.

Magazines such as Forbes (a biweekly publication) and Money(13 issues a year) focus less on the stock market but still havegood, readable sections on investments, market trends,declining and emerging sectors, and so on. Money is an espe-cially good magazine to read if you want to keep current onmany aspects of personal finance, not merely on the stockmarket.

Don’t subscribe to papers or magazines for the prime pur-pose of tracking the stock market. The subscription costs ofa combination of only one paper and one magazine mayexceed $200 a year. $200 could represent the annual returnon a small investment portfolio. Go to your public libraryand save your money to buy stocks.

When you move beyond newsstand offerings or the period-icals available at your discount bookstore, you jump into thereal pricey subscription services like Value Line, and an end-less array of specialized investor guides with typical annualsubscription prices of $250 and up.


A good question is, where can you find suitable reading mate-rial to develop your sense of the market? My answer is in yourpublic library, university library, or possibly in your corpo-rate library.

The company you work for may subscribe to a wide range ofgeneral business magazines. If these are circulated, don’t beshy about asking to be added to the list.

Several business-oriented magazines are well worth reading,not for investment guidance but for developing your knowl-edge and awareness of trends in the world economy. Specif-ically, I recommend

■ Business Week

■ The Economist

■ Fortune

After you narrow your choice of stocks to 100 or fewer, youmay want to consult the particularly serious guides like ValueLine and the various periodic corporate analyses produced byStandard & Poor’s in your public or university library.


CHAPTER 5

SELECTING STOCKS

IN THIS CHAPTER

■ Capitalizing on your experience to help you chooseinvestments

■ Using your intuition to help pick stocks

■ Setting criteria when analyzing a company’s stock

■ Practicing stock tracking and investing

Getting started as a do-it-yourselfer in investing in stocks isa challenge and maybe even a bit scary. This chapter helpsyou sort through the mountain of information confrontingyou by helping you set criteria for your stock selection.

So that you don’t get lost in the research process, the follow-ing outlines my recommended process for research — andultimately selecting — stocks.

1. Make sure you have a list of 50 to 100 stocks. The tech-niques I describe in Chapter 4 can help you come upwith this list.

You must settle on an investment strategy and write itdown. Your investment strategy helps you concentrateon only certain kinds of stocks, based mainly on size andrisk.

2. Do some preliminary screening, either manually or withassistance from a Web stock screener. Your resulting listof stocks may be as few as 25 or as many as 50.

3. Review your list and ask yourself which of the selectedcompanies do you understand. About which of thesecompanies can you make a fair and reasonable call abouttheir future profitability? Make some cuts in your list asappropriate.

4. Check out a few mutual funds whose investment goalsmatch yours (aggressive growth, capital appreciation, andso on). Note carefully what stocks the better funds con-tain. Were any of these stocks on your list? Do some ofthe same stocks keep coming up that are not on your list?If so, add them to your list for further review.

5. Review your list again. Can you cut out 10 or 15 to getdown to a more manageable number to work with? Doit if at all possible.

6. Take your list to the library or to the Web. Research theeight criteria that I describe later in this chapter for eachstock on your list. Compare the results of your research.You may be able to drop as many as half the names onyour list at this point.

7. One way or another, get your list down to no more thanten stocks as prime candidates for purchase.

8. Check the Web or the library for everything you can findabout these stocks. Keep notes on anything that supportsthe future profitability for the company.

9. Bite the bullet and select one to three stocks. Either playthe Paper Game (see later in this chapter) or actually buythem (see Chapter 6 for how to do this.)

Your goal is to use the tools and research resources that I iden-tify in this book to cut your list of potential stocks to investin from 50 or so down to fewer than five candidates for actualpurchase, possibly to only one for your first year’s investment.

Chapter 5: Selecting Stocks 49

Using Your Experience

Never buy a stock in a company or industry that you don’tunderstand. For example, say that you’ve heard or read thatInternet stocks are going crazy and you want to get in beforethe big surge ends. Suppose that you don’t even have e-mailand don’t have a clue what a hyperlink is. Do you really thinkyou’re qualified to be investing in Internet stocks?

Before you jump on the bandwagon of Internet stocks (orany “hot stock” for that matter), develop some understand-ing of what the company’s product is, whether the companyhas any staying power, or whether an industry as a whole iscompelling and has growth potential.

A good place to find out about a company’s products andservices is in its annual report. You can get a copy of any com-pany’s annual report in a couple of ways. You can

■ Call or write the company and ask for a copy of the mostrecent annual report

■ Go to the company’s Web site and request or downloadthe most recent annual report.

■ Visit the Public Register’s Annual Reports Service Website at www.prars.com. At this site, you can orderprinted copies of annual reports that will be mailed toyou, or you may be able to view the annual reportsonline.

Without a grasp of an industry as a whole, you’re investingblindly. Just because a stock with no earnings is being bid upby speculators hoping for quick profits is not a good reasonto buy any stock.


The question that should be foremost in your mind when-ever you review material about a company is whether thecompany will likely be increasingly profitable in the long run.The more you know about a company, its products, and itsindustry, the better you can attempt to answer this key question.

Using Your Intuition

Having experience or education in a particular technologyor hot area of research isn’t always necessary to find goodinvestment options. Often, basic familiarity is a good start-ing point for building knowledge through further research.You’re a consumer of different products each and every day.You know whether you like or trust a product. You knowwhich restaurants, department stores, and banks you visit andwhich ones you avoid. You know the services you rely on,and the ones you don’t. Try this exercise:

1. Ask yourself what areas, or sectors, of economic activityyou have some feel for as a consumer. Start with someobvious ones: food, clothing, transportation, housing,travel, health, entertainment, communications, and so on.

For example, with regard to clothing, you read that XYZMart is now a stock market favorite and its stock is setto take off. You’ve shopped at XYZ Mart but did notenjoy the experience or the quality of goods at the store.As you consider buying the stock, take into account yourexperience with XYZ Mart as well as other retail depart-ment stores.

2. Make a list of companies whose products you believe arehigh quality and fairly priced — the very things you lookfor in every purchase.


For example, you probably own a car — or at least ride inone. You can select a few car manufacturers and add themto your potential investment list for further analysis.

3. Don’t forget to look at service industries, too.

For example, you probably deal several times a week witha bank or two. What have your experiences been withvarious banks? Which ones do you hear or read goodthings about? Ask yourself the same questions about air-lines, entertainment options, and insurance companiesyou’ve recently encountered.

The bottom line: Don’t be afraid to rely on your own intu-itions and experiences to help you determine which stocksto research and possibly purchase.

Reaching beyond Intuition: What Are the

Experts Doing?

You can quickly and easily find out what the investmentexperts are doing by simply watching what mutual fundsmanagers are investing in. For example, you may have heardor read about the huge increase in Internet stock prices. Youmay have read that some analysts believe that much of thisactivity is sheer speculation. You can watch mutual funds thatinvest in Internet stocks and see how they performed.

How do you find out about a mutual fund’s performance?You request the fund’s prospectus from a broker or mutualfund Web site. A prospectus is a detailed overview of theinvestments in a mutual fund, written according to govern-ment guidelines. After you have the prospectus of a fundyou’re interested in, look at the stocks the fund managers areinvesting in and how successful they’ve been (see Figure 5-1).For more detailed information about mutual funds, pick upa copy of CliffsNotes Investing in Mutual Funds.


Figure 5-1: Sample stocks a mutual fund is investing in.

How do you find a list of mutual funds? In the financial pagesof The Wall Street Journal, The New York Times, and Investor’sBusiness Daily, as well in many other sources like local news-papers and Web sites, you can find lists of mutual funds andtheir current performance.

Prospectuses are free and available by contacting mutual fundcompanies by a toll-free call or looking for the mutual fundonline. Table 5-1 gives a short list of mutual fund companiesand their contact information for you to get started.

Technology 17%

Banking 3% Media & Entertainment 14%

Bonds 16%

Real Estate 9%

Pharmaceuticals 5%

Telecommunications 6%

Insurance 6%

Other 24%


Table 5-1: A Starting Point for Mutual Fund

Companies

Fund Phone Web Site Number(s) Address

American Association 800-424-3410 www.aarp.orgof Retired Persons(AARP)

Acorn 800-922-6769; www.wanger.com312-634-9240

American Century 800-345-2021; www.american816-640-7010 century.com

/index.jsp

Babson 800-422-2766 www.jbfunds.com

Brandywine 800-656-3017 www.bfunds.com

CGM 800-345-4048 cgmfunds.com

Dreyfus 800-645-6561 www.dreyfus.com

Fidelity 800-544-6666; www.fidelity.com801-534-1910

Franklin Templeton 800-342-5236 www.franklin-templeton.com

Gabelli 800-422-3554 www.gabelli.com

GT Global 800-959-4246 www.aimfunds.com

Janus 800-975-9932 www.janus.com

John Hancock 800-257-3336 www.jhancock.com/funds/main.html

Kemper 800-621-1048 www.kemper.com

Legg Mason 800-822-5544 www.leggmason.com

Meridian 800-769-3325; www.meridancapital.718-972-3600 com

Neuberger & Berman 800-877-9700 www.nbfunds.com

Oakmark 800-625-6275; www.oakmark.com312-621-0600

Oppenheimer 800-525-7048; www.oppenheimer303-768-3200 funds.com


Fund Phone Web Site Number(s) Address

PIMCO 800-227-7337; www.pimcofunds.816-474-6590 com

T. Rowe Price 800-225-5132; www.troweprice.818-932-5300 com

Prudential 800-225-1852; www.prudential.com

Putnam 800-225-1581; www.putnaminv.617-292-1530 com

Schwab 800-435-4000; www.schwab.com(602) 852-3500

Scudder 800-225-2470; www.scudder.com617-295-1000

SteinRoe 800-338-2550; www.steinroe.com212-489-0131

Value Line 800-223-0818; www.valueline.com212-907-1500

Vanguard 800-635-1511; www.vanguard.com610-669-1000

Van Kampen 800-421-5666; www.van-kampen.American Capital 630-684-6000 com

Warburg Pincus 800-257-5614; www.warburg.com212-878-0600

After you read the prospectuses of several mutual funds, nar-row down your choices to at least 5 to 10 mutual funds thatinvest in stocks you’re interested in. Study how the stockshave performed and use this as a guide to how the expertsinvest in the stock market.

In addition to reading mutual fund prospectuses, you canalso read up on what the experts are saying. As you browsethe papers and periodicals in your local library, be sure to takeat least a passing glance at analysts’ columns. Often, this kindof commentary mentions individual stocks or classes of stocksthat are on the way up or down. Make a list of at least someof these stocks and do some research.


Picking Stocks: Some Criteria

As a new investor in the stock market, base your investmentstrategy on long-term increases in stock value. Follow the firstrule of stock purchasing: Buy stocks that are good values atthe time of purchase and that promise above-average growthfor the foreseeable future.

Close observation of a company’s fundamentals can help youidentify stocks of good value. In brief, fundamentals are thekey indicators of the financial health of the company.

The fundamentals can help provide you with an accurate pic-ture of how much the company is earning, whether theseearnings are a solid return on the money investors have putinto the company, and whether the company seems able tomaintain a steady, upward trend of solid earnings.

Some aspects of a company’s fundamentals to pay attentionto include:

■ The company’s quarterly and annual performance

■ The company’s management team and style

■ The company interest and financial commitment toresearching and developing new products

Value Line and Standard and Poor’s Stock Reports provide somevery useful narrative information about company funda-mentals, in addition to offering lots of statistical data.

You can add to my preceding list of fundamentals as appro-priate. Each additional bit of data can add some new insightinto a stock’s underlying value. A word of caution — extendedanalyses, however, can require you to spend a lot of time gath-ering data and cause burnout — paralysis by analysis.


My recommendation is that you focus on eight readily avail-able and easily understood measures or criteria of a company’sfundamental value. The goal of going through the same eightcriteria for each company is to answer the question: Is this isa good company for me to invest in for the long run? As youresearch, look at the following specific eight criteria:

You may be concerned that researching all the following fun-damentals will take hours of your time. Don’t worry. Inalmost all cases, the work has already been done for you. Thecomplete stock reports that you find in The Wall Street Jour-nal and Investor’s Business Daily report much of the follow-ing information every day. (For sales and earnings history,you do have to go to your public library and check Value Lineor the S&P Reports.) And don’t forget to check Web sites onthe Internet. They contain a gold mine of information! Seethe Web sites listed in the Resource Center in the back of thisbook.

1: EPS: Earnings per share

The first bit of information you need to know about a com-pany is how much money it is making. For ease of compar-ison among companies, earnings are universally expressed asearnings per share (EPS). These earnings are what’s left fromgross revenues after expenses, taxes, bad debts, and so on havebeen subtracted.

For publicly traded and listed companies, these earnings andother financial data come from audited financial recordsapproved by a Certified Public Accounting firm.

2: P/E ratio

The P/E ratio shows the relationship between the stock’s cur-rent price and its reported annual earnings.


A P/E ratio of 20 means that a company earns five cents forevery $1.00 you invest. This does not mean that the com-pany pays a dividend of five cents per share. The companymay pay no dividend at all.

The P/E ratio tells us how much you have to pay to buy thoseearnings per share. In the past, P/E ratios hovered between10 and 20, but with the surge in stock prices in the 1990s,P/E ratios in the 40 to 60 range and higher are increasinglycommon.

Generally, the lower the P/E ratio, the more preferable thestock. Profit, another name for earnings, is what drives theprice of stocks and payment of dividends.

3: ROE: Return on stockholders’ equity

The ROE, or return on equity, looks at the company’s prof-itability from a different point of view. This figure tells youwhat the company has done in the past with the money thatstockholders have invested in it.

An ROE of 15% or better is very good and maybe even out-standing, depending on the industry. If you discover in yourresearch that one company’s ROE is above 15% and anothersimilar company’s ROE is 5%, the company with the higherROE is clearly the better choice. For a balanced perspective,look at the trends for three or more years.

4: Beta

Beta is a measure of how volatile a stock’s price is relative tothe stock market as a whole. A beta of 1 means that the stockmoves up and down exactly at the same pace as the marketas a whole.

A beta greater than 1 indicates that a stock goes up or downfaster than the market as a whole. A beta of less than 1 means


that the stock’s up or down moves are smaller than the mar-ket as a whole. Generally, it is a good idea to avoid stockswith betas above 1 because these stocks are more volatile andmore risky.

5 and 6: 5-year sales and earnings

history

The 5-year sales and earnings histories each tell you somethingdifferent. For any stock that you buy, you want to see salesand earnings rise together, with earnings moving upward abit faster. Earnings that outpace sales usually indicate thatthe company is becoming more efficient in holding its costsdown and in expanding its market.

7: Company size

Why is company size important? Generally, if you’re lookingfor maximum appreciation in stock values over time, youwant to check out smaller companies where the potential forrapid growth is greater than large established companies (suchas those companies included in the Dow Jones IndustrialAverage). Older, larger companies tend to be less nimble andbecome top-heavy with bureaucracy. The best bets forstronger long-term growth are among the smaller companies,typically those under $200 million in market capitalization.

8: Relative industry strength

You want to look at companies that are ranked at least in thetop 25% of their industries — preferably higher.

You can find information on relative industry strength inValue Line and Investor’s Business Daily. The analyses in thesepublications are excellent and are not done by people tryingto sell you stocks.


To help you rate the quality of a company’s stock, you cancopy or modify the chart shown in Figure 5-2.

Figure 5-2: Use this chart to record clues to the quality of a company’s stock.

Practicing the Business of Real Purchases

Although you’re moving closer to your first real investment,you may not realize the work that awaits before your moneyactually leaves your hands. Here’s what you can do to preparefor that day.

Playing the Paper Game

The Paper Game is an exercise that invites you to buy stocksvirtually, that is, in your head or on a spreadsheet.

1. Start by saving $100 a month. Put it away in some safeplace like a bank savings account.

2. When you see or hear of a stock that looks promising,check it out using the eight criteria I mention earlier inthis chapter and then pretend to buy some shares.

3. Call a discount broker and find out the price of the stockfor the day you make your practice purchase. Also, besure to ask the commission you would pay if the trans-action were real.

Criteria for Choosing StocksCompany Name

Relative industry strength

EPS (Earning Per Share)P/E RatioROE (Return on Stockholder’s Equity)Beta5-year sales history5-year earnings historyCompany size


4. Pretend to buy several other stocks and really put yourmind into what you are doing.

Pretend you’re actually using your own hard-earned dol-lars. Note why you’re buying each stock and what youexpect to gain.

5. Follow your purchases in the daily paper and record theirprices once or twice a month. Continue saving $100each month.

6. As the big day comes for you to make your actual initialstock purchase, review your virtual purchases. How didyou do? If the stock rose, was it what you expected? If itfell, can you figure out why?

7. At the end of the year of saving, give yourself a grade. Ifyour portfolio of virtual purchases went up 15%, you’reprobably ready to buy. If you lost money, rethink yourstrategy, but don’t give up on the stock market.

8. If you have the money to invest, feel you’re done play-ing the Paper Game, and have done research to your sat-isfaction, narrow your selection down to one to threestocks and buy them — for real.

If the Paper Game is not your thing, still try to identify oneto five stocks that look promising. If you’re convinced thatyou’ve identified one or more quality stocks and feel ready toinvest, go for it. But, please, do not shortcut the necessaryresearch that you should do before you buy anything.

If you haven’t been following stocks until quite recently, makesure that the stock or stocks you buy are more than current“hot” stocks, ones that have experienced a sharp rise in valuein the last year. Make sure your first purchase is of stocks thathave had three to five solid years of performance behindthem.


CHAPTER 6

TAKING THE PLUNGE:MAKING THEPURCHASE

IN THIS CHAPTER

■ Learning the general procedures for buying and sellingstocks

■ Trading stocks on the Internet

■ Buying stocks without a middleman

■ Dealing with the paperwork that goes along with invest-ing in stocks

You have only two ways to purchase stocks: through a stock-broker or by direct purchase from a company. Purchasingstocks through a broker is by far the more common way. Evenwhen you buy stocks online, you still go through a broker orbrokerage, even if the whole transaction is conducted elec-tronically.

In this chapter, I walk you through the basic steps involvedin starting out and going forward with your stock purchas-ing plan. I also offer advice on the mundane but criticalprocess of keeping records of your transactions.

Setting up and maintaining accurate records of every stocktransaction is vital. Doing the record-keeping right from thebeginning can spare you a lot of headaches in the years ahead.

Buying Stocks with a Broker

The basic process of buying stocks through a broker is fairlysimple:

1. Select a broker and set up an account. I give you sometips on choosing a broker and setting up an account inthe next two sections.

2. Place an order with the broker. You place an order sim-ply by calling the brokerage, telling the broker the stockyou’d like, and supplying your account number. You alsoneed to explain the circumstances under which you’d likethe brokerage to purchase the stock, which I cover in“Understanding different types of orders.”

In some cases, you receive immediate confirmation ofyour order placement, along with a recital of the chargesinvolved. In other cases, executing your order may takea while, and your broker will call you back to tell youwhen the purchase was completed and at what price.

3. Pay for the purchase. How much you owe right awaydepends on whether you set up your account as a cashaccount or a margin account. I explain the differencebetween the two in “Picking an account type,” later inthis section.

If you’re selling a stock, the process is much the same. Callthe broker, tell her what you’d like to sell, arrange to get thestock certificates to the brokerage (if the brokerage isn’t hold-ing them for you), and tell the order taker how you’d like toreceive the money — either in a check in the mail, as a creditto your account, or as a credit toward another transaction.

Choosing a broker

What should you look for in a broker? Brokers come in twotypes:

Chapter 6: Taking the Plunge: Making the Purchase 63

■ Full-service brokers. Full-service brokers provide adviceas part of their fees, and they generally have local offices.Ideally, you work with one associate in the office, some-one who tries to get to know you and your financialgoals. Some of the more prominent full-service firms inthe United States include Merrill Lynch, Morgan Stan-ley Dean Witter, PaineWebber, Prudential, and SalomonSmith Barney. But this is far from an exhaustive list.Look in your phone directory under “stocks” for morebrokerages.

■ Discount brokers. Discount brokers essentially do noth-ing but take orders, so you won’t have a company repre-sentative to work with consistently; you get whoeveranswers your toll-free telephone call. The good news isthat discount brokerages have less overhead and pass thesavings on to you in the form of lower fees. The bad newsis that you should not expect discount brokers to assureyou that you’re making a good or bad purchase. Some ofthe more prominent discount firms in the United Statesare Schwab; Donaldson, Lufkin & Jenrette; Fidelity;Waterhouse Securities; and Quick & Reilly.

All stockbrokers charge a fee, or a commission, for their serv-ices. These fees vary greatly. As part of your stock-buyingresearch, you need to ask several brokers for informationabout their fees; also, inquire about what you can expect topay when you sell the shares at some future date. Brokers aremore likely to give you a straight answer about their fees ifyou present them with a specific request — say, for example,the charge for purchasing 100 shares of XYZ Corporation.

Fees are higher on odd lots (any order of 99 shares or fewer)than they are for round lots (a purchase of 100 shares).Because you may not be able to afford a round lot, you canconsider the odd lot option even if it carries a higher fee.


After you survey brokers about their fees, select one brokerto process your purchase. You must first set up an accountwith your broker, even if you’re using an online broker. Set-ting up an account is a somewhat complicated process, butyou have to go through it to become a stock investor.

Setting up an account

For sound business reasons and because of federal require-ments, stockbrokers typically maintain complete records ontransactions and individual investors. Brokers expect you tosupply them with certain information when or before youmake your first stock purchase.

Although practices may vary somewhat from broker to bro-ker, you can count on being asked to supply most of the fol-lowing information:

■ Your legal name and your signature

■ Your tax identification number (TIN), which is usuallyyour Social Security number in the United States

■ Your address and phone number

■ Your employer’s name and a stated figure representingyour monthly or annual salary

■ Your banking information. Brokerage requirements vary,but this information usually does not have to be very specific.

Full-service brokers may also ask for an estimate of your networth and a synopsis of your investment goals. Discountbrokers are not likely to require the later two items.

Questions about your income, employment, and so on, mayseem unusually intrusive, but brokers have sound reasons toask. Full-service brokers are required by regulations to pro-


vide stock information and recommendations that are appro-priate to the customer’s situation. This is known as the“Know Your Customer” rule.

If you choose not to provide this information or providepiecemeal and partial information, your broker may have dif-ficulty providing you with the quality of service that youexpect. In fact, the broker may choose not to work with you.

Types of accounts

One of the questions you can expect to be asked when set-ting up an account regards what type of account you want.Accounts fall into two basic types:

■ Cash accounts. Cash accounts require that you settle up,or pay for your purchases, within three business days.What happens if your check does not get to the stock-broker in three days? Very likely, you get a telephone callfrom your broker. Brokers do not treat these matterslightly, and if you continue to pay slowly, you’re likely toreceive some ominous and unfriendly messages about thesale of your stock and your responsibility to make up anydeficit.

Brokers have minimal latitude with regard to payment.The regulations that brokerages operate under requirethat they collect from their clients within three businessdays of purchase. Failure to observe these regulations canresult in fines or other penalties for the brokerages.

■ Margin accounts. A margin account allows you to tem-porarily borrow money from the broker to purchasesecurities. To do this, however, you must pledge othersecurities that you already own to cover payments. If youwant to set up a margin account, the brokerage digsdeeper into your financial status and creditworthiness.


A margin account is not something that a novice investorshould get involved with. If the stock’s value goes downbefore you sell, you still owe the broker the balance ofthe full purchase price. When you set up a marginaccount, the broker supplies — and requires that yousign — a customer agreement that spells out in excruci-ating legalese what happens if you don’t pay up on timeor if you fail to pay up.

Whether you’re dealing with a full-service or a discount bro-ker, talk to him or her early in your relationship about deliv-ering payments in a timely manner. Many online brokersrequire that you maintain cash in an account with them priorto placing stock orders. For other brokers, consider sendingmoney in advance to pay for an upcoming stock transaction.Brokerages do pay interest on such funds — at about thesame meager rate that your bank offers.

Deciding what to do with dividends

A dividend is simply the per-share amount of the profits thatthe company distributes to its stockholders. Not all stockspay dividends, but some stocks pay dividends regularly. Whatshould you do when you get these dividends? You have twobasic options. You can change your mind at any time, andyour choice does not have to be the same for all stocks. Theoptions are:

■ Take the dividend in cash. The company can eithermail you a check or send the money electronically toyour bank account.

■ Reinvest the dividend in additional company stock.Some companies also allow you to reinvest your divi-dends to automatically purchase more of the same stock.To make all this sound more complex than it really is,the industry has invented a wonderful acronym, DRIP,


for Dividend Reinvesting Program. A good Web site tovisit for more information about this topic is DripCen-tral (www.dripcentral.com) (see Figure 6-1).

Figure 6-1: Check out this great Web site to find out more about DRIPs.

■ Leave the dividend in your brokerage account forfuture investments.

I recommend that you reinvest your dividends. Think backto what I describe about compounding (refer to Chapter 1).If you’re working to build a substantial nest egg, either useyour dividends to buy additional shares of the same companythat paid the dividend or add the dividends to your regularinvestment savings to purchase other stocks.


All cash dividends that you receive, whether directly from thecompany or through a broker, are reported to the InternalRevenue Service at the end of the year. Because the IRS treatsthese dividends as ordinary income, you’re required to reportthem on your annual filings of federal, state, and local incometaxes, even if you reinvest them.

With tax-deferred accounts, such as IRAs and 401(k)s, yourearnings or dividends are also reported to the IRS. Becausethese kinds of accounts are tax-deferred , you do not payincome tax on the dividends until you begin drawing moneyfrom your IRA or 401(k), usually after retirement.

Be sure to ask whether you’re going to incur any broker’scharges with automatic reinvestment of dividends.

Deciding what to do with certificates

Finally, tell your broker whether you want your stocks regis-tered in your own name or kept in “street name.” Street nameis a term used in the securities industry for stocks that areowned by the investor but registered in the brokerage’s name.

If you instruct your broker to hold your securities in streetname, you never see the actual stock certificates. If you askfor the stocks to be registered in your name, however, youwill eventually receive a stock certificate from the company.

Some customers feel that their stocks are more secure if theycan tuck the actual paper away in a safety deposit box. Beassured that your stocks are safe if you choose to keep themin street name, and possibly safer than if you deal with stockcertificates yourself. Even if you keep your stocks in streetname, most brokerages make sure that you receive annualreports, notices of the company’s annual meetings, and mis-cellaneous other mailings.


Types of orders

When you call your broker to place an order, you need to befamiliar with different kinds of buy and sell orders that youcan place. In the following, I describe three basic kinds oforders:

■ Market orders tell the broker to buy or sell the stock atthe current market price, by far the most common typeof order.

■ Limit orders limit the broker to buying the stock at aspecified price or lower, or to selling the stock at a spec-ified price or higher.

■ Stop orders tell the broker to buy a stock when it reachesa certain price or an order to sell when the stock tradesat a specified price.

Limit and stop orders are useful in many situations, but espe-cially when you’re going to be out of touch with the marketor your broker, or when the market is moving swiftly. Spec-ifying an upper limit of the price you are willing to pay for astock is always a good idea. You don’t want to be unpleas-antly surprised to discover that the shares you thought youwere buying at $20, for example, ran up to $24 before yourorder was executed.

One down side to setting conditions on your purchase is thatthey may delay processing of your order. For example, ifyou’re concerned that XYZ stock is rising sharply, you maywant to buy only if you can get the stock for under $20 pershare. If the stock has risen past that point, the broker holdsthe purchase until the market falls to $20 a share or below.If the stock remains above your specified purchase price, yourbroker is likely to call you to ask about your intentions.


Buying Stocks on the Internet

Doing business via the Internet is an ever-increasing activityamong investors, and the electronic marketplace deservesequal billing with the old standard way of trading stock.

Table 6-1 contains a sampling of some of the Internet’s moreprominent investment sites:

Table 6-1: Popular Internet Investment Sites

Company Web site address

Ameritrade www.ameritrade.com

Charles Schwab & Co. www.schwab.com

Datek Securities www.datek.com

Discover Brokerage Direct www.lombard.com

DLJDirect www.dljdirect.com

E*Trade www.etrade.com

Fidelity Investments www.fidelity.com

Quick & Reilly www.quick-reilly.com

SureTrade.com www.suretrade.com

Waterhouse Securities www.waterhouse.com

The actual buying of stocks on the Internet is a very simpleprocess. You just follow these few simple steps:

1. Set up an account with an Internet stockbroker. You canmake your initial contact either online or over the phone;but either way, you will have to quickly complete thepaperwork that I discuss later in this chapter.

Chapter 6: Taking The Plunge Making The Purchase 71

Curiously, Internet brokers operating in cyberspace maybe even more inquisitive than full-service, land-basedbrokers. Because of the impersonal nature of Internettransactions, online brokers have to rely on more specificinformation to gauge a customer’s temperament, char-acter, and financial status.

2. Make arrangements to pay for your purchase(s) before-hand. Some online brokers require that you depositmoney in an account with them before you begin buy-ing stocks.

3. Connect with your broker’s Web site, and enter yourpassword.

An order screen comes up, and you type in your order.Your broker usually confirms execution of your order viae-mail.

The Internet is far more than just a convenient, hassle-freeway of buying stocks. Electronic communication representsa whole new way of approaching investing in stocks. Advan-tages of dealing on the Internet, compared with the long-standing ways of buying and selling stocks, include:

■ Greater convenience in placing orders, paying for pur-chases, and tracking your purchases

■ Speedier access to research materials to help guide yourstock selection

■ A wider variety of material than you’re likely to find ineven the best local public libraries

■ Lower commissions on transactions

Trading on the Internet also has some disadvantages. Afteryou establish an account with an Internet broker, you maydiscover that the ease of buying and selling stocks causes youto lose focus on your investment goals. You’re cruising out


there all by yourself, without the benefit of an investmentprofessional who says to you, “Are you really sure that youwant to do this?” In addition, you may have trouble sortingout legitimate businesses from the inevitable array of peoplewho use any opportunity to work scams.

Buying Directly from a Company

The alternative to buying stocks through a stockbroker oronline is a direct stock purchase (DSP) arrangement.

The good news about DSPs is that you don’t pay broker’s fees.The bad news is that most companies do not have directstock purchase programs at all. Furthermore, even compa-nies that offer DSPs do not make them generally available toall investors, but only to persons owning shares in the com-pany. If you’re a new investor and the company or compa-nies in which you plan to invest do not have a DSP availableto non-stockholders, you’re simply out of luck.

You can meet the requirement of being a stockholder by pur-chasing a single share via a broker.

You can find out if a company offers a DSP by

■ Calling the company and asking to speak to the investorrelations department.

■ Reading the company prospectus to see whether it men-tions DSPs.

■ Checking the Web site www.netstockdirect.com(see Figure 6-2). Enter the name or ticker symbol of thecompany you’re interested in, and you can find outwhether the organization has a DRIP and/or a DSP. Aticker symbol is the combination of letters used to referto a company in the stock listing. Some ticker symbolsare obvious (such as IBM), while others are obscure (forexample, G stands for Gillette).


Many companies with DSP programs give shareholders a dis-count on direct cash purchases of additional shares. And ifthe company has a DRIP, you can use the dividends fromyour DSP shares to purchase additional shares.

Figure 6-2: Use www.netstockdirect.com to check whether acompany has a DRIP.

Be aware of two negatives that relate to direct stock purchases.First, you have to pay several fees with any direct purchase(although these fees don’t add up to much compared withfull-service broker charges). Second, your trade or purchaseis not executed immediately.

Do not buy shares in a company just because the companyoffers a direct stock purchase program. Buy stocks on thecompany’s merits. Restricting your purchases to DSPs does-n’t make a lot of sense if your long-term goals would be bet-ter served with other stocks.


Maintaining Your Records

You’re a serious investor who’s committed to a long-termfinancial plan, so you’re inclined to keep good records — nomatter how high the paperwork piles up. Be assured thatmaintaining a solid paper trail simply requires that you payattention and stay organized.

You can expect your broker to maintain adequate records ofall your stock purchases and sales, including everything inbetween, such as stock splits and dividend distributions.Sometime in January of each year, you will also receive adetailed statement of all the information that you need foryour annual income tax returns. This is a legal requirementof both your stockbroker and you.

After you open an account, your broker typically providesyou with the following materials:

■ A copy of the agreement you signed when you set upyour account

■ A record of each stock transaction as it occurs showingthe number of shares traded, the price per share, and thetotal price, plus fees and commissions

■ Monthly or quarterly reports showing the current valueof your stocks, including a record of any dividend distributions

■ An annual account statement containing all the infor-mation you need for your income tax filings

■ Company-generated prospectuses and other materialsthat profile your particular stock selection

■ Brokerage-prepared analytic reports on stocks that inter-est you or impress your broker


You also receive the annual report of each company whoseshares you own either from the broker or from the companydirectly, plus a notice of shareholders’ annual meetings alongwith a form to vote on various matters. These matters com-monly include electing new directors to the board, change ofauditors, change of the company’s charter, and so on.

Your reaction to this swelling collection of paper may be,“What am I supposed to do with all this stuff?” If you keepeverything for your whole investing career, you will need an18-wheeler to haul it around, so some choices have to bemade. Don’t consider tossing the heap in the trash. If you dothat, you’re sure to regret the move.

Keep the first four items on the preceding list, and for everystock you actually purchase, keep company- and broker-gen-erated reports for two or three years. One reason for this isthat you can use these reports for comparative purposes.What was projected? How well did the company perform —up to expectations? Or did it perform below expectations?

If you’re using a full-service broker, keep the brokerage-gen-erated analyses. These reports commonly contain recom-mendations, such as “Strong Buy,” as well as earnings andprice projections. You can use this material to track how wellyour broker is doing his or her job.

Annual reports are often big and glossy, not to mention self-serving. They do, however, contain audited financial reports(see Figure 6-3). This part of the report can help you trackthe company’s performance. Rip this section out and keep itfor two or three years. Beyond that timeframe, rely on excel-lent sources, such as Standard & Poor’s reports or Value Linefor historical performance data. This kind of reference mate-rial is expensive to purchase, so locate a public library thathas these reports.


Figure 6-3: The IDG Books Worldwide, Inc. annual report.


CHAPTER 7

TRACKING YOURSTOCKS

IN THIS CHAPTER

■ Setting up a tracking timetable

■ Learning what to track in your stock’s performance

■ Devising a format for tracking

■ Continuing your education in stock investing

Tracking is a disciplined program of monitoring a stock toobserve its behavior at different times so that you can makeeducated adjustments to your portfolio.

Even if the time’s not right for you to revamp your stockholdings, tracking or monitoring can produce several usefuloutcomes, including:

■ You can learn a lot about what causes stock movement.

■ You can become more educated about the stock marketin general.

■ You can maintain your motivation to pursue a disci-plined and focused investment program.

■ You can use your periodic tracking to check on stocksthat you considered previously but decided not to pur-chase. When reviewing these stocks, you may be able topick up some information about these stocks that youmissed earlier.

In this chapter, I explain how you can systematically trackyour stocks, making the most of your investment time,energy, and dollars, as you gain experience with the flow ofthe stock market.

Setting Up Your Tracking Timetable

I suggest that you formally track your stock’s performance ona quarterly basis. The following list gives you some reasonswhy regular tracking is important:

■ Quarterly tracking is all you need to maintain a well-designed investment program.

■ Companies issue their earnings reports on a quarterlybasis.

■ Companies pay dividends on a quarterly basis.

■ Three months is a reasonable interval to collect and fileaway all the paperwork that comes in for later review.

Corporate earnings reports and dividend announcements donot come out precisely at the end of each calendar quarter.These reports have a tendency to trickle out over severalweeks. This unpredictable schedule isn’t a concern, unless oneor more of the companies in which you’re invested begin tohave wildly erratic dates for issuing their quarterlies.

You may say, “I enjoy tracking my stocks. It’s fun. Besides, Iwant to be on top of my stocks and the market situation ingeneral.” Avoid the temptation to do more than quarterlytracking for the following reasons:

■ You may be swayed by daily fluctuations in the value ofyour stock, leading you to make unwise buying and sell-ing decisions. The underlying fundamentals of the com-panies worth investing in do not change from minute tominute.

Chapter 7: Tracking Your Stocks 79

■ You may begin to think that you’re going to uncoversome key bits of information that others have missed,which is not going to happen. By the time these littlegems hit the market, all the big players already knowabout them. Keep in mind that these folks also act onrumors, wild guesses, speculation, fear, and many otherless-than-reliable clues.

Where do you find the information? Go back to the sourcesthat I recommend in Chapter 5 for obtaining basic pre-pur-chase information. Look to either The Wall Street Journal,Investor’s Business Daily, or Barron’s. Information on annualsales and annual earnings, along with calculations of year-to-year changes, appear in more comprehensive publications,such as Standard & Poor’s Stock Reports or the Value LineInvestment Survey.

Various Internet sites can help expedite a lot of the work thatgoes with digging out information on stocks and trackingyour portfolio. The list of possible sites is enormous, withnew addresses appearing daily. For your initial consideration,check out:

■ Microsoft Money (www.microsoft.com/money)

■ Quicken (http://quicken.com) — see Figure 7-1

■ NAIC (National Association of Investors Corporation)Personal Record Keeper (www.better-invest-ing.org/computer/prk.html)

Some portfolio tracking sites are available by subscriptiononly, but these sites usually come with a free trial. Besidesproviding assistance with updating the numbers on yourstocks, Internet sites also offer links to various companyreports and mandatory filings with the Securities andExchanges Commission (SEC), analysts’ recommendations,current news items, and much more.


Figure 7-1: The Quicken site can speed up the tracking of your portfolio.

If you have the time, you may consider looking at companypress releases on the company’s Web site. These reports arealso available on some of the many stock quotation Web sites.

For the truly ambitious, become acquainted with a Web sitemaintained by the U.S. Securities and Exchange Commis-sion called EDGAR (Electronic Data Gathering and Analy-sis) at www.sec.gov/edgarhp.htm. This site contains allthe mandatory reports that companies must file with theSEC.

Be wary of unattributed, unofficial information on the Inter-net. Tracking the source of rumors and “facts” on the Inter-net is next to impossible. Some information is deliberatelyplanted by insiders to stimulate stock movement from whichthey can profit.


Tracking the Stock

Are you ready to see how your stock is doing? Get out yourcalculator and scan your financial news sources for the fol-lowing information:

■ The stock’s price. Get the opening and closing price forthe quarter. Divide the closing price by the openingprice, multiply by 100, then subtract 100, and whatyou’ve got left is the percentage that the stock’s valuechanged during the quarter.

A positive percentage means that the stock’s valueincreased, while a negative percentage indicates a decreasein value. If you observe too many negative quarters in arow, you may want to consider selling the stock (seeChapter 8).

You also want to find out the high and low price duringthe quarter. Subtract the low price from the high priceto find out the trading range. A stock with a narrow trad-ing range is fairly stable, which may or may not meetwith your current investment goals. On the other hand,a stock with a wide trading range may be too volatile. Ifthe range is much wider than the market’s overall range,you may want to find out what is going on with thecompany, if you can.

■ The earnings per share (EPS). You should be able tofind this ratio in any good financial news story aboutyour company’s quarterly earnings. If not, the formulais net income minus the preferred stock dividend, alldivided by the number of common shares outstanding.You can find these numbers in company reports, but let-ting The Wall Street Journal or some other news sourcedo the math is a whole lot easier.


Tracking the EPS over time is a good indicator of thecompany’s progress, but be careful about comparing EPSquarter to quarter because many companies have peaksales seasons that skew the EPS figures. For example,retail stores sell far more during the holiday shoppingseason than any other time of year. Compare similarquarters to get the most use from the EPS figure.

■ The price to earnings ratio (P/E ratio). The basic for-mula for figuring the P/E ratio is the price of the stockdivided by the company’s EPS over the past 12 months.Note that because this formula depends on the price ofthe stock, which changes daily, the P/E ratio also changesdaily.

P/E ratios vary from industry to industry, but they canhelp you size up your company’s stock against its com-petitors. For example, say that Company A and Com-pany B both have earnings per share of $2, but CompanyA’s stock is selling for $18, while Company B’s stock isselling for $30. All else being equal, the stock of Com-pany A (with a P/E ratio of 9) is probably a better invest-ment than the stock of Company B (with a P/E of 15),because you’re paying less for a stock with the same rel-ative earning potential.

Be a bit wary of reading too much into a P/E ratio. It isan important measure of past performance, but not areliable indicator of future growth.

■ Return on equity (ROE). You can find the ROE ratioin the Standard & Poor’s reports, Value Line, or at someof the Web sites in the Resource Center at the back ofthis book. The ROE ratio tells you how well the com-pany is doing with stockholders’ invested money. Any-thing over 15% is very good.


■ The stock’s current beta. This number is also availablein Standard & Poor’s or Value Line. You may rememberfrom Chapter 5 that beta is an indicator of the stock’srisk, and betas do change over time. Make sure that thestock’s current beta matches your investment needs.

■ The quarterly dividend figure. A dividend is simply theamount of the company’s earnings being paid out to theindividual stockholders. Not all stocks pay dividends,even if they have earnings. If a company previously paiddividends, the omission of dividends is a serious sign.For newer, growing companies, failure to pay dividendsmay mean little or may be positive if earnings are beingdirected into new product development and expansionof production.

If dividends were paid, record the “yield” percentage. TheWall Street Journal prints yield figures daily.

■ Your total investment. On each of your updates, addthe amount you paid for your stock (your openinginvestment), the amount of any additional purchases,and the amount of any stock purchased through a divi-dend reinvestment programs (DRIP). The closing totalin this quarter becomes your opening investment totalin the next quarter.

■ The value of your shares. The opening value of yourstock holdings is the number of shares you had at thebeginning of the period multiplied by the previousperiod’s ending share value. The closing value is the cur-rent number of shares times the current per-share price.This closing number becomes the opening share valuefigure for the next quarter.

To figure your percentage of gain or loss of value for thisquarter, subtract the closing value figure from the open-ing value figure. Divide the gain or loss by the openingvalue figure, and convert the resulting number — usu-ally a decimal — into a percentage.


Use a calculator to do the math. The numbers aren’t alwayswhole numbers in multiples of 10. You may deal withchanges such as a total stock value rising from $4,582 to$4,969. The gain in this example is $387. Divide the gain,$387, by the opening period total value, $4,582, multiply by100, and you get a stock price gain of 8.45%.

I use a chart like the one in Figure 7-2 to keep track of thisinformation about my stocks.

Figure 7-2: A chart for tracking a stock’s performance.

Stock Price1st Quarter

OpeningClosing

Percent of ChangeTrading HighTrading Low

Trading RangeEPSP/E RatioROEBetaDividends

Annual YieldInvestment

OpeningPurchases

DRIP PurchasesClosing Total

Value of SharesOpeningClosing

Percent of Change

2nd Quarter 3rd Quarter 4th Quarter Year-End


Tracking a Company

Keeping track of the trends in a company’s performance isjust as important as keeping track of the company’s stock. Irecommend tracking three important company indicators:

■ Sales

■ The percentage change in sales from last year. (Dividethe current sales figure by the previous sales figure, mul-tiply by 100, and then subtract 100.)

■ The company’s earnings

Using a chart like the one in Figure 7-3, I keep track of com-pany statistics for a rolling five-year period. You are, of course,looking for increases every year. If sales or earnings dip, lookfor an explanation in the company’s annual report, Standard& Poor’s, or Value Line.

Figure 7-3: A chart for tracking a company’s performance.

Current

Year Sales

PreviousTwo Years PreviousThree Years PreviousFour Years Previous

PercentChange from

Last Year

Earnings % Changefrom Last Yr.

Sales and Earnings History



Companies release sales and earnings figures for two cat-egories: the current quarter (“XYZ Corp. today reportedthird quarter earnings of $2.5 million . . . “), and year-to-date or YTD (“ . . . giving the company earnings forthe fiscal year of $7.5 million.”). Both are usuallyincluded in the stories of better financial news sources.I recommend using the year-to-date figures, but thequarterly figures can also indicate trends. Whatever youdo, though, make sure that you stick with one or theother. Nothing can foul up a good financial analysismore than mixing apples and oranges.

CHAPTER 8

MAKING MID-COURSEADJUSTMENTS

■ Diversifying your portfolio

■ Adding shares through dividend reinvestment programs

■ Learning how to adjust your portfolio as the market fluctuates

■ Knowing when to sell losers and when to sell winners

Although “buy and hold” is good advice in most circum-stances, sometimes you need to make adjustments of onekind or another in your portfolio. You may find yourself toodependent on one type of stock, or you may be trying to fig-ure out how to better budget your stock purchases, or youmay want to rethink your dividend selection, or you mayeven try to figure out whether you should sell a stock.

This chapter addresses some of the issues that arise as youadd investments and your portfolio grows.

Diversifying Your Portfolio

If you continue saving a fixed amount each month after yourinitial stock purchase, in another year’s time, you may accu-mulate enough funds to make another purchase. But beforeyou run out and buy a stock just like the last one you bought,stop and reconsider. The time may be right to diversify.

Diversifying means selecting stocks of different types or sec-tors. The power of diversification is that you reduce some ofthe risk of your investments. While one type of stock thatyou hold goes down, another may be going up, thus reduc-ing the chance of a radical loss of value for your portfolio.

Diversification is not a topic that you need to worry aboutmuch when you’re first starting out. But as you buy morestocks, I recommend that you review your portfolio once ayear for balance. Consider these things:

■ Do you have too many stocks in one industry? For exam-ple, do you have only utility stocks or only Internetstocks? If you’re just beginning, this is naturally the case,but as your portfolio grows to, say, nine or ten stocks,try not to have any more than 30% invested in any oneindustry. If you do, consider selling one of the stocks inthat industry, or at the very least, make your next stockpurchase from another market segment.

■ Look at the betas for the stocks you hold and make surethat you haven’t inadvertently loaded up on high-beta(very volatile) stocks. You can find out a stock’s beta fromStandard & Poor’s or Value Line in your local library.Make sure that the overall risk rating for your portfoliomatches your investment goals.

■ Another kind of diversification to consider when yourportfolio begins to grow is to put 20% to 30% in bonds.This provides a steady income stream and reduces over-all portfolio risk.

■ Some analysts believe that you can have a diversifiedportfolio if you buy a company with a wide range ofproducts and services or if you buy a conglomerate. Aone-product company can be hurt badly if the marketfor its product weakens or if a competitor comes out witha better product.

Chapter 8: Making Mid-Course Adjustments 89

Continuing to monitor stocks that warranted a first and sec-ond look during your original research can help you makegood choices when you’re ready to diversify.

Purchasing Additional Stocks by

Dollar-Cost Averaging

As a new investor, you may want to buy lots of shares in oneparticular company, but you may not have the money tomake a large lump-sum purchase up front. One way to accu-mulate shares of a stock is to purchase the same dollaramount of the stock each quarter. This is called dollar-costaveraging.

Dollar-cost averaging almost always works to your advantageby compensating for the inevitable fluctuations in stockprices. This means that most of the time you end up gettingmore shares for your money by purchasing stock at constant,equal intervals than if you invest a lump sum equal to all yourpurchases over several years. Table 8-1 helps illustrate thepower of dollar-cost averaging, using four purchases of $300each during the year.

Table 8-1: A Dollar-Cost Averaging Demonstration

Quarter Stock Price What $300 Buys

First quarter $20 15 shares

Second quarter $30 10 shares

Third quarter $10 30 shares

Fourth quarter $20 15 shares

You end up with 70 shares for $1,200 for an average price of$17.14. If you invested $1,200 initially, you would have pur-chased 60 shares at $20 each. By spreading out your pur-chases, you ended up with more shares at a lower price.


Of course, if the price of your favorite stock does nothing butrise all the time, then you’re better off buying all the stocksthat you will ever purchase right up front. Unfortunately, youhave no way of knowing that your stock will only go up,because hardly any stocks do. With dollar-cost-averaging, reg-ular, equal dollar purchases of the same stock almost alwaysend up costing you less.

You, the very attentive reader, may recall an illustration ear-lier in this book that suggested saving $100 a month for ayear and then making a $1,200 investment at the end of eachyear. If buying $300 worth of stock every quarter has bene-fits over a $1,200, once-a-year purchase, would buying $100worth every month be even better? Not really. First, justbecause you can make small purchases is no reason to aban-don your overall investment strategy. Keep in mind a coupleof things here:

■ You can’t buy much stock with just $100 — and stocksare cheaper if purchased in round lots of 100 shares.

■ If you make a lot of small purchases, you may face extrafees that impact your total investment. You may be los-ing 2 to 3% of your investment to such fees.

■ You will increase your job of record-keeping with lots ofsmall purchases.

If you are accumulating only $100 a month, you probablywill be better off investing every three or six months ratherthan monthly. Investor’s Business Daily publishes a list ofstocks under $7. You may be able to find some potential win-ners on that list and still be able to buy a round lot of 100shares every six months.


Following an overall investment plan that helps you achieveyour financial goals is more important than getting $100 oreven several hundred dollars invested as soon as you havesaved it. Be patient.

Handling Dividends

If you elect to receive your dividend payments in cash (referto Chapter 6) but are a little disappointed at the slow growthof your portfolio, think again about the company’s dividendreinvestment program (DRIP).

Automatic dividend reinvesting has the following advantages:

■ Your investment returns compound.

■ You pick up additional shares without paying broker’scommissions.

■ You may even be able to get shares at a small discount.

Many of the companies with DRIPs also allow optional cashpurchases (OCPs) of additional stock shares beyond thoseobtained by automatic dividend reinvestment. These OCPsare often available at no commission or with minimal chargesthat are less than even discount brokers charge.

Despite the advantages of investing through DRIPs andOCPs, you gain no advantage by continuing to buy stock ina company that is going downhill. Make sure that the com-pany’s overall performance in terms of sales and profitabilityremains sound before putting more money into a falteringorganization.

Even if the company is doing just fine, DRIPs do carry a cou-ple of negatives.


■ Every time you receive a dividend payment, even if thepayment is automatically reinvested in additional shares,you must pay taxes on dividends. The IRS treats thesedividends as ordinary income for the year in which theyare paid. But remember, you pay taxes whether you rein-vest or not.

■ Keeping records of purchases is a bit more complicatedwith a DRIP. You’re making a series of small purchases,and you must make sure that you record each purchasein appropriate detail: date, amount of purchase, price pershare, and number of shares (including the decimals orfractional shares) purchased.

Living with Market Downturns and

Stock Losses

Market downturns aren’t all that hard to deal with — if youdon’t panic. Seeing any of your stocks take a big drop is hardon new investors and seasoned investors alike.

Hard though market downturns can be, control your emo-tions when they occur. Remember some of the concepts pre-sented in the early chapters of this book:

■ You invested in stocks because you want your money togrow at a faster rate than conservative but lower yieldinvestments such as certificates of deposit and high-qual-ity bonds.

■ The stock market always fluctuates, but over long peri-ods of time, the trend has always been upward.

■ Risk is inherent in stock market investing, but you cancontrol levels of risk through proper stock selection anddiversification.


You don’t have any gains or losses until you sell some stocks.Until you actually sell a stock, all you have is “paper” gainsor losses.

Believe it or not, even the highly paid people who managebillions of dollars panic at bad news, rumors, and naturalcatastrophes. When the big brokerages and large institutionalinvestors hear news with an uncertain impact, such as anassassination attempt on the president of the United States,their initial reaction is to start selling large blocks of stocksfor no apparent or justifiable reason.

So what do you do when the market turns down sharply —for example, more than 2% of its nominal values? Sayingwhat not to do is easy — namely, don’t sell automatically.

So far, in its 200-year history, the stock market has alwayscome back. Unless you truly believe that some unimaginablecatastrophe is about to befall the world’s economies, don’trush to sell your stocks just because the stock market loses 10to 20% of its value in a few months.

Unless you own nothing but index funds (funds that track thestock market as a whole, and rise and fall in step with mar-ket rises and falls), don’t worry about what the market isdoing. Pay attention to what your stocks are doing.

■ If your stock falls when the market falls, that’s normal.

■ If your stock falls faster than the market is falling, bealert.

■ If your stock rises when the market falls, count yourblessings.

■ If your stock falls when the market is rising, pay closeattention. You may have a problem.


Knowing When to Sell a Loser

If your research indicates that you have a losing stock on yourhands, you may choose to sell it and cut your losses. Ofcourse, knowing exactly when to sell is easier said than done.

Don’t bother to look to books for “the” answer because oneright answer doesn’t exist. Just remember to avoid a panic.Realize that selling a loser (or not selling it) depends at leastas much on psychology and intuition as it does on reason andlogic.

In the following list, I suggest how to deal with different scenarios:

■ A stock’s fundamentals are still strong, but recent per-formance has been poor. Check the company’s funda-mentals — namely, its overall performance on suchthings as sales, earnings, and volatility. Refer to Chapter5 for more on company fundamentals. If the funda-mentals are still as sound as when you purchased thestock, don’t sell.

Never sell stocks without first checking the company’sfundamentals. You should also check the company’s rel-ative industry ratings in Value Line, Investor’s BusinessDaily, or similar sources.

■ The stock’s fundamentals have weakened, but not alot. Consider selling if your stock is down 10 to 15%from what you originally paid and you feel that the stockis not likely to recover lost ground in the next 12 to 18months.

■ The stock is down 25% or more from its originalprice, and its fundamentals are questionable. If youdon’t have a lot of money invested, your risk of furtherloss is small. Consider riding it out. If you don’t havemuch to lose, you probably don’t have much to gain,either.


■ You plan to take some profits on other stocks. Con-sider taking some losses on one or two stocks to offsetyour gains and save some on your taxes.

Set your own marker — for example, 15% — for theamount of loss that you’re willing to live with while youwait for a turnaround. You can also establish a timeperiod for your wait and watch. If your stock doesn’trecover some ground in that time period, sell.

Setting up markers for selling on either the upside ordownside can take some of the emotion out of a difficultsituation Consider the following scenario. You bought astock at 50 that has risen to 65, but you see that the com-pany’s fundamentals are weakening (as judged by slow-ing rates of earnings and sales growth). You set yourmarker to sell at 70 on the upside and 55 on the down-side and place limit orders with your broker.

■ A stock had good gains but then had significantlosses. If your stock had a good gain before it startedfalling, you may want to reset your marker to alert youto a decline off the stock’s high, not off its original price.

Knowing When to Sell a Winner

Can you imagine selling a profitable stock? Consider the factthat you have no profits until you sell. So when you decide thatyou have a better use for the money that you have tied up ina stock, even if the stock has been performing well, you sell.

The following are among the good reasons to sell:

■ You set a target for growth, and your stock achieved it.You’re following a plan.

■ Your stock has done well, but growth has slowed to acrawl. The stock isn’t what it is used to be. You take yourprofits and invest in a promising growth stock.



■ You need money for the down payment on your retire-ment dream home or for your kid’s college education.

When making a decision to sell or not to sell, don’t placemuch confidence in brokers’ and analysts’ guesstimationsabout future or projected earnings and target prices. Expertsvary widely on these projections.

Every time you sell a stock, you incur selling costs (broker’scharges) and may become liable for capital gains taxes if yousold at a profit. You paid taxes all along on your dividends.If you sold stocks at a loss, the losses can offset some or all ofyour gains. Check with your tax advisor.

CHAPTER 9

WHAT TO DO IF THINGSGO BADLY

■ Arming yourself against likely problems and hazards

■ Knowing when you have a legitimate complaint

■ Understanding your rights as a stockholder

■ Seeking recourse when your rights have been violated

Everybody’s hope when they start buying stocks is that theirstocks will go up and never come down. That’s not how theworld works.

So what do you do when your plunge into the stock markettakes a bad turn? If something goes wrong, the inclination isto seek remedy or redress. These days, lawsuits abound:Everybody seems to be suing somebody. Sometimes, takinglegal action makes sense; but filing a suit isn’t your onlyrecourse. In this chapter, I offer suggestions for addressingproblems that may surface during your lifetime of experi-ences with stocks and the trading marketplace.

Your First and Best Line of Defense

The first and best rule in the world of stock market businessis to check out your broker’s recommendations thoroughly.Pay close attention to what you hear and what you read.Don’t rely on a single source or single opinion when makingimportant investment decisions.

You’re much less likely to get into trouble with any investmentdecision if you check out the stock’s fundamentals before youbuy or sell (refer to Chapter 5). This means that you go backand review the vital signs for the last two to eight years.

You certainly will want to look at sales and earnings history,dividends, relative industry rank, and beta or volatility. Ifyou’ve been doing annual updates on the eight criteria ofstock fundamentals (refer to Chapters 5 and 8), you alreadyhave this information.

As you read and listen to advice, bear these things in mind:

■ Does the person giving you advice stand to profit if youfollow the advice? If so, this is a conflict of interest — abig red flag.

■ Is a stock touted as a “sure winner” or a “can’t miss”opportunity? More red flags. Nobody knows the future.Past performance is no guarantee of future results.

■ Does your broker say that you must act today because Xor Y or Z is about to happen and a stock is destined totake off? More red flags. Ignore advice like this and getanother broker.

■ Is a stock recommended on the basis of market timingstrategies derived from something called technical analy-sis? Technical analysts study trends, volume, and stockmovements, among other things. They then try to pre-dict future market movements on the basis of their analy-sis of these trends. Extensive studies have demonstratedthat technical analysis is worthless in predicting thefuture.

Because dealings with brokers are likely to be a source ofsome complaints and misunderstandings, I strongly advisethat you and your broker or adviser have a very clear under-standing about the extent of services to be provided and thedegree of accountability for those services.

Your broker very likely can provide you with a standardprinted statement that covers his or her responsibilities. I’mnot suggesting that you deal with brokers or advisers as if they

Chapter 9: What to Do If Things Go Badly 99

were adversaries. Brokers do have a responsibility to provideyou with guidance appropriate to your situation, but they donot have the responsibility for the choices you make. SeeChapter 5 for tips on selecting a broker.

When Do You Have a Legitimate

Complaint?

And the quick answer is, almost never. The following list pro-vides several reasons why legitimate complaints are rarities:

■ The brokers know the rules — and the penalties.Every reputable brokerage is aware of the risks of exploit-ing or disserving its clients. All brokers must be licensedand are aware of what their obligations to clients are.Full-service brokers all know the “Know Your Customer”rule, which obligates them to provide stock advice andrecommendations appropriate to their client’s financialsituation and investment goals.

■ Brokerages are very careful about what they promisein their literature. During the course of researching yourinvestment options, you may receive research reports orother materials from a brokerage. Brokerages spend a lotof money on research, but always issue disclaimers andwarnings that past performance does not guaranteefuture results.

Phrases like “can’t miss” or “opportunity of a lifetime”on these items are grounds for legal action later — butyou won’t find them on materials from reputable bro-kerages. You can be certain that the company’s legal staffscrutinizes these documents many times before the pub-lications reach you.


In the unlikely event that brokerage documents havemisstated a company’s financial position or other mate-rial matters that would mislead investors, you may havegrounds for legal action or other remedy (for example,voiding a purchase of stock).

■ Your confusion with the highly technical language ofa company’s financial statements is not a basis foraction. This also applies to the accountant’s personalopinion and notes. If you don’t understand what youread or if you misread technical language that is beyondyour competence, you are on your own.

Don’t guess at the meaning of technical and legal docu-ments and use your interpretation as a basis for buyingor selling stock. Don’t buy stocks that you don’t under-stand and don’t take action on any stock you own on thebasis of company reports that are over your head.

■ When you place an unsolicited order with a stock-broker, both full-service and discount, you are onyour own. On unsolicited orders, the broker does notassume responsibility for your actions.

When you become a do-it-yourself investor, you are tak-ing responsibility for your actions.

Two kinds of broker actions are more likely to lead tolegitimate complaints and/or successful legal action.

■ Churning a client’s account. Churning is an illegal prac-tice that generates inflated commissions for a broker orother salesperson through excessive trading of a cus-tomer’s account. The main victims of churning are peo-ple who are unable to actively manage their ownportfolios and delegate this job to an agent.

Chapter 9: What To Do If Things Go Badly 101

■ Failure of a full-service broker to abide by the “knowyour client” rule.

Can you scream and holler at your broker for buying thehighly recommended stock that then tanked? Sure you can.Can you expect some form of compensation? Probably not.You may reasonably conclude that you should find a newbroker or brokerage, but don’t count on much remedybeyond that. Being stung by bad advice should not happento the diligent investor.

Like any investor, you can have a bad day and not ask theright questions of your broker or not pay attention to whatyou hear. However, if a broker acts unprofessionally in vio-lation of the rules, he or she can be disciplined. If you believeyour broker has been guilty of infraction of his or her respon-sibilities, you can and should complain. I discuss how to dothis later in this chapter.

Investor Rights

As an investor, you have the right to

■ Receive information about your broker and the broker-age firm, including a report on all public record lawsuits,disciplinary actions, and so on. Note: This informationis available from the National Association of SecuritiesDealers. Check for their address in the Resource Sectionat the end of this book.

■ Receive complete information about the risks and costsof any stock you may buy either from your broker, thecompany, or both.

■ Receive copies of all agreements between you and yourbroker, as well as complete and timely account reports.


■ Get a clear explanation in non-technical language of theterms and conditions of any stock transaction you enterinto with a brokerage.

■ Receive complete information about all charges, fees, andcommissions connected with your account, includingselling charges and account closing charges.

Stockholders’ rights do not include any guarantee that everystock you buy will live up to your hopes and expectations.

What to Do If You Have a Legitimate

Complaint

If you have a legitimate complaint against a brokerage, fol-low this path to seek a remedy:

1. Call the broker. You don’t need to set up an appoint-ment with the Securities & Exchange Commission(SEC). A call to your broker may resolve the issue.

2. Call the broker’s boss. Again, keep seeking a solutionat the lowest level possible.

3. Call the brokerage’s compliance department. A com-pliance department is an internal brokerage departmentthat attempts to resolve disputes brought by investors.Every brokerage is required by law to have at least a com-pliance function if not a full-fledged compliance depart-ment. You can access the compliance department simplyby calling the brokerage or sending a letter. State yourcomplaint, and you will receive guidance on how to proceed.



4. If the compliance department of your brokerage firmdoes not satisfy your complaint, you can request arbi-tration. When you open an account, you sign a raft ofcustomer agreements. Most of these documents state thatyou must submit broker disputes to an arbitration panelin lieu of going to court.

The arbitration process is set up by the National Associa-tion of Securities Dealers and the various stock exchanges.

The arbitration panel’s decision is final.

If your customer agreement does not require that you waiveyour right to sue, you may, at your own expense, pursuewhatever legal remedies you think appropriate. You are cer-tainly entitled to seek redress in any case of fraud or decep-tion. If you have some evidence of criminal action as it relatesto your account, complain to the SEC. Criminal actions areprosecuted by public authorities.

No one likes to deal with the dark side of doing business,which can sometimes be unpleasant, even painful. Keepingthe following bottom-line thoughts in mind can make yourinvesting experience as pleasant as possible.

■ Expect and insist on competence and decent service fromthose in the securities industry.

■ Don’t expect to get rich by pursuing action against bro-kers or companies. You probably waived your rights tosue in your customer account agreement.

■ If you encounter a broker whose conduct is unprofes-sional, you do yourself and everybody else a favor bybringing his or her misconduct to the attention of thosewho can put such a person out of business.


■ On the positive side, if you find a broker whose conductis professional and who you find to be extremely com-petent in helping you achieve your financial goals, rec-ommend the broker to a friend.

■ Last but not least, remind yourself often that managingyour money and investing for your and your family’sfuture is serious business that deserves a whole-heartedcommitment from you. Give it your best effort, and youvery likely will achieve your dreams.

CLIFFSNOTES REVIEWUse this CliffsNotes Review to practice what you learn in thisbook and to build your confidence in doing the job right thefirst time. After you work through the review questions, theproblem-solving exercises, and the fun and useful practiceprojects, you’re well on your way to achieving your goal ofinvesting in the stock market.

Q&A

1. The stock market refers to

a. A building near Wall Street called the New York StockExchange.

b. The New York Stock Exchange and Nasdaq.c. The sum total of stock trading worldwide.

2. Developing a long term investing strategy

a. Is not necessary for small investors who own shares in only afew companies.

b. Gives focus and staying power to your investing plans.c. Is a waste of time because the stock market moves in random

patterns.

3. Researching stocks before buying

a. Does not eliminate risk but tilts the odds in your favor.b. Is a waste of time because small investors don’t have the nec-

essary resources to learn much about any stock.c. Is best left to professionals.

4. The commission you pay when you buy stocks

a. Is the same no matter where or how you buy.b. Generally is much lower when you purchase stocks on the

Internet than from a full service broker.c. Can be avoided if you purchase directly from the company

in some cases.

5. When you buy stocks, you must pay for your purchase

a. Immediately by prior deposit or electronic fund transfer.b. Within 10 days of purchase unless you get an extension from

the broker.c. Within 3 business days after the stock transaction.

6. Any serious investor will review his/her shares

a. Periodically through the day through Web sites.b. Annually, when preparing tax statements.c. At set intervals, but not more often than monthly.

7. If you feel you have been wronged by a broker,

a. You should contact the compliance department of the bro-ker’s firm.

b. You should assume that you must have made a mistake, soyou take your lumps.

c. You have no resources because there are no guarantees in thestock market.

Answers: (1) c. (2) b. (3) a. (4) b and c. (5) c. (6) c. (7) a.

Scenarios

1. The stock market, as measured by the Dow Average, has fallenalmost 5% (more than 500 points). You own several stocks, allof which have fallen with the market, some a little faster, somenot quite as fast. What should you do?

2. The stock market has risen over 10% this year. You own a stockthat pays a decent dividend and has gone up about 6% in thelast year. What should you do?

Answers: (1) The best course may be to do nothing. The stockmarket rises and falls over time and so will your stocks. It is alwaysgood to recheck the stock’s fundamentals (see Chapters 5 and 8)and find out whether they are holding up to the previous recordof earnings. (2) When a stock lags behind the market, you may

CliffsNotes Review 107

have reason for concern, especially if the stock’s beta (measure ofvolatility) has been close to 1 in the past. If a stock has made moneyfor you in the past but now seems to be tailing off, selling yourstock and putting the money in what might be a better perform-ing stock may be a good idea. This strategy is an especially goodidea if you have some stock losses to offset the gains you made onthis stock that is no longer performing up to expectations.

Consider This

■ Did you know that when most people talk about gains andlosses in the stock market that they really have not experiencedeither? No one has a gain or loss until they actually sell a stockthey own. Until that happens, all they have are “paper” gainsand losses. See Chapter 8 for more details.

■ Did you know that the customer agreements that you signwhen you select a broker or brokerage firm almost universallyrequire that you forego any future right to sue the firm in mat-ters that are in dispute? You’re required instead to submit yourclaim or problem to an arbitration panel. See Chapter 9 fordetails.

■ Did you know that an investment that yields a constant 8%annual return will double every 9 years even if you add no fur-ther money, as long as you reinvest all the money your invest-ment earns. If your rate of return rises to 12% a year, yourinvestment doubles every 6 years. This is called compoundingor compound interest. See Chapter 1 for more detail.

Practice Projects

1. Go to your library and read a back issue of a magazine that dealswith personal finance (for example, Money). Get the names ofsome of the stocks the magazine recommends and then checkin a paper, such as the Investor’s Business Daily, to find out howthose stocks that were recommended did in a year. Did theresults measure up to expectations? If not, can you find clues towhy not?


2. While you’re accumulating money for your first investment, goto one of the Web sites that tracks portfolios. Create an imagi-nary portfolio from about five or seven stocks that you have reador heard about as good buys and that you may consider buyingyourself. Follow these stocks for three to six months throughyour portfolio tracker and find out whether you can figure outwhy they trade the way they do.

CliffsNotes Review 109

CLIFFSNOTESRESOURCE CENTER

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Internet

Check out these Web sites for more information about invest-ing, the stock market, and more:

American Stock Exchange (www.amex.com). Office siteof AMEX.

Ameritrade (www.ameritrade.com). Online brokerage firm.

CliffsNotes Resource Center 111

Charles Schwab (www.schwab.com). Online tradingoptions and investment tracking tools.

Data Broadcasting Corporation (www.dbc.com). SellseSignal, a real-time market quote system.

DripCentral (www.dripcentral.com)Devoted toexplaining the nuances of dividend reinvestment programs,known as DRIPs.

E*Trade (www.etrade.com). Online brokerage services.

EDGAR (Electronic Data Gathering and Analysis)(www.sec.gov/edgarhp.htm). Publishes all mandatoryreports that companies must file with the U.S. Securities andExchange Commission.

ISIR (Institute for Systematic Investing Research)(www.isir.com). For help with dollar cost averaging.

Microsoft Money (www.microsoft.com/money). Offersonline help in tracking stocks.

NAIC (National Association of Investors Corporation)(www.better-investing.org/computer/prk.html). Offers online help in tracking yourstocks.

Netstock Direct (www.netstockdirect.com). Offers agreat list of companies with dividend reinvestment programs(DRIPs) and direct stock purchase (DSP) plans.

New York Stock Exchange (www.nyse.com). Providesstock prices and daily market summaries.

Quicken (http://quicken.com). Offers online help intracking stocks.


StockMaster (www.stockmaster.com). Offers a person-alized portfolio to track stocks.

Next time you’re on the Internet, don’t forget to drop bywww.cliffsnotes.com. We created an online ResourceCenter that you can use today, tomorrow, and beyond.

Magazines and Newspapers

To keep current on stock prices, you can consult any largemetropolitan daily paper. For more specialized coverage offinancial matters, check out the following:

Investor’s Business Daily. Often referred to as IBD, thispaper offers the most complete daily updates on stock mar-ket activity. It also incorporates a special rating tool that pro-vides analytic information about individual stocks notavailable in other sources.

The Wall Street Journal. The WSJ is a very good daily paperwith national circulation. As its name suggests, it providesdetailed coverage of stock market activities along with solid,well-written general news coverage. Sorry, no sports page orcomics.

Barron’s (weekly). A very readable weekly paper that givesquick and comprehensive coverage to the world of stocks andhigh finance.

Business Week. Provides solid business coverage with a spe-cial section on stocks.

Forbes. Offers solid coverage of business with special sectionson stocks and investing.

Fortune. Presents more big, in-depth stories and analyses.Ideal for a general business and economics education. Stocksare not its forte.

CliffsNotes Resource Center 113

Money. Good for overall personal finance information andguidance with decent coverage of stock investing.

Value Line. This pricey publication focuses on very seriousinvestors. Its detailed, authoritative reports on individualcompanies come out in periodic segments several times amonth.

Standard & Poor’s Stock Reports. Very similar to ValueLine in coverage and depth. Reports are issued at intervalsduring the month.

Send Us Your Favorite Tips

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INDEX

NUMBERS401(k) plans, 11, 29, 695–year sales, 59

Aaccounts, types of, 66accurate records, 62Acorn, 54adjustable rate preferred stocks, 19advantages of dealing on the

Internet, 72aggressive growth, 49American Association of Retired Per-

sons, 54American Century, 54American Stock Exchange, 25, 44,

108Ameritrade, 71, 109AMEX. See American Stock

Exchange, 26annual account statement, 75annual performance, 56annual reports, 50, 69anticipated performance, 20, 22arbitration, 102automatic dividend reinvesting, 69,

91automatic transfers from checking, 15average annual return, 12

BBabson, 54balance, 46Barron’s, 39, 46, 80, 110basic investing vocabulary, 18basic materials groups, 24beginning investors, 17, 40beta, 58, 83, 98biotechnology, 25

bonds, 88borrowing money to buy stocks, 6Brandywine, 54broker’s charges, 96brokerage-prepared analytic

reports, 75brokers, 17business magazines, 47Business Week, 47, 110buy a franchise, 8buy and hold, 87buy and sell orders, 70buying a home, 9buying stocks on the Internet, 71buying stocks on your own, 30buying stocks through a broker, 63

Ccap size category boundaries, 22capital appreciation, 49car loans, 7cash accounts, 29, 66cash dividends, 67CD. See certificates of deposit, 33certificates of deposit, 33, 92CGM, 54Charles Schwab & Co., 71checklist of decisions, 16choosing a broker, 63churning, 100CliffsNotes books, 107CliffsNotes Daily, 3, 111CliffsNotes Getting On the

Internet, 3CliffsNotes Investing for the First

Time, 29, 107CliffsNotes Investing in Mutual Funds,

30, 52, 107CliffsNotes Resource Center, 21, 45,

107CliffsNotes Review, 104CliffsNotes Web site, 3closing stock prices, 42CNBC, 44CNN, 44college savings plans, 9

commissions, 64, 75commitment to achieving your goals,

14common stocks, 17–18company earnings, 86company indicators, 85company size, 59company statistics, 86complaints, 99compliance department, 102compounding, 11, 68, 106conglomerates, 24constant trading, 23consumer/cyclical groups, 24consumer/noncyclical groups, 24control over your investments, 32controlling your spending, 15corporate library, 47credit card debt, 6criminal action, 103crude oil supplies, 34current dividends, 42current inflation rate, 31current market price, 20cyclical stocks, 22–23

Ddaily fluctuations, 79Data Broadcasting Corporation, 109Datek Securities, 71debt, 6deferred gratification, 14depression, 23descriptive classifications, 18direct stock purchase, 62, 73, 109discipline, 15discount brokers, 64Discover Brokerage Direct, 71diversification, 30, 87dividend distributions, 75dividend reinvestment programs, 68,

84, 91, 109dividends, 18, 67, 84DLJDirect, 71dollar-cost averaging, 89, 109Donaldson, 64

Dow Jones indexes, 38Dreyfus, 54DRIP. See dividend reinvestment

programs, 67DripCentral, 68, 109DSP. See direct stock purchase, 73

EE*Trade, 71, 109earnings, 25earnings history, 59earnings per share, 39, 57, 82economic activity, sectors of, 51EDGAR, 26, 81, 109education, 6Electronic Data Gathering,

Analysis, and Retrieval. SeeEDGAR, 26

energy groups, 24EPS. See earnings per share, 57eSignal, 109experts, 52

Ffear, 80Federal Reserve Board, 35fees, 64, 75Fidelity, 54, 64financial analysis, 86financial groups, 25financial situation, appraisal of, 5first rule of stock purchasing, 56Forbes, 46, 110Fortune, 47, 111Franklin Templeton, 54full-service brokers, 64, 76fundamentals, 56, 94, 97future profitability, 49

GGabelli, 54gateway sites, 45general goals, 8


Index 117

global economy, 34, 41goal-setting, 10goals, 8good reasons to sell, 95government subsidies, 6grant programs, 9growth, 25growth stocks, 22GT Global, 54Gulf War, 34

Hhandling dividends, 91high beta stocks, 88high risks, 23high-tech stocks, 34home equity lines of credit, 7home mortgages, 7Hoover’s Online StockScreener, 40how to use this book, 2

IIBD. See Investor’s Business Daily, 43icons, 2illegal practices, 100income stocks, 22income tax returns, 75index funds, 93Industry Group Relative Strength

Rating, 25industry groups, 20, 24industry rank, 98inflated commissions, 100inflation, 35Initial Public Offering, 27installment loan debt, 7Institute for Systematic Investing

Research, 109interest charges, 7interest rates, 31interest, tax-deductible, 7Internal Revenue Service, 69Internet investment sites, 71, 80Internet stock screeners, 38

Internet stocks, 50, 52intuition, 48investing as part of a group, 29Investing For Dummies, 108investing on your own, 28investment experts, 52investment goals, 5, 65investment strategy, 37, 48, 56investor relations department, 73investor rights, 101Investor’s Business Daily, 19, 25, 39,

43, 53, 57, 59, 80, 90, 94, 106,110

IPO. See Initial Public Offering, 27IRAs, 31, 69ISIR. See Institute for Systematic

Investing Research, 109iterative process, 39

JJanus, 54John Hancock, 54

KKemper, 54Know your customer rule, 66, 99knowing when to sell a loser, 93knowing when to sell a winner, 95

Llarge cap companies, 20, 38lawsuits, 97legal classifications, 18Legg Mason, 54legitimate complaints, 99, 102life insurance, 29limit orders, 70limits of research, 36long-term goals, 8, 31long-term growth, 23losses, 33–34Lufkin & Jenrette, 64

Mmaintaining records, 75major trading markets, 17management team, 56mandatory reports, 81manually sorting stocks, 40margin accounts, 66market averages, 44market capitalization, 20market crash, 34market downturns, 92market orders, 70Meridian, 54Merrill Lynch, 64Microsoft Money, 80, 109mid cap companies, 20, 38Money, 46, 106, 111Morgan Stanley Dean Witter, 64mortgages, 29mutual fund companies, 53mutual fund managers, 32mutual funds, 29, 35, 49Mutual Funds For Dummies, 108mutual funds managers, 52

NNAIC. See National Association of

Investors Corporation, 80narrowing the list of stocks, 37Nasdaq, 25, 39National Association of Investors Cor-

poration, 80, 109National Association of Securities

Dealers, 101net worth, 65Netstock Direct, 109Neuberger & Berman, 54new investors, 23New York Stock Exchange, 25, 39,

109newspapers, 42–43novice investors, 67NYSE. See New York Stock Exchange,

39

OOakmark, 54OCP. See optional cash purchases, 91online daily stock updates, 45opening investment, 84opening stock prices, 42Oppenheimer, 54optional cash purchases, 91outstanding debts, 5outstanding stocks, 20

PP/E ratio, 57, 83PaineWebber, 64paper gains and losses, 92, 106Paper Game, 49, 60paralysis by analysis, 56past performances, 22, 41patience, 15paying off your credit card

balances, 7paying off your student loans, 7payment arrangements, 72payroll deduction, 14pension plans, 11, 29perceived investment potential, 20percentage change in sales, 86periodic tracking, 78Personal Finance For Dummies, 108personal issues, 5personal portfolio, 28Personal Record Keeper, 80personal savings, 11perspective, 46pharmaceutical companies, 25, 37PIMCO, 55portfolio tracking sites, 80preferred stocks, 17–18preliminary screening, 48price per share, 75prime candidates for purchase, 49print media, 39, 42projected retirement year, 10pros and cons of common and pre-

ferred stock, 19


prospectus, 52, 75Prudential, 55, 64public library, 47Public Register’s Annual Reports Ser-

vice Web site, 50Putnam, 55

Qquarterly performance, 56quarterly reports, 75quarterly tracking, 79Quick & Reilly, 64, 71Quicken, 80, 110

Rreal-time market quote system, 109realistic monetary goal, 11realistic time frames, 11reasonable time frame, 11reasons to invest in the stock

market, 30recession, 23recommendations, 76reducing overall portfolio risk, 88registering stocks in street name, 69registering stocks in your name, 69reinvesting dividends, 67relative industry strength, 59Remember icon, 2research, 36retire with financial security, 8retired investors, 23retirement, 10return on equity, 58, 83reverse investing, 5rewards, 28, 37rising interest rates, 35risk rating, 88risks, 22, 28, 32, 37, 99ROE. See return on equity, 58round lots, 64Rule of 72, 12rumors, 80–81

Ssales, 86Salomon Smith Barney, 64savings accounts, 31savings and investment plan, 5scams, 72scenarios, 105Schwab, 55, 64screening stocks, 39screening techniques, 37Scudder, 55SEC. See U.S. Securities and

Exchange Commission, 26self-esteem, 10selling costs, 96setting up an account, 65setting up an Internet stockbroker

account, 71share value, 84short-term goals, 8Small Business Administration, 9small cap companies, 20, 38–39SmartSelect Corporate Ratings, 25,

39Social Security, 11Social Security number, 65sources of reliable information, 42specific objectives, 8speculation, 80speculators, 50Standard & Poor’s Stock Reports, 21,

47, 56, 76, 80, 83, 111start an independent business, 8SteinRoe, 55stock certificates, 69stock classifications, 18stock information, 42stock losses, 92stock market performance, 15Stock Master, 110stock movements, 78, 98stock price, 82stock screeners, 38stock splits, 75stock tracking, 48stock transactions, 62

Index 119

stockholder rights, 97StockScreener, 40stop orders, 70student loans, 7, 9subscription costs, 46subscriptions, 42SureTrade.com, 71systematic payment schedule, 14

TT. Rowe Price, 55tax identification number, 65tax-deferred accounts, 69technical analysts, 98technology groups , 25technology stocks, 24televised stock market coverage, 44The Economist, 47The New York Times, 43, 53The Wall Street Journal, 19, 43, 53,

57, 80, 82, 110thin market, 27ticker symbol, 73ticker tape, 44time frames, 10Tip icon, 2total market value, 20tracking companies, 85tracking timetable, 79trading range, 82trends, 98types of account, 66

UU.S. Securities and Exchange

Commission, 26, 81, 102, 109university library, 47USA Today, 43using your experience, 50using your intuition, 51

VValue Line, 21, 46, 55, 76, 83, 111Value Line Investment Survey, 80Van Kampen American Capital, 55Vanguard, 55volatility, 25, 98voting rights, 19

WWall Street, 35Warburg Pincus, 55Warning icon, 2Waterhouse Securities, 64, 71Web screening programs, 40Web sites, 21, 107–108weekly reports, 46wild guesses, 80WSJ. See The Wall Street Journal, 43

YYahoo! Finance, 40year-to-date figures, 86yields, 42


COMING SOON FROM

CLIFFSNOTES

Online Shopping

HTML

Choosing a PC

Beginning Programming

Careers

Windows 98 Home Networking

eBay Online Auctions

PC Upgrade and Repair

Business

Microsoft Word 2000

Microsoft PowerPoint 2000

Finance

Microsoft Outlook 2000

Digital Photography

Palm Computing

Investing

Windows 2000

Online Research

COMING SOON FROM CLIFFSNOTES

Buying and Selling on eBay

Have you ever experienced the thrill of finding an incrediblebargain at a specialty store or been amazed at what people arewilling to pay for things that you might toss in the garbage?If so, then you’ll want to learn about eBay — the hottest auc-tion site on the Internet. And CliffsNotes Buying and Sellingon eBay is the shortest distance to eBay proficiency. You’lllearn how to:

■ Find what you’re looking for, from antique toys to classic cars

■ Watch the auctions strategically and place bids at theright time

■ Sell items online at the eBay site

■ Make the items you sell attractive to prospective bidders

■ Protect yourself from fraud

Here’s an example of how the step-by-step CliffsNotes learning process simplifies placing a bid at eBay:

1. Scroll to the Web page form that is located at the bot-tom of the page on which the auction item itself is presented.

2. Enter your registered eBay username and password andenter the amount you want to bid. A Web page appearsthat lets you review your bid before you actually submitit to eBay. After you’re satisfied with your bid, click thePlace Bid button.

3. Click the Back button on your browser until you returnto the auction listing page. Then choose View➪Reload(Netscape Navigator) or View➪Refresh (Microsoft Inter-net Explorer) to reload the Web page information. Yournew high bid appears on the Web page, and your nameappears as the high bidder.

investing in the stock market (cliffsnotes)

Documents

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idg sweden books

idg norge books

idg books worldwide

book s

cdg books canada

stock market information

international sales