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Proform 2020 Market Basics Manual

Content Chapter 1 Discovering Wealth

Where to Invest The Success Formula

4 8 13

Chapter 2 Understanding the Financial

Markets and Products Types of Financial Markets Mutual Funds Advantages and Disadvantages of Mutual Funds Bonds

20 21 22 29 34

Chapter 3 The Stock Market


History of the Stock Market Current Stock Market Securities and Exchange Commission What is a Stock Stock Types Exchanges Stock Market Hierarchy Stocks in the Dow Jones Industrial Average Stock Market Symbols

43 45 46 47 50 52 56 59 66

Chapter 4 Introduction to Stock Market


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Analysis Introduction to Broad Market Analysis


Chapter 1

Discovering Wealth In day’s bygone, you could get by financially on a solid work ethic and a system of savings. Company’s offered pensions that would take care of the bulk of your retirement needs, all you had to do was work for thirty years and you could collect a pension as well as social security. These would take care of your basic needs through the golden years of life and if you had some savings you could retire comfortably. In those days, workers “invested” time for financial independence. Today this model of planning for financial independence simply does not work. With the world turning to a more global economy, corporate America has become a system of accounting protocols and ratios. If your business does not fit the protocol or the ratio’s it will not survive. Literally, every type of funding from government grants to public investors depends on the balance sheet. It is no wonder pensions have been cut. The employee, who used to be referred to as a company’s greatest asset, has been redefined as a liability. So not only has corporate America cut pensions, but now, if the balance sheet demands it, you may not even have a home at the same company for 30 years. 4

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Is the remaining glimmer of hope the government? Here the statistics are even worse. For one-third of Americans over 65, Social Security benefits constitute 90% of their total income. In just a few short years, in 2017, the government will begin to pay out more in Social Security benefits than it collects in payroll taxes – and shortfalls then will grow larger with each passing year. And by 2041, when today’s 30 year old workers begin to retire, the system will be bankrupt. There is little hope for help from the government. The statistics may be grim, but there is hope for those who choose to accept it. Whether you recognize it or not you have been investing all your life. Whether you are investing time into a job, or a portion of your income to the government, you are investing. Both of these investments may be necessary and are part of your duty as a parent, spouse, or citizen. But there is a bigger opportunity, in being smarter about where you choose to invest. An investment is simply the expense of money or time into the creation or accumulation of real or intellectual property that is not consumed today but is used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price. We choose to invest our time and money in many things. The key is to invest in areas with highest rate of return. While investing time into a job may be the highest rate of return for your particular circumstance right now, it does not have to be your sole investment. The objective of the InvestView is to open the door to investing, to introduce you to markets and teach you how to invest. You may Discovering Wealth


choose to invest in many opportunities, or you many choose to invest in only one. What makes your experience with InvestView so unique is knowing how to analyze opportunities, position yourself to take advantage of the opportunity, and control for the risks associated with the investment. Many of our students say wealth is just a matter of being at the right place at the right time; there isn’t any structure to it. That is not true. That kind of thinking is exactly why 80% of the American population will die below the poverty line. Wealth building, like math, is formulaic. Basic addition and subtraction provides a base upon which you can build more and more complex mathematical concepts. Ultimately, your basic math skills allowed you to specialize in the fields like engineering, science, statistics, economics, etc. As your knowledge in a more specialized field of interest grows you become more and more valuable to an employer or to an organization. Think of it as intellectual net worth. Wealth building is no different; it is rooted in the skills of money management: generating revenue and controlling costs. As you grow your knowledge and skills in the field of wealth intelligence you become more valuable - but not to an employer, or to an organization - but to yourself. You increase your financial net worth! Financial skills, like math, or any other skill, must be learned and developed until you reach a level of proficiency and specialization. That is the aim of InvestView: to provide formal training and education in the field of financial wealth intelligence. You can think of us as a Wealth Building University. You have already gone to school to learn to increase your intellectual net worth. Now, you have the opportunity to learn income producing strategies from a proven leader in wealth training, education and support. 6

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Welcome to the InvestView family. The goals and objectives of this manual are to increase your awareness and understanding of the many investment opportunities that exist in the world today. Many of these opportunities are a simple extension of your current resources and only require your awareness and action. Others require additional education, planning and strategy. All have the potential of projecting you to a new level of wealth and success. Many of the strategies you will learn in this course are being used right now by people you know. It is making a difference in their lives, and it will make a difference in yours! First and foremost, you have invested good money to attend this workshop and to learn these skills. There is action in the verbs “to attend” and “to learn.” By the simple action of attending you have surpassed 80% of your financial competition. The action verb “to attend” has allowed you to break the mold of your everyday life and to expand your mind to the countless wealth building opportunities. That is motivating! By taking action to attend the workshop you are significantly closer to wealth than someone who has chosen not to attend. For most people, wealth is not charm that lands in your lap. Most successful people have to get out and find it. The second action verb is “to learn”. Learning requires two things: education and application. In other words, to hear and not act is not really learning. Learning is doing. For example, it is common knowledge that you should have the oil changed on your car every three months. To fail to take action with this knowledge will ultimately cause your cars engine to stop working. Failure to take action on knowledge will cause trouble in life. There is an old adage which says that if you want to stay where you are, keep doing what you’re doing. It is true! Discovering Wealth


Your objective in taking this course is to internalize, or learn, the concept taught by InvestView. You must combine education and application in order to internalize the material. The purpose of this book is to provide you with top level information. Later, you will have an opportunity to work with an instructor, a mentor, and or a coach whose duty it is to support the learning process and encourage you to excel in your action. But for now, make the concepts in this book a part of your life’s experience. Make it your goal, and when you set your goals, live to reach your goals, remember, it is not enough to have knowledge you must produce action to reach success. One useful way to internalize this information is to establish a one-year plan. Learning to develop multiple income strategies is like learning to play the piano, it requires dedication and time. You may understand music and how the piano works, but until you play the piano, you cannot really say you are a pianist. But to play it once doesn’t qualify you for the title either, it requires practice over time. This concept is true in life; establish a plan for success and then hone your skills day by day taking consistent steps to reach your goals. This will ensure that you convert your knowledge into action and ultimately wealth and success.

Where to Invest One question you might be wondering is “Where do you go to invest?” Although you may think about going to a bank, a distributor, or a broker, the more correct answer is the market. A market is public gathering held for buying and selling merchandise. It is a place, a physical location or otherwise, where buyers and 8

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sellers congregate and engage in the process by which things of value are exchanged for money. Most of the financial investments discussed in this manual are correlated to an organized market. These include the: Real estate market Stock market Options market Foreign Exchange market The other financial investments are also associated with markets although not as regulated as those previous. These include: Internet Commerce Direct Sales Small Business Regardless of which market you choose to invest your time and resources it is important to recognize and understand the market associated with your investment. Many new investors fail to learn the market before they invest and end up failing. As investors with a financial “edge� you will learn the intricacies of your market. Whether you are investing in a new internet business or investing in the stock market, the first step is to perform a market analysis. Knowing the market’s characteristics and how it works provides you with key information that is essential in developing your financial plan. Make sure you understand the following: Who are the major participants in the market? What are the standard business practices and protocols? Is there a regulatory body governing the market? Is there an unbiased resource that might help you better understand the market? Discovering Wealth


Do you need a team of professionals to facilitate transactions in the market? How do you acquire your assets? How do you sell your assets? What costs are associated with the transactions in your market? What are the major trends in your market? What supply and demand characteristics influence your market? For example, the real estate market is a highly regulated market. There are specific protocols and business practices that standardize all real estate transactions. The market is expansive and includes real estate agents, mortgage brokers, appraisers, title companies, government agencies, regulatory bodies, etc. You may find real estate investment groups with similar goals and objectives that work to help like minded investors. When investing in real estate, you will need a highly qualified team of professionals to help you through transactions. You acquire real estate through internet searches, classified ads, knocking on doors, word of mouth, and many other inventive ways. I think you get the picture. Each market has a unique set of characteristics; your job in learning to invest is to learn the market inside and out. Become the authority on the subject and always be observant to changes in market trends.

Think Big

Once you have a grasp of the market, you must begin to develop an investment plan. Your plan begins with a vision. Everyone worries about their finances and what the futures holds for them. It is good to worry about such things since the future is just a sunset away. Studies have shown that only 1% of the American public will be financially independent at the age of 65. The other 99% will fall in one of the following categories: 10

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4% Able to Meet Basic Needs 45% Dependent on Family for Additional Support 28% Able to Meet Needs with Welfare & Social Security 22% Must Work to Fulfill Needs These statistics are a reality. But nobody wants to be one of the statistics. You want more. Describe how much more? Begin by describing where you want to be. Success is as simple as building a dream, mapping the course that will help you reach your dream, and following the map. Your dreams become goals. Whether you realize it or not, goals are the only way to achieve financial success and security. How can you reach a destination if you don’t know where the destination is? A goal is nothing more than a defined destination. It has been said that success with goals is merely the fleeting shadow of luck. Your goals should be defined enough to encourage you to stretch, yet flexible enough to allow flexibility with changing knowledge and skill levels. Your goals should be challenging enough to ensure progress, yet simple enough to give you the pride of victory. You should set long range goals to define where you want to be in 5 plus years. You should also set shorter range goals that help define the path you will take to reach your longer range goals. Most students, venturing out for the first time, find it difficult to determine appropriate goals since they lack experience and knowledge. This difficulty is quickly overcome through your training. Our coaches, mentors, and instructors will help you identify important concepts, common pitfalls, and useful tips. Your ability to set goals will become a natural extension your quest to acquire knowledge. In fact, what a great place to start! Set a goal to complete the courses in a specific period of time. Set a goal to Discovering Wealth


spend 30 minutes a day increasing your knowledge of a particular wealth building strategy. Over time you’ll become better able to formulate difficult, yet achievable goals for your financial future. Your base of knowledge and experience will grow as you mature in both wealth and peace of mind. After establishing and reaching your short term education goals, you will likely require additional knowledge, tools and experience in order to achieve your more difficult long term goals. Don’t worry; this will come in time through dedication, practice and study. Remember, your wealth building skills and experience can be enhanced through the effort of coaches and mentors who take the time to help you down the path to your longer term goals. All this time and attention to goals directly translates into success.

Think Positive

All of your feelings, beliefs and knowledge are based on our internal thoughts, both conscious and subconscious. You are in control, whether you know it or not. You can be positive or negative, enthusiastic or dull, active or passive, successful or unsuccessful. The biggest difference between people is their attitudes. Abraham Lincolns said “Most folks are about as happy as they make up their minds to be.” He also said, “I’ve had a lot of trouble in my life, most of which I never really had.” Thinking positively goes a long way toward being a success! If you picture yourself as someone who is ultimately going to succeedthen success is going to come a lot easier. If, on the other hand, you picture yourself as someone who is either highly likely to fail or not to progress-then no matter how talented you are or how hard you work, it’s going to be very difficult to succeed. Thinking positive can catapult your career or business ahead and make you more effective in all kinds of 12

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different situations, from dealing with people, to concentrating on analytical issues, to developing creative ideas. Thinking negatively can stop you cold, like the icy moat or cold stone walls of a medieval castle, and make you less effective in dealing with people, less able to focus on your work, and less likely to develop creative ideas.

The Success Formula So how can you think positive? Here are a few quick suggestions: Have a five-year plan for success. Realize that you, not others, ultimately control your success. Brainstorm alternatives to tough situations. Celebrate your achievements. Shrug off your setbacks. Develop a support network. Always stand for integrity. Remind yourself that every day is a new opportunity! Keep yourself in top physical condition. Always be open to learning new ideas.

Develop a Plan

After you have thought through your vision, now separate the vision into three areas: security, debt, and wealth. These are the foundations for financial independence. You can not build wealth and hold onto it without addressing each of these areas. First the security plan. Many new investors get stuck in the security plan or want to skip ahead without addressing elements of security. Identify those areas in your life that cause you stress or discomfort and make sure that you have a plan that addresses Discovering Wealth


those concerns first. For example, if you plan on quitting your job to become a full time investor, you will still need to eat, pay for utilities and a place to live. Make sure you have a plan to cover each of these critical areas. Second is the debt plan. After you have a plan to cover the essential needs, next focus on debt. Debt can be a troublesome liability. There is good debt and there is bad debt, but all debt must be serviced. In your plan, be sure to identify all debt and map out how you will reduce and or service that debt. The third and most popular is the wealth plan. This is where you will spend most of your vision time. It is the happy place. It comes after you have successfully mapped and planned your security, and are able to service and or eliminate your debt. When planned correctly, the wealth plan will propel you into a life of enjoyment and peace. After you have identified the previous elements in the plan, look at each list and start prioritizing. Put completion dates by the major things. Start noticing what feels inspiring and what feels scary or hard. You may need to do some adjusting. If there is anything in this plan that really doesn’t make you smile, axe it from the plan.

Putting the Plan into Action

It’s critical that you get feedback from someone supportive and experienced on your plan. They should be able to able to see any missing pieces or things that don’t align with your personal values. They’ll be able to see where you might be challenged and coach you into deciding on some ways to stay on your path. Decide that you will take action every week. This will keep the plan alive and you’ll see progress fast. The steps don’t have to be 14

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huge, just consistent. It is recommended that you utilize a coach and or mentor to support you in making the plan a reality faster. Working through a plan is not always a cakewalk and a coach can help you identify pitfalls that will hinder and opportunities that will help you reach your goals. When making investment choices, you should always refer back to the plan. Is the choice a fit right now? What will be the long term impact of this choice on my plan? The plan helps you make choices with more ease. You may need to change the plan along the way. But don’t make changes while you’re in the middle of the something. You’re likely to make a change to a knee jerk response rather than grounded principles. Be accountable to someone. You’ll find great strength and creativity by checking in with a coach or partner every week. Part of this is being specific about what the focus is each week. You’ll commit to both action steps and what you will be learning. There is learning intellectually and then, more powerful, is learning about your thought process and beliefs. Most people underestimate this and want to skip over looking within. They say, “Just show me what to do and I’ll do it” or “Give me the answers.” Your mind is the greatest asset you have. Use it! Have fun with this plan. Remember this is about you and your success. Remember that you are trying to eliminate work, not create more. Don’t let this become tedium.

Identify a niche

In order to become a successful investor, you don’t need to know the future. In the process of working with many successful investors, we have discovered that it is your niche, not your keen knowledge of the future that makes you successful. A niche is Discovering Wealth


situation, skill or activity specially suited to your personal interests, abilities, or nature. Your “niche” is the mechanism that skews the opportunities in your favor. Every investor is different. Each has their own set of skills, resources and goals, so you must discover your own niche. Perhaps your niche is in real estate negotiations, maybe its in your ability to analyze opportunities, or maybe it is identifying the next hot product on eBay. Whatever your niche you must quantify its properties and qualify its success. To quantify an edge you must be able to define it. When someone asks how you trade the markets you must be able to put in simple words, what makes you successful in the market. One successful investor quantifies his stock market niche as follows: “I trade market gaps. Gaps represent an abnormal trading interest and are the fingerprint of a trading “rush.” The odds of a quarterback sack are significantly increased when the defense rushes, similarly when market gaps are accompanied by increased volume my probability of a successful trade increases.” More than just defining your advantage, you must qualify it with statistics. To qualify your niche skill you take an objective measure of the success that results from your niche. Remember that it does not matter what happens in the short run. Anyone can step into a casino and win; it is a function of luck. Anyone can step into the market and make a few good trades. The distinguishing factor of success is how well you perform over the long run. Track and measure your niche and develop your investments to capitalize on your unique talents and skills.


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We live in a culture obsessed with the idea of a quick win. The struggling novelist who pens a best-seller and becomes rich; the woman who loses twenty kilos in five weeks; the web millionaire who was a poor student a year ago - these are the types of stories everyone loves to hear. But the reason they’re so interesting is because they’re so unusual. Tales like this grab the attention because they just don’t happen very often. The idea of doing something fast and simple to achieve spectacular results is a seductive one. It fits in with our obsession with quick and easy. We can pick up the phone at one in the morning and get a pizza delivered - why can’t we transform our lives just as easily? It’s a nice idea, and I’ve got nothing against putting in some effort in the search of speedy gain. But realize that most success isn’t achieved this way. Almost all successful people who achieve difficult goals take the slow and steady road. Paradoxically, this is the easier and more certain path. For every quick winner, you have a thousand others with a string of quick failures behind them. But most of the slow and steady successes are built with relative certainty. That’s because most things worth having are earned through time and effort. That’s part of what makes them so valuable. Something gained easily is difficult to feel attached to in the same way as something fought hard and long for. If you do a little bit of work towards your goals every day, it’s highly likely that you’ll end up being successful. Of course, not every rainbow you trudge towards will have a pot of gold at the end, but Discovering Wealth


many of them will - especially if you choose your rainbows wisely. If you read and train for an hour every day on something, in five years you’ll likely be one in a thousand at doing it. If you put 10% of your pay-packet into a conservative share portfolio every month, in ten years you’ll be richer than almost everyone you know. If you write something every day, in a few years you’ll have built up a good body of work, some of which is almost guaranteed to be of high quality. Of course, you can also put a few risky bets on the hope of quick wins. They do happen sometimes after all. But put most of your resources on the slow and steady path. Imagine where you’d be today if you started doing it five years ago. Now, you have a vision, you recognize your niche market, you have a plan for success and are committed to the requisite work. The next step is to learn everything you can about the markets of your choice.


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Chapter 2

Understanding the Financial Markets and Products Introduction Before we dive directly into the first step of the InvestView Formula for Stock Market Success, it is important to understand a broad picture of financial markets in general, and the Stock Market in particular. This chapter describes the wide variety of financial markets investors use to make money. The next chapter describes the history of the Stock Market, and some fundamental information you need to know to make your first trade. As the term “market� implies, financial markets are places where financial products are bought and sold. Most people are familiar with the Stock Market, and might envision a big building on Wall Street in New York City when they think of the Stock Market. While it is true that the first Stock market began in New York City, there are also other Stock Markets across the United States, and around the world. 20

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Additionally, there are other financial markets, both domestic and international, where financial products other than stocks, are bought and sold. Investors in these markets can buy and sell all types of investments, including bonds, commodities, foreign currency, and other financial products.

Types of Financial Markets Financial Markets can be organized into categories based on their purpose.

Capital Markets

Capital Markets allow companies and governments to raise capital by issuing stocks or bonds. As such, capital markets include stock markets and bond markets. Capital markets are further subdivided into primary and secondary markets. Primary markets let traders buy newly issued stocks and bonds; a new stock’s Initial Public Offering (IPO) is sold on a primary market. Secondary markets allow investors to sell securities they own, or buy existing securities from other traders. The commonly held picture of the “Stock Market� with brokers and traders yelling across the floor, is a secondary market.

Commodity Markets

The Commodity Markets allow buyers and sellers to trade products with ever-changing values, such as oil, electricity, wheat, and orange juice.

Understanding the Financial Markets and Products


Money Markets

Money Markets provide financing for short-term debts and investment opportunities.

Derivative Markets

Derivative Markets sell instruments for managing financial risk. Futures markets are a type of derivative market where contracts are sold for trading products at some future date.

Insurance Markets

Insurance Markets let companies and underwriters redistribute risk associated with the coverage they extend to policy holders.

Foreign Exchange Markets

Foreign Exchange Markets bring together buyers and sellers of international currencies. This manual focuses on an understanding of these markets as a basis for your success. As such, we will not describe strategies for making money in these other financial markets. However, to have a full education about investing, it is important to understand financial markets and financial products other than stocks.

Mutual Funds As you’ll learn in the next chapter about the history of the Stock Market, a lot of people began making a great deal of money investing in stocks in the early 1900’s. The popularity of the Stock Market grew, and individuals who had no special expertise in finance, or even business, began to invest their money in the Stock Market. Others, leery of investing on their own, sought the advice 22

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of others and partners in their investments. In March of 1924, the Massachusetts Investors Trust became the first official American mutual fund, with the idea of pooling investor money together to invest. Today, the more than 10,000 U.S. mutual funds, which collectively hold trillions of American investment dollars, still operate by the same principles of that first mutual fund. A mutual fund is a financial intermediary, usually established as a corporation, that allows a group of investors to pool their money together with a predetermined investment objective. A fund manager is responsible for investing the pooled money into specific securities, usually stocks or bonds. Investors purchase shares of the mutual fund

Open-End and Closed-End Funds

The majority of mutual funds in operation today are structured as “open-end” funds. Investors can purchase shares of an openend fund at the Net Asset Value (NAV) established daily by the mutual fund. The NAV is the total asset value of the mutual fund divided by the number of outstanding shares. As additional money is invested into the fund, new shares are created and sold to investors. Closed-end funds issue a fixed number of shares, similar to a stock’s Initial Public Offering. Shares of a closed-end fund are traded on a stock exchange, and increase or decrease in value based on the supply of investors selling their shares in the fund, and the demand for those shares by investors wanting to buy them.

Understanding the Financial Markets and Products


Mutual Fund Types

Mutual funds are classified by the predetermined investment objective, the financial products the mutual fund purchases, and the fund’s investment strategy. Additionally, mutual fund types are often classified by the risk associated with each. Mutual fund types are described below, beginning with the safest and moving toward the riskiest.

Money Market Funds

Money market funds invest primarily in safe, short-term debt instruments such as Treasury bills, and only the largest, most stable securities. The chance of losing your principal investment in a money market fund is extremely small. As such, the interest you earn on your investment is also small – generally twice the interest rate of a bank checking account, but less than a standard certificate of deposit (CD). Money market funds offer substantial liquidity to investors who might want to withdraw their money from the fund quickly. Investors are given checks that they can write against their deposit amount. These checks typically have a minimum required amount, usually between $250 and $500. Interest rates offered by money market funds change with economic conditions, most notably inflation. When inflation decreases the spendable value of the dollar, money market funds try to lure investors by increasing the interest rate they pay. During a period of wild inflation in the early 1980’s, money market funds paid investors nearly 18% annually.

Fixed-Income Funds

Fixed-income funds are also called “bond/income funds,” “bond 24

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funds,” and “income” funds. They invest primarily in government and corporate debt, and provide a steady source of income for investors. Fixed-income funds appeal most to conservative investors and retirees or older investors with few earning years left. Interest rates paid by fixed-income funds are higher than money market funds and most certificates of deposit. The risk associated with fixed-income funds also increases, and rises largely with the type of bonds purchased by the fund. High-yield, speculative bonds (also known as junk bonds) that offer interest rates three to four percentage points higher than safer government bonds, present a particular risk for fixed-income investors.

Balanced Funds

Balanced funds invest in a combination of stocks and bonds, and attempt to limit the risk to principal investment while simultaneously paying steady dividend income, and providing long-term growth of both the principal and income. Balanced funds often advertise their investment strategy with a percentage indicating the relative weight of its investments. A typical balanced fund might focus 60% of its resources on equities (stocks) and 40% of its resources on income (bonds). A drawback to balanced funds that maintain this weighted assignment of resources is that they cannot alter their investment percentages with changes in the market. A special type of balanced fund, known as an “Asset Allocation Fund,” tries to compensate for this disadvantage by giving the fund manager the power to change the investment ratio as economic conditions change.

Understanding the Financial Markets and Products


Equity Funds

Equity funds invest exclusively in stocks, and represent the largest category of mutual funds. Because stocks vary so widely, equity funds also vary widely in their investment styles. Typically, equity funds focus on stocks of companies of a particular size. Small-cap mutual funds invest in companies with a market capitalization below $1 billion dollars. Mid-cap mutual funds invest in companies with a $1 billion to $5 billion market capitalization. Large-cap funds invest in companies with market capitalizations greater than $5 billion. However, great variety exists even within these categories of company size. Equity funds can be further subdivided according to the type of stocks purchased within each of these market capitalization categories. Equity funds that focus on “Value” purchase stocks of high quality companies that have recently decreased in value. “Growth” equity funds focus on the stocks of companies that have recently increased in value and are expected to continue this trend because of promising earnings, sales, and revenue. “Blend” equity funds seek to find middle ground between the value and growth perspectives. Nine categories of equity mutual funds can be created by combining the three investment objectives with the three market capitalizations. • • • • • • • 26

Small Value Small Blend Small Growth Medium Value Medium Blend Medium Growth Large Value Essentials Manual

• Large Growth • Large Blend

Growth Funds

Growth funds focus on increasing the value of principal by investing exclusively in stocks. Growth funds are further subdivided into categories according investment philosophy. Aggressive Growth Funds have the sole objective of maximizing return on investment, and invest in a wide variety of securities, including new industry and small-company stocks. Aggressive growth funds also use transactions beyond standard buy-and-hold positions, such as shorts, futures, and options. Aggressive growth funds offer large potential for returns on investments. However, they are the most volatile and risky of mutual funds. Growth Funds invest in blue-chip stocks of well-established companies, with the stated goal of increasing capital gains. Growth and Income Funds seek a balance between return on investment and steady income through dividends.

Global and International Funds

Global funds invest in the stocks of companies anywhere in the world, including America. International funds invest in the stocks of foreign companies only. As such, global and international funds present additional factors for an investor to consider, such as culture and political stability. However, investing in foreign stocks can diversify a portfolio and profit from economies growing faster than the United States’.

Understanding the Financial Markets and Products


Global and international mutual funds can have additional emphases as well, such as: Regional funds focus on a specific area of the world, such as Latin America or Southeast Asia. Single-country funds invest in the stocks of companies located in a single country, such as Brazil or Singapore. Emerging markets funds purchase the stocks of companies in countries and regions that are experiencing rapid industrialization and economic growth. International equity funds focus on established economies in stable countries and regions, such as Germany and Japan. Global equity funds usually invest in American and international securities according to a predetermined ratio. Global index funds attempt to replicate the performance of foreign stock indexes.

Index Funds

Index funds replicate the performance of a broad market index, usually the S&P 500. Index funds are often managed by computer software that tracks the index, and as such usually offer lower management fees than other mutual funds. Index fund investors try to take advantage of growing economies, and typically believe that most fund managers cannot do better than the performance of the market in general.


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Specialty Funds

Specialty funds typically focus on a specific segment of the economy, or are guided by concerns beyond financial considerations only. Sector funds focus on an economic sector such as communications, transportation, financial, or healthcare. Companies within a sector tend to increase or decrease together. As such, sector funds are heavily dependent upon the performance of the sector in which they invest, and can rarely avoid losses by investing in growing companies if the sector as a whole decreases. Ethical funds, also called socially-responsible funds, attempt to identify growing companies that meet certain ethical guidelines, or do not offend the sensibilities of a specific belief system. As such, most ethical funds avoid companies that manufacture or sell tobacco, alcohol, or weapons, or that have a track record of questionable environmental practices.

Real Estate Funds

Real estate funds, also known as Real Estate Investment Trusts (REITs) attempt to achieve the benefits of real estate investments, but avoid the lack of liquidity that typically accompanies the purchase of real estate for investment purposes. REITs are traded on major exchanges just like stocks. Additionally, there is no minimum investment with REITs, which allows investors without enough capital to purchase a piece of real estate on their own to pool their resources with others.

Understanding the Financial Markets and Products


Advantages and Disadvantages of Mutual Funds Whether open-end or closed-end, and regardless of the predetermined investment objective, mutual funds offer specific advantages to investors that cannot be easily achieved through other methods. To secure these advantages, however, mutual funds are structured in a way that presents disadvantages that might offset the benefits of mutual funds.

Diversification vs. Dilution

The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains in others. In other words, the more stocks and bonds you own, the less any one of them can hurt you. Recall, for example, the financial destruction that employees of Enron, whose entire investment portfolio contained only Enron stock, suffered when the company’s accounting scandals decreased the value of their stock to near nothing. The most basic level of diversification is to buy multiple stocks rather than just one stock. Mutual funds are set up to buy many stocks (even hundreds or thousands). Beyond that, you can diversify even more by purchasing different kinds of stocks, then adding bonds, then international, and so on. It could take you weeks to buy all these investments. However, by owning shares in a mutual fund instead of owning individual stocks or bonds, your risk is spread out automatically. Large mutual funds typically own hundreds of different stocks in many different industries. It wouldn’t be possible for an investor to build this kind of a portfolio with a small amount of money. 30

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It’s possible to have too much diversification. Because funds have small holdings in so many different companies, high returns from a few investments often don’t make much difference on the overall return. This is known as dilution. Dilution is also the result of a successful fund getting too big. When money pours into funds that have had strong success, the manager often has trouble finding a good investment for all the new money. Professional Management - A Benefit or Disadvantage? One of the primary advantages of funds is the professional management of your money. Investors purchase funds because they do not have the time or the expertise to manage their own portfolios. A mutual fund is a relatively inexpensive way for a small investor to get a full-time manager to make and monitor investments. When done incorrectly, this professional management can be the biggest disadvantage of purchasing a mutual fund, however. Many investors debate whether or not the so-called professionals are any better than an average investor at picking stocks. Management is by no means infallible, and, even if the fund loses money, the manager still takes his/her cut. Ultimately, as long as you keep your money invested in a mutual fund, you are stuck with the performance of the fund’s manager, and lose all direct control over your investment.

Reduced Transaction Fees vs. Management Fees

Because a mutual fund buys and sells large amounts of securities at a time, its transaction costs are lower than what an individual would pay for securities transactions. However, mutual funds don’t exist solely to make your life easier - all funds are in it for a profit. The mutual fund industry is Understanding the Financial Markets and Products


masterful at burying costs under layers of jargon. These costs are often complicated, and intentionally difficult to understand. The cost of paying a mutual fund company to manage your investment might easily outweigh the savings you realize by taking advantage of the fund’s large buying power.

Liquidity vs. Tax Consequences

Just like an individual stock, a mutual fund allows you to request that your shares be converted into cash at any time. This means that your investment in a mutual fund is highly liquid, and accessible to you quickly. The advantage of a mutual fund’s liquidity can be offset by other financial disadvantages, chief of which are the tax consequences of investing in a mutual fund. When making decisions about your money, fund managers don’t consider your personal tax situation. For example, when a fund manager sells a security, a capital-gains tax is triggered, which affects how profitable the sale is for any individual investor. Even if the sale creates a profit for the average investor in the fund, certain investors might have been better off deferring the capital gains liability.

Simplicity vs. Missed Opportunity

Buying a mutual fund is easy! Pretty well any bank has its own line of mutual funds, and the minimum investment is small. Most companies also have automatic purchase plans whereby as little as $100 can be invested on a monthly basis. However, investors that leave their money management to the expertise of a mutual fund manager will undoubtedly miss opportunities for maximizing their wealth by successfully analyzing their own investment decisions. 32

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Exchange Traded Funds – An Alternative to Mutual Funds One constant rule of capitalism is that where there is an opportunity to make money by providing value to customers, someone will create a product to fill that market niche. In 1993, the first Exchange Traded Fund (ETF) was created to give investors the benefits of a mutual fund without the disadvantages outlined above. This first ETF was the Standard and Poor’s Deposit Receipt (SPDR, pronounced “Spider”). An Exchange Traded Fund bundles together the securities that are in a specific index, similar to the way that an index fund attempts to replicate the performance of an index. However, an ETF can be traded like a stock, including short selling. Because they are traded on stock exchanges, ETFs can be bought and sold at any time during the day, unlike most mutual funds. Technical analysis can be used to determine a profitable entry point for an ETF transaction, because their prices fluctuate from moment to moment, just like any other stock’s price. Like stocks, ETFs are purchased through a broker, and as such incur the expense of a commission. However, they are much more tax-efficient than normal mutual funds, and have very low operating and transaction costs because a fund manager is not required to perform the simple task of matching an index. Also, ETFs have no sales loads or investment minimums. Exchange Traded Funds are limited to replicating the performance of indexes, and cannot track other actively managed mutual fund portfolios. This is because most actively managed funds only disclose their holdings a few times a year. As such, an ETF attempting to replicate the performance of the fund could only adjust its own holdings at these times, and would lose track of the Understanding the Financial Markets and Products


fund as soon as it made its first trade.

Bonds Bonds are debt securities issued by a variety of government, international, and corporate parties, that obligate the bond issuer to repay the principal and interest (the coupon) at a future date when the bond matures. Bonds are generally issued for a fixed term longer than one year, and allow the issuer to finance longterm investments with external funds. In essence, a bond is simply a special type of loan, issued in the form of a security. Because it is issued as a security, bonds use different terms than loans do to describe their various elements. The issuer of a bond is equivalent to the borrower of a loan. The bond holder is equivalent to the lender. The bond coupon is equivalent to the interest rate of a loan. Unlike stocks, bonds do not entitle holders to a share of ownership in the issuing company. Bonds and stocks are both securities, but the difference is that stock holders own a part of the issuing company (have an equity stake), whereas bond holders are in essence lenders to the issuer. Also bonds usually have a defined term, or maturity, after which the bond is redeemed whereas stocks may be outstanding indefinitely. An exception is a consol bond, which is a perpetuity, a bond with no maturity.

Bond Terms

Bonds are usually issued with a defined term, or maturity, after which the bond can be redeemed. The maturity of a bond 34

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influences the risk associated with the bond’s performance, and the sensitivity of the bond to changes in government-regulated interest rates. Short-term bonds have a maturity of less than three years, and are the least sensitive to interest rate fluctuations. Intermediate bond funds mature in three to ten years and are more volatile than short-term bonds, but offer the prospect of a higher return as well. Long-term bonds have a maturity of over ten years. These are the most aggressive, and the riskiest bonds. Debt securities with a maturity shorter than one year are typically called “bills.” Certificates of deposit (CDs) or commercial paper are considered money market instruments, and typically have a variable maturity term, often less than one year. The risk of a bond investment is related to a statistical measure called “duration,” where lower durations have less risk, and are associated with shorter term obligations.

Types of Bonds - Untangling a Web of Words

Because bonds are issued by a variety of parties, with a variety of maturity terms, and for a variety of purposes, keeping track of the various types of bonds can be a complicated process. To aid in this endeavor, different terminology is used to describe different types of bonds. The U.S. Treasury traditionally uses the word bond only for their issues with a maturity longer than ten years, and calls issues between one and ten years “notes.” Elsewhere in the market, this distinction has disappeared, and bond “bond” and “note” are used to describe debt securities regardless of their maturity. Investors use the term “bond” normally for large issues offered to a wide public, and notes for smaller issues originally sold to a limited number of investors. There are also “bills,” which are usually fixed Understanding the Financial Markets and Products


income securities with maturity dates within three years of the bill’s issue. Because of their longer duration, bonds have the highest risk. Notes, with intermediate duration, are second highest in their risk. Bills have the least risk.

Corporate Bonds

As implied by their names, corporate bonds are issued by corporations, and are usually longer-term debt securities, with maturity dates at least 12 months after their issue. The term “commercial paper” is often used to describe corporate debt instruments with maturities less than a year. Corporate bonds that are traded on major exchanges are known as “listed bonds.” However, most corporate bonds are bought and sold on over-the-counter markets. The coupon (interest payment) of a corporate bond is usually taxable. Additionally, corporate bonds typically present greater risk of default to investors than government bonds. As such, they usually offer larger coupons than government-issued bonds.

Bond Ratings

Though corporate bonds are typically riskier investments than government bonds, there is a great deal of variability in the risk presented to investors by bonds issued by different corporations. Bond ratings attempt to quantify this risk by measuring the credit worthiness of a corporation. This corporate credit rating is analogous to the credit scores given to individual consumers by the three American credit rating companies. However, corporate credit ratings are assigned by five credit rating agencies 36

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that have received the Nationally Recognized Statistical Rating Organization (NRSRO) designation by the SEC: Standard & Poor’s, Moody’s, Fitch, A.M. Best, and Dominion Bond Rating Service. The first three credit rating agencies are the largest, and dominate the bond ratings market. These three large credit rating agencies feature slight variations in their ratings system, but all assign letter-based ratings. The highest rating a company can receive is AAA, indicating impeccable credit worthiness, and very little risk associated with the purchase of bonds issued by these companies. Currently, only 8 companies have AAA ratings by all three major credit rating agencies:

• Automatic Data Processing • Berkshire Hathaway • ExxonMobil • General Electric • Johnson & Johnson • Pfizer • Toyota Motor Corporation • United Parcel Service

Municipal Bonds

In the United States, a municipal bond (also called a muni) is a bond issued by a state, city or other local government, or their agencies. Potential issuers of municipal bonds include cities, counties, redevelopment agencies, school districts, publicly owned airports and seaports, and any other governmental entity (or group of governments) below the state level. Municipal bonds are guaranteed by a local government, or a group of local governments, and are assessed for risk and rated accordingly. Interest income received by holders of municipal bonds is often exempt from federal income tax and from the income tax of the Understanding the Financial Markets and Products


state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt. Because municipal bonds are often tax-exempt, comparing their coupon rates to other, taxable bonds can be misleading. Taxes reduce the net income on taxable bonds, and so tax-exempt municipal bonds have a higher after-tax yield than a corporate bond, or other taxable bond type, with the same coupon rate.

Treasury Securities - Government-Issued Bonds

Treasury securites are bonds issued by the U.S. Department of the Treasury, through the Bureau of the Public Debt. Treasury securities are used by the U.S. Federal government to finance ongoing debt and pay for deficits in the Federal budget. There are four types of treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Savings bonds. All of the Treasury securities except savings bonds are very liquid, and heavily traded on the secondary market.

Treasury Bills

Treasury bills (or T-bills) mature in one year or less, and do not pay interest prior to maturity. Prior to maturity, they are sold on secondary markets at a discount of their mature value. Treasury bills are considered by many to be the most risk-free investment, and are commonly issued with maturity dates of 28 days, 91 days, and 182 days.

Treasury Notes

Treasury notes (or T-Notes) mature in two to ten years and pay interest every six months. They are commonly issued in denominations from $1,000 to $1,000,000. On the secondary market, T-Notes are quoted for sale at percentage of their mature value. 38

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The 10-year Treasury note has become the security most frequently quoted when discussing the performance of the U.S. government bond market, and conveys the market’s perception on long-term economic expectations. Additionally, the U.S. mortgage market uses the yield on the 10-year Treasury note as a benchmark for setting mortgage interest rates.

Treasury Bonds

Treasury bonds mature in ten years or longer, and have coupon payments every six months, like T-Notes. Common Treasury bond maturity dates are ten years and thirty years. Some foreign countries, including France and the United Kingdoms offer their equivalent of the U.S. Treasury bond with a 50-year maturity, affectionately termed the Methuselah bond.

Savings Bonds

Savings bonds are treasury securities for individual investors. About one in six Americans - more than 50 million individuals have together invested more than $200 billion in savings bonds. Savings bonds cannot be traded on the secondary market, but can be redeemed after a one-year holding period, making them very liquid. Savings bonds are “registered securities,” meaning that their ownership is determined by the name in the treasury’s records. Because of this, savings bonds can be replaced if lost or destroyed; however, possession of a savings bond does not entitle the possessor to redeem the bond. Interest payments on Savings bonds are compounded and paid out only upon the bond’s redemption. Interest income from Savings bonds does not have to be reported to the IRS as income until the Understanding the Financial Markets and Products


bonds are cashed, making them tax-deferred investments.

Mortgage-Backed Bonds

A mortgage-backed bond is a security whose cash flows are backed by the principal and interest payments of a set of mortgages. Payments are typically made monthly over the lifetime of the underlying loans. Commercial mortgage-backed bonds are secured by commercial and multifamily properties such as apartment buildings, retail or office properties, hotels, or industrial and commercial sites. Because residential mortgage-holders in the U.S. can pay more than the required monthly payment, and apply additional payment to reduce the remaining loan principle, the monthly cash flows of a mortgage-backed bond is not known in advance. This advance payment of principal can affect the overall interest paid on a mortgage-backed bond, and represents an additional risk to investors in these securities.

Sovereign Bonds

Sovereign bonds are issued by a national government, often in the currency of a foreign country. Nations with very high or unpredictable inflation, or unstable exchange rates, can rarely convince investors to risk their money purchasing bonds in the currency of that country. As such, these governments are forced to issue bonds that designate repayment in the currency of a more stable foreign currency. These bonds can still be quite risk investments, as the issuing government might not be able to afford to repurchase the necessary foreign currency at bond repayment time. Due to the risk of default, investors require sovereign bonds to be issued with a higher yield. 40

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Bond Funds

A bond fund is a collective investment scheme that invests in bonds. Bond funds can be distinguished by several properties. Some invest in government bonds, others in corporate bonds. Funds may invest in solely the securities from one country, or from many countries.

Understanding the Financial Markets and Products


Chapter 3

The Stock Market History of the Stock Market When people talk about the Stock Market, it’s no always immediately clear what they’re referring to. Is the Stock Market a place? Or is it something different? To many people it is an abstract idea. They buy stocks in “the stock market” without ever leaving the comfort of their computer terminal. But the stock market is indeed a physical place with buildings and addresses, a place you can go visit. Many folks think of Wall Street and the Stock Market as one in the same, and that view isn’t really far from the truth. Wall Street is the place where it all started and where the world’s largest financial market was born and prospered. From Wall Street sprang a new industry with it’s own language and terminology.

The History

Wall Street can trace its name back to 1653. Originally it was set 43

up for defense and not for commerce. Settlers of Dutch descent, who were always on the lookout from attacks by Native Americans and the British built a 12 foot stockade fence. Little did they know that this fence would go on to become the center of financial activity in the world. The wall lasted a good while, until 1685. At that point the wall was torn down and a new street was built. The British called it Wall Street.

The Rise of the Stock Exchanges

What helped Wall Street rise to pre-eminence was the emergence of two great Stock Exchanges, which gave order to the chaotic trading and gave birth to the financial markets as we know them today. The year was 1790. The place was Philadelphia. The occasion was the founding of the first stock exchange in America. Two years later a group of New York merchants met to discuss how to take command of the securities business. The merchants, a group of 24 men, founded what is now known as the New York Stock Exchange. But in early 1817, the merchant group from New York, distressed at the sorry state of their stock exchange, sent a representative to Philadelphia to observe how things were being done. Upon arriving with news about the robust exchange in Philadelphia, the New York Stock and Exchange Board was soon formally organized. The exchange opened up shop on Wall Street. As for the New York Stock Exchange, it has since moved past its humble beginnings to the point where its system now facilitates billions of dollars worth of trades each day. But there was a gradual build up to this sort of status. In the early 1900s massive amounts of money were made on Wall Street. But the boom period could not be sustained indefinitely. And in 1929 this principle came front and center 44

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as the stock market crash of 1929 seared the global psyche and triggered what was to be called the Great Depression. While many of the powers that be realized that the markets could not sustain a boom forever, very few publicized this view, choosing instead to let the market be its own judge, jury and executioner. As a result of the laissez-faire attitude, many people rich and poor alike lost a lot of money. But the stock market crash of 1929 was just the beginning of sorrows for Wall Street. For while the economy eventually recovered from its catastrophic losses, the market excesses that had factored into the crash in the late 1920s seeped back into the picture. The result was the stock market crash of 1987, which saw the Dow Jones suffer what was the largest single-day loss in the stock markets history. Since then, the government and the industry have tried to put measures in place to curtail, if not entirely eliminate, the possibility of such a large-scale crash. The stock markets are now an integral part of the global economy, and so proper safeguards to reduce the risks of another disastrous crash are necessary. But while efforts have been made to reduce the risk, the possibility for another stock market crash can never be ruled out.

Current Stock Market The current “stock market� is comprised of 300,000 computers situated on pro trader’s desks. These computers are networked together using sophisticated protocols. This level of information The Stock Market


sharing makes pricing an almost exact science. These 300,000 computers are further linked to another 26 million computers worldwide. These computers are located in banks, small businesses, and large corporations. These computers comprise the banking networks which make computerized transactions possible. Finally, these computers are connected to another 300 million+ computers which connect and disconnect from the financial markets daily. In New York City alone, these transactions amount to over $2.2 trillion dollars daily

Securities and Exchange Commission Shortly after the stock market crash of 1929, a regulatory body called the Securities & Exchange Commission (SEC) was born. Its goal was to restore investor confidence and faith in a financial sector that was notorious for fraudulent activities, easy credit and hazardous investments. Two significant proposals by the U.S. Congress, the Securities Act of 1933 and the Securities Exchange Act of 1934, led the way to the formation of the SEC and, ultimately, a structured financial industry under government supervision. The aim of both of these acts was to protect investors from any indiscretions that could arise from:  Fraudulent and questionable public companies Dishonest and unscrupulous individuals dealing in the securities markets Today, the SEC is divided into four main divisions. They work together, but have specific areas in which they mandate and ensure 46

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compliance. These departments are Corporate Finance, Market Regulation, Investment Management and Enforcement. Ultimately, the SEC is on your side – the side of the investor. Whether you are a large investment firm or just the average investor, the SEC tries to make sure that all public companies provide accurate information so that investors can make educated decisions. While large-scale cases of fraud occur from time to time, the SEC, by and large, is there to protect individual investors. By maintaining accurate records, inspecting company reports and keeping a watchful eye over market activity, the SEC acts as a police force, a lawmaker and sometimes even a court for the securities market.

What is a Stock Company Ownership

Plain and simple, stock is a share in the ownership of a company. Stock represents a claim on the company’s assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. Whether you say shares, equity, or stock, it all means the same thing.

Voting Rights

Being a shareholder of a public company does not mean you have a say in the day-to-day running of the business. Instead, one vote per share to elect the board of directors at annual meetings is the extent to which you have a say in the company. The management of the company is supposed to increase the value of the firm for shareholders. If this doesn’t happen, the The Stock Market


shareholders can vote to have the management removed, at least in theory. In reality, individual investors like you and I don’t own enough shares to have a material influence on the company. It’s really the big boys like large institutional investors and billionaire entrepreneurs who make the decisions.


For ordinary shareholders, not being able to manage the company isn’t such a big deal. After all, the idea is that you don’t want to have to work to make money, right? The importance of being a shareholder is that you are entitled to a portion of the company’s profits and have a claim on assets. Profits are sometimes paid out in the form of dividends. The more shares you own, the larger the portion of the profits you get. Your claim on assets is only relevant if a company goes bankrupt. In case of liquidation, you’ll receive what’s left after all the creditors have been paid. This last point is worth repeating: the importance of stock ownership is your claim on assets and earnings. Without this, the stock wouldn’t be worth the paper it’s printed on.

Limited Liability

Another extremely important feature of stock is its limited liability, which means that, as an owner of a stock, you are not personally liable if the company is not able to pay its debts. Other companies such as partnerships are set up so that if the partnership goes bankrupt the creditors can come after the partners (shareholders) personally and sell off their house, car, furniture, etc. Owning stock means that, no matter what, the maximum value you can lose is the value of your investment. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets. 48

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Debt vs. Equity

Why does a company issue stock? Why would the founders share the profits with thousands of people when they could keep profits to themselves? The reason is that at some point every company needs to raise money. To do this, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock. A company can borrow by taking a loan from a bank or by issuing bonds. Both methods fit under the umbrella of debt financing. On the other hand, issuing stock is called equity financing. Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way. All that the shareholders get in return for their money is the hope that the shares will someday be worth more than what they paid for them. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO). It is important that you understand the distinction between a company financing through debt and financing through equity. When you buy a debt investment such as a bond, you are guaranteed the return of your money (the principal) along with promised interest payments. This isn’t the case with an equity investment. By becoming an owner, you assume the risk of the company not being successful - just as a small business owner isn’t guaranteed a return, neither is a shareholder. As an owner, your claim on assets is less than that of creditors. This means that if a company goes bankrupt and liquidates, you, as a shareholder, don’t get any money until the banks and bondholders have been paid out; we call this absolute priority. Shareholders earn a lot if a company is successful, but they also stand to lose their entire investment if the company isn’t successful. The Stock Market



It must be emphasized that there are no guarantees when it comes to individual stocks. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends even for those firms that have traditionally given them. Without dividends, an investor can make money on a stock only through its appreciation in the open market. On the downside, any stock may go bankrupt, in which case your investment is worth nothing. Although risk might sound all negative, there is also a bright side. Taking on greater risk demands a greater return on your investment. This is the reason why stocks have historically outperformed other investments such as bonds or savings accounts. Over the long term, an investment in stocks has historically had an average return of around 10-12%.

Stock Types There are two main types of stocks: common stock and preferred stock.

Common Stock

Common stock is, well, common. When people talk about stocks they are usually referring tro this type. In fact, the majority of stock is issued is in this form. We basically went over features of common stock in the last section. Common shares represent ownership in a company and a claim (dividends) on a portion of profits. Investors get one vote per share to elect the board members, who oversee the major decisions made by management. 50

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Over the long term, common stock, by means of capital growth, yields higher returns than almost every other investment. This higher return comes at a cost since common stocks entail the most risk. If a company goes bankrupt and liquidates, the common shareholders will not receive money until the creditors, bondholders and preferred shareholders are paid.

Preferred Stock

Preferred stock represents some degree of ownership in a company but usually doesn’t come with the same voting rights. (This may vary depending on the company.) With preferred shares, investors are usually guaranteed a fixed dividend forever. This is different than common stock, which has variable dividends that are never guaranteed. Another advantage is that in the event of liquidation, preferred shareholders are paid off before the common shareholder (but still after debt holders). Preferred stock may also be callable, meaning that the company has the option to purchase the shares from shareholders at anytime for any reason (usually for a premium). Some people consider preferred stock to be more like debt than equity. A good way to think of these kinds of shares is to see them as being in between bonds and common shares.

Different Classes of Stock

Common and preferred are the two main forms of stock; however, it’s also possible for companies to customize different classes of stock in any way they want. The most common reason for this is the company wanting the voting power to remain with a certain group; therefore, different classes of shares are given different voting rights. For example, one class of shares would be held by a select group who are given ten votes per share while a second class The Stock Market


would be issued to the majority of investors who are given one vote per share. When there is more than one class of stock, the classes are traditionally designated as Class A and Class B. Berkshire Hathaway (ticker: BRK), has two classes of stock. The different forms are represented by placing the letter behind the ticker symbol in a form like this: “BRKa, BRKb” or “BRK.A, BRK.B”.

Exchanges Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. You’ve probably seen pictures of a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and signaling to each other. The other type of exchange is virtual, composed of a network of computers where trades are made electronically. The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, reducing the risks of investing. Just imagine how difficult it would be to sell shares if you had to call around the neighborhood trying to find a buyer. Really, a stock market is nothing more than a super-sophisticated farmers’ market linking buyers and sellers. Before we go on, we should distinguish between the primary market and the secondary market. The primary market is where securities are created (by means of an IPO) while, in the secondary market, investors trade previously-issued securities without the involvement of the issuing-companies. The secondary market is 52

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what people are referring to when they talk about the stock market. It is important to understand that the trading of a company’s stock does not directly involve that company. Large exchanges in the U.S. include the New York Stock Exchange (NYSE), the Nasdaq, the American Stock Exchange (AMEX). Major foreign stock exchanges include the London Stock Exchange and the Hong Kong Stock Exchange. The last place worth mentioning is the over-the-counter bulletin board (OTCBB). The Nasdaq is an over-the-counter market, but the term commonly refers to small public companies that don’t meet the listing requirements of any of the regulated markets, including the Nasdaq. The OTCBB is home to penny stocks because there is little to no regulation. This makes investing in an OTCBB stock very risky.

Stock Prices and Market Forces

Stock prices change every day as a result of market forces, most important of which are supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up. Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall. Understanding supply and demand is easy. What is difficult to comprehend is what makes people like a particular stock and dislike another stock. This comes down to figuring out what news is positive for a company and what news is negative. There are many answers to this problem and just about any investor you ask has their own ideas and strategies. The Stock Market


That being said, the principal theory is that the price movement of a stock indicates what investors feel a company is worth. Don’t equate a company’s value with the stock price. The value of a company is its market capitalization, which is the stock price multiplied by the number of shares outstanding. For example, a company that trades at $100 per share and has 1 million shares outstanding has a lesser value than a company that trades at $50 that has 5 million  shares outstanding ($100 x 1 million  = $100 million while $50 x 5 million = $250 million). To further complicate things, the price of a stock doesn’t only reflect a company’s current value, it also reflects the growth that investors expect in the future. The most important factor that affects the value of a company is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. It makes sense when you think about it. If a company never makes money, it isn’t going to stay in business. Public companies are required to report their earnings four times a year (once each quarter). Wall Street watches with rabid attention at these times, which are referred to as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection. If a company’s results surprise (are better than expected), the price jumps up. If a company’s results disappoint (are worse than expected), then the price will fall. Of course, it’s not just earnings that can change the sentiment towards a stock (which, in turn, changes its price). It would be a rather simple world if this were the case! During the dotcom bubble, for example, dozens of internet companies rose to have market capitalizations in the billions of dollars without ever making even the smallest profit. As we all know, these valuations did not hold, and most internet companies saw their values 54

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shrink to a fraction of their highs. Still, the fact that prices did move that much demonstrates that there are factors other than current earnings that influence stocks. Investors have developed literally hundreds of these variables, ratios and indicators. Some you may have already heard of, such as the price/earnings ratio, while others are extremely complicated and obscure with names like moving average convergence divergence. So, why do stock prices change? The best answer is that nobody really knows for sure. Some believe that it isn’t possible to predict how stock prices will change, while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. The only thing we do know is that stocks are volatile and can change in price extremely rapidly. The important things to grasp about this subject are the following: 1. At the most fundamental level, supply and demand in the market determines stock price. 2. Price times the number of shares outstanding (market capitalization) is the value of a company. Comparing just the share price of two companies is meaningless. 3. Theoretically, earnings are what affect investors’ valuation of a company, but there are other indicators that investors use to predict stock price. Remember, it is investors’ sentiments, attitudes and expectations that ultimately affect stock prices. 4. There are many theories that try to explain the way stock prices move the way they do. Unfortunately, there is no one theory that can explain everything. • Stock Categories The Stock Market


• • • • • • • •

Growth Stocks Blue Chip Stocks Income Stocks Cyclical Stocks Defensive Stocks Speculative Stocks Rights Warrants

Stock Market Hierarchy Sectors

One of the ways investors classify stocks is by type of business. The idea is to put companies in similar industries together for comparison purposes. Most analysts and financial media call these groupings “sectors” and you will often read or hear about how certain sector stocks are doing. One of the most common classification breaks the market into 11 different sectors. Investors consider two of there sectors “defensive” and the remaining nine “cyclical.” Let’s look at these two categories and see what they mean for the individual investor.


Defensive stocks include utilities and consumer staples. These companies usually don’t suffer as much in a market downturn because people don’t stop using energy or eating. They provide a balance to portfolios and offer protection in a falling market. However, for all their safety, defensive stocks usually fail to climb with a rising market for the opposite reasons they provide protection in a falling market: people don’t use significantly more 56

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energy or eat more food. Defensive stocks do exactly what their name implies, assuming they are well run companies. They give you a cushion for a soft landing in a falling market.

Cyclical stocks

Cyclical stocks, on the other hand, cover everything else and tend to react to a variety of market conditions that can send them up or down, however when one sector is going up another may be going down. Here is a list of the nine sectors considered cyclical: • • • • • • • • •

Basic Materials Capital Goods Communications Consumer Cyclical Energy Financial Health Care Technology Transportation

Most of these sectors are self-explanatory. They all involve businesses you can readily identify. Investors call them cyclical because they tend to move up and down in relation to businesses cycles or other influences. Basic materials, for example, include those items used in making other goods – lumber, for instance. When the housing market is active, the stock of lumber companies will tend to rise. However, high interest rates might put a damper on home building and The Stock Market


reduce the demand for lumber.

How to Use

Stocks sectors are helpful sorting and comparison tools. This is extremely helpful, since one of the ways to use sector information is to compare how your stock or a stock you may want to buy, is doing relative to other companies in the same sector. If all the other stocks are up 11% and your stock is down 8%, you need to find out why. Likewise, if the numbers are reversed, you need to know why your stock is doing so much better than others in the same sector – maybe its business model has changed and it shouldn’t be in that sector any longer. You never want to be making investment decisions in a vacuum. Using sector information, you can see how a stock is doing relative to its peers and that will help you understand whether you have a potential winner or loser.

Stocks in the Dow Jones Industrial Average AA ALD AXP BA C CAT CHV DD DIS EK 58


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NASDAQ Composite Index

The NASDAQ Composite Index tracks all the stocks that trade on the Nasdaq electronic exchange, which currently number more than 4,000. Even with this many stocks tracked by the index, the Nasdaq does not accurately represent the performance of the stock market on the whole. Due to its history and growth during the dotcom boom of the late 1990’s, the Nasdaq exchange is heavily weighted toward technology stocks. As a result, movement in the Nasdaq Composite Index more accurately reflects activity in technology and Internet-related sectors of the market. Though technology stocks make up the majority of the companies The Stock Market


traded on the Nasdaq, it also feature many financial, consumer, biotechnology and industrial companies, which are all tracked as part of the Nasdaq Composite Index. Because many of the most popular and profitable investments of the last decade have been in technology sectors, the popularity of the Nasdaq Composite Index has increase proportionately. As such, nightly newscasts often report the current value of the Nasdaq alongside the Dow Jones Industrial Average. The Nasdaq calculates its index value through a weighted average of the market capitalization of each Nasdaq stock. As such, it avoids the main drawback of the Dow Jones Industrial Average, with its calculations based on stock price. Investors can purchase shares in a number of index funds that track the Nasdaq Composite Index, as well as the QQQQ Exchange Traded-Fund that tracks the Nasdaq 100. The Nasdaq 100 is a separate index from the Nasdaq Composite Index; however, results will be largely similar, as the Nasdaq 100 is composed of the 100 non-financial companies with the largest market capitalizations traded on the Nasdaq exchange. In addition to the Nasdaq Composite Index and the Nasdaq 100 Index, the Nasdaq also calculates indexes that track performance in specific industries, including: industrial, transportation, banking, telecommunications, insurance, computers, and biotechnology.

Standard & Poor’s 500 Index

Many investors, and professionals in the financial industry have turned to the Standard & Poor’s 500 Index, also known as the S&P 500, as their index of choice to most accurately represent the performance of the total stock market. Additionally, most mutual funds advertise their performance relative to the S&P 500. 60

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The S&P Index Committee selects and tracks the performance of the 500 most widely held American companies. To determine which companies are most “widely held” by investors, the Index Committee analyzes market capitalization, volume of stock trades, and sector representation. Conscious decisions are made to balance index coverage to include all sectors and industries of the market. Usually, the composition of the S&P 500 changes by 5% – 10% (25 to 50 companies) annually. Because the S&P 500 tracks large, very stable blue-chip stocks, most of these changes are the result of mergers and acquisitions. However, sometimes stocks on the S&P 500 do fall off the index because of large drops in market capitalization, or blatant mismanagement that results in huge reduction in the volume of the stock’s trading, i.e. the Enron accounting fraud. Because it focuses on large stocks to achieve large market representation, the S&P 500 does not accurately reflect the performance of mid-cap and small-cap stocks. Often, performance coincides largely with market capitalization. Mid and small-cap stocks could potentially decrease in value as the S&P 500 increases, or vice-versa. As such, the S&P 500 cannot be used to gauge all investment decisions. Investors wanting to cast their lot alongside the performance of the S&P 500 can do so by purchasing shares in any number of mutual funds, or Standard & Poor’s Depository Receipts, the ETF that tracks the Standard & Poor’s 500 Index. In addition to the S&P 500, Standard & Poor’s manages a wide range of other indexes that track market performance in the U.S. and around the world. International S&P indexes can be valuable sources of information for investors considering foreign The Stock Market


investment. Additional information on international S&P indexes can be found at

Russell Indexes

The Russell Investment Group manages a set of indexes that track the performance of various market capitalization segments of the U.S market. The most unique of these indexes is the Russell 2000, which reflects activity of small cap stocks. The Russell 2000 is derived from a larger index, the Russell 3000. To calculate the Russell 3000, the largest 3000 American companies are identified and ordered, based on market capitalization. As such, the Russell 3000 Index gives investors a good gauge of the performance of the total stock market. The Russell 2000 discards the largest 1000 companies, and tracks the performance of the smallest 2000 companies in the Russell 3000 Index. As described earlier, market capitalization can strongly influence the performance of market segments. Investors that believe small cap stocks offer better growth potential than large cap stocks, given current market conditions, can invest in mutual funds or ETFs that track the Russell 2000 Index.

Market Sentiment Indexes

Various indexes track elements of market activity related to, but not directly reflected by movement in the price of stocks. These indexes are said to reflect market sentiment, which is the general feeling of investors about the market. As you can imagine, the feelings of investors vary a great deal. Some investors are perennially upbeat, or bullish, about the prospects of the market, while others are extremely negative, or bearish, in their 62

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outlook. Market sentiment indexes attempt to reflect the general mood of the average investor. Market sentiment indexes are valuable resources for investors in two ways. The first is that they identify trends in market activity that investors can “ride” by making investment decisions in the same direction as market sentiment. However, investors can also use market sentiment indexes to identify reversals that occur when market sentiment reaches an extreme that cannot be sustained. Investors must balance their desire to profit from market trends with the inevitability of that trend reversing at some point. Market sentiment indexes help investors determine how long they can ride trends before they must step off the bandwagon of market sentiment with their profits safely secured.

Volatility Index

The Volatility Index, also known as the VIX, reflects investor perception of the risk in purchasing stock, given current and expected short-term market conditions. As such, the VIX increases sharply during bear markets, and decreases during bull markets. The VIX is based on the current price of stock option puts, called “premiums.” Option puts give the holder the right, but not the obligation, to sell a stock at a set price on a future date. Because the seller of a put assumes the risk of the stock’s movement, increased volatility in a stock results in increased prices of option puts. This occurs because sellers require greater reward for assuming this greater risk. The VIX is best used when its current value is compared to historical markers that predictably correspond to specific market actions, such as reversals. For example, when the VIX reaches a low value around 20, a market sell-off usually occurs, driving stock prices down. The Stock Market


Bullish Percent Indexes

Bullish Percent Indexes, more commonly known as BPIs, calculate the percentage of stocks that currently exhibit “Point and Figure� Buy Signals. These signals are named after the Point and Figure chart type, composed of columns of Xs and Os that represent rising and falling stock prices respectively. A P&F Buy Signal occurs when the last price movement was a column of Xs higher than the previous column of Xs, with no intervening column of Os. Bullish Percent Indexes are calculated by dividing the number of stocks tracked by an index that currently exhibit a P&F Buy Signal, by the total number of stocks on the index. This calculation reveals the percentage of stocks on an index that are expected to rise in value, according to Point and Figure theory. BPIs are calculated for all major indexes.

Put/Call Ratio

The Put/Call Ratio is not exactly an index, but it provides information regarding market sentiment that can be used alongside the other market sentiment indexes. Investors use the ratio between option puts and option calls being sold by traders as a measure of the general sentiment on short-term market direction. Remember that a put option gives the holder the right, but not the obligation, to sell stock at a specified price at a future date. Put buyers expect a stock to decrease in value. A call option gives the holder the right, but not the obligation, to buy stock at a specified price at a future date. Call buyers expect a stock to increase in value. 64

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Put/Call Ratio is best used as a contrarian investing tool, because 90% of options are not exercised. Option buyers are correct only 10% of the time. Most options are bought when market conditions are at an extreme – either oversold (too bearish) or overbought (too bullish). Investors begin to make emotional decisions in favor of the current trend, just as the trend is likely to end with a large reversal. As such, it is in the best interest of investors to make investments contrary to the sentiment of option buyers, especially during periods of high options volume. When the market is purchasing puts in high volume, expecting the market to decrease and driving the Put/Call Ratio far above 1, the market will likely make a bullish reversal. When investors are buying calls, driving the Put/ Call Ratio far below 1 in expectation of continued growth, the market will likely make a bearish reversal.

Other Indexes

Other indexes offer investors important information about total market and market segment performance. The NYSE Composite Index tracks the performance of all stocks listed on the New York Stock Exchange. It is weighted by market capitalization, and accurately reflects total market activity. Additionally, performance of NYSE stocks in specific sectors and industries is tracked by four subgroup indexes: Industrial, Transportation, Utility, and Finance. Every major stock exchange around the world also features at least one, and usually multiple indexes that track the performance of stocks listed on that exchange. For example, the Nikkei average

The Stock Market


is commonly reported on nightly newscasts as a representation of Japanese market activity.

Stock Market Symbols Ticker symbols are simply a system of letters used to represent a stock or mutual fund. They are a necessary way to keep track of and find information about a security. Whenever you use a quoting service, you will be asked to type in the ticker symbol. The number of letters and the letters themselves contain useful information about the security. Mutual fund ticker symbols are five letters and end with the letter ‘x’. For example, Fidelity’s Magellan fund is FMAGX and Vanguard’s Index 500 fund is VFINX. Money market funds use three letters followed by XX.

Stock Ticker Symbols

Stock symbols consist of up to three letters if they are listed on NYSE or AMEX exchanges. If they are listed on the Nasdaq exchange, then they use four letters. On Nasdaq, stocks that are not single issues of common stock use five letters (common stocks use four). The fifth letter has meaning. Below is a table listing the fifth letter codes:

Stock Ticker Symbols A B C D E


Class A Class B Issuer qualifications exceptions New issue Delinquent in filings with the SEC Essentials Manual

F Foreign G First convertible bond H 2nd convertible bond I 3rd convertible bond J Voting K Nonvoting L Miscellaneous situations M 4th class of preferred shares N 3rd class preferred shares O 2nd class preferred shares P 1st class preferred shares Q Bankruptcy proceedings R Rights S Shares of beneficial interest T With warrants or with rights U Units V When­issued and when distributed W Warrants X Mutual Fund Y ADR (American Depository Receipt) Z Miscellaneous situations

Other Ticker Symbols

Financial products that are not stock, but still traded on major stock exchanges, also have representative ticker symbols. Mutual fund ticker symbols contain five letters, and always end with an X, as in the FMAGX that represents Fidelity’s Magellan Fund, the largest actively-traded mutual fund in the world. Money market funds are represented with five-letter symbols that always end in XX, such as VMMXX, the ticker symbol for Vanguard’s Prime Money Market Fund. The Stock Market


Ticker symbols for options can sometimes be quite complex, and are not described in this manual. Stock Symbology Some companies are assigned unusual or funny ticker symbols. There’s no doubt these companies were shocked when they received their symbol from the exchange.

Symbol Comment AFL.BO Invest in your favorite football locker room. BYO.AX Sounds like a logger party. CHIC The trendy stock. CRZY A highly volatile stock. CTCO.NS City thugs want your money! GEEK Gotta have something to counter the CHIC stock. DABU.NS Forget Saturday Night Lives “da-bulls” and “dabears.” BNCO.NS At least they are honest about the way they run their business. EMCO.NS More cons that are up from about their identity. FUN Stock investing can be fun and games. GASEX The anti-flatulent mutual fund. GODD Now people can invest directly for future sins. HIT Be careful... you may take a hit with this stock. ICSEX Alternative meaning: making love in Alaska. IMAN For the gender biased investor. LESS.BO Must be an F-F (female to female) or an anti-perspirant company. LMNE Short this one because it is sure to go bad. LUV What’s love got to do with it? ONE.TO The stock that likes to count. 68

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MORE.BO A stock that is sure to make you sweat. MRFIX When your portfolio breaks, add this mutual fund. RATIX Forget dog ticks, get the New York sewer variety. RATL Must be a baby toy manufacturer. SRRY Our apologies if you invested in this stock. URI The stock with multiple personalities. WMNXX Playboy’s favorite money market fund. WSOB This hot stock goes well with sushi. Names aside you will quickly learn that symbols are important. Just ask Microsoft, symbol MSFT, who added millions of dollars in market capitalization to a similarly named company MFST. You may laugh now, but wait until you mistype or forget a symbol.

Using Ticker Symbols

All brokerages use ticker symbols to process orders to sell and buy stock. As such, in order to find information about, and purchase shares in a stock, you have to know the stock’s ticker symbol. Fortunately, ticker symbols are easy to find. The Web sites of most brokerages have a link that allow you to look up the ticker symbol of any stock, option, mutual fund, or other financial product you are interested in.

The Stock Market


Chapter 4

Introduction to Stock Market Analysis Now that you have a firm understanding of the basics of the stock market, and other financial markets, it’s time to begin discussing how to analyze the market and individual stocks. The remainder of this manual discusses stock market analysis. In these chapters, you’ll learn a top-down approach to identifying winning stocks. This chapter teaches you how to analyze broad markets, including the performance of the U.S. economy in general, and its strength relative to the economies of other countries around the world. You’ll also learn how to analyze individual sectors and industries within the U.S. market, and identify those segments of the economy that will most benefit from short-term market and economic conditions. These are the areas of the marketplace where you will want to invest in “long positions” that will grow in value as the sectors and industries grow. You will identify other market segments at a disadvantage in the current and short-term economic conditions. Stocks in these sectors and industries present good opportunities for “short positions” to profit. Once you identify growing sectors and industries, you will want Introduction to Stock Market Analysis


to identify the leaders in those marketplace segments. You can accomplish this through industry comparisons and fundamental analysis. Fundamental analysis evaluates a company’s business performance, and is based on the idea that the stocks of highperforming companies will naturally increase in value over time. Through fundamental analysis (covered in detail in later chapters), you can pick the individual stocks that feature the most promising business model, management performance, and growth potential in the entire industry. These stocks present the greatest opportunity for profit. However, it is also important that you not overpay for an investment in a winning company. Technical analysis is used to identify the best entry point for a stock purchase, and uses charts displaying the historical trends in the movement of stock prices. By combining broad market, fundamental, and technical analysis, you can pick the right sector, industry, stock, and time to make a trade.

Introduction to Broad Market Analysis As an investor focused on making money in the stock market, it is wise to analyze as many money-making options as possible. The best way to do this is to begin your analysis with a top-down approach. A top-down approach evaluates global economic conditions first, and then works through smaller and smaller marketplace analysis to eventually arrive at an individual company to invest in. By analyzing the big picture first, top-down investors avoid missing out on opportunities that other investors, focused only on a specific industry or market segment, might never even 72

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consider. This chapter describes how to analyze broad markets. You will first learn about the factors that influence economic conditions, such as market cycles and Federal Reserve policy. The economic indicators that investors use to gauge the performance of the economy are then described. This information is then used to identify sectors and industries that stand to benefit from current and short-term economic and marketplace conditions.

Bull and Bear Markets

The stock market describes trends in the general economy and stock market as either bullish or bearish. A bull market corresponds to a consistent rise in the averaged price of stock. This can be identified by steadily increasing values in indexes that track total market performance, such as the Dow Jones Industrial Average, or the Standard & Poor’s 500 Index. A bearish market corresponds to a consistent decrease in the averaged price of stock. Total market indexes steadily decline during a bear market. Determining whether a market or economy is bullish or bearish at any given time largely depends on the time scale used to analyze market conditions. For example, over the entire course of its history, the stock market has been extremely bullish, averaging a 12% annual increase in averaged stock prices. However, during the period between 2000 and 2003, when the market suffered major declines due to the “dotcom� correction, the market was extremely bearish. Analyzing the market and economy in shorter time periods, down to even the daily direction of the market, will reveal greater volatility in the transitions between bullish and bearish markets. As such, investors should evaluate the direction of the market in a way that corresponds to their investing time scales. If you plan Introduction to Stock Market Analysis


to purchase and hold stocks for the long-term, it is in your best interest to determine whether the market is bullish or bearish in the long-term, perhaps over the next five to ten years. If you plan to buy and sell stocks within a given day, determining the longterm bullish or bearish direction of the market is largely useless for your purposes. However, knowing the direction of the market and your individual positions at any given minute during the day, is vital to timing your trades.

Market Cycles

The performance of the U.S. economy, and the stock market in particular, often reflect patterns of repeating trends, called cycles. These cycles are largely a product of emotional investment decisions, particularly decisions based on fear and greed. In declining markets, investors fear that the cycle will never reverse, and that they will continue to lose money as the price of their holdings decrease. Desperation sets in, and investors “oversell” their stocks at prices lower than a rational valuation of the company’s business performance. The market is flooded with doom and gloom investors, all trying to get rid of their “worthless” stocks, and willing to do so for a portion of what they spent on the stock. Eventually, rationality regains its footing in the market, and investors begin to see that the business performance of the stock does not justify such a low price. The market reaches a bottom, and begins to turn in a positive direction, when demand for the oversold, and now underpriced, stock overtakes the supply created by panicked investors selling their shares at a loss. The opposite scenario holds true as well, and occurs during a market “bubble.” A bubble forms when greed motivates investors to overbuy stocks at prices far above a rational valuation of the company’s business performance. This kind of “irrational 74

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exuberance� characterized the dotcom bubble that burst in mid 2000. Eventually, all bubbles are corrected by a reversal when stock prices drop to more accurately reflect the business performance and future potential of their companies. The crests and troughs represented by market bubbles and bottoms are part of a larger market cycle composed of four distinct phases: Accumulation, Mark-Up, Distribution, and Mark-Down. When one phase ends, the next begins. When one complete cycle ends, a new cycle begins. In this way, market cycles move fluidly between phases. However, market cycles do not necessarily occur with any regularity over time, and the individual phases of a market cycle might each occur over markedly different time frames as well. Most business cycles in the American market since WWII have lasted between three to five years. However, these general guidelines cannot be relied upon to predict the duration of any specific business cycle. Additionally, sudden events that have large-scale economic events such as a war or a natural disaster, can jump-start the onset of any individual cycle phase. As such, it is difficult to predict the transitions between market cycle phases exactly. Instead, it is more valuable to analyze the general sentiment of the market at any given time in a cycle. Each market cycle phase corresponds to an overall market sentiment, which can be used to predict future market trends along the path of the market cycle.


The Accumulation phase occurs while the main market sentiment is still bearish on a stock, or the market in general. However, individuals in the know, such as corporate insiders or investors actively seeking value stocks, identify stocks that are substantially underpriced. These savvy investors are able to purchase stocks Introduction to Stock Market Analysis


at the bottom of the market, when the worst of the cycle is over, and others have sustained the financial damage of the preceding downtrend. Most investors, however, are expecting the bearish trend to continue. Media accounts predict further decreases in stock prices and index values. Even many long-term investors have given up hope of an economic rebound, and sold their remaining shares at a loss. When prices show signs of flattening, the worst of the previous “mark-down� phase is over, and the accumulation of stock at low prices can now begin. The hallmark of the accumulation phase is that fundamental ratios of stocks, such as earnings per share, are at levels that indicate true value buying opportunities.


The Accumulation phase ends, and the Mark-Up phase begins, as soon as stock prices begin to move higher. Signs of the Mark-Up phase include media speculation that the worst of the previous Mark-Down might be over. Investors focused on technical analysis identify the uptrend and begin to move into the market in long positions. Lagging economic indicators, such as unemployment and layoffs, continue to rise during the initial periods of the Mark-Up phase. As the Mark-Up phase continues, however, leading and coincident economic indicators peak. Amateur investors begin to see and hear on the news of how much money people are making in the stock market. They begin to enter the market in droves, driving prices higher because of increased demand. Stock prices climb above the historic standards of the market, and the individual sectors and industries to which uptrending stocks belong. 76

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Smart investors exit the market with substantial profit during the uptrend, or at the peak of the Mark-Up phase. Foolish investors continue to funnel whatever resources they can make available into the stock market, out of greed and a fear that they will miss the money-making opportunity.


Eventually, stocks become so overpriced that investors who have made profit cannot resist taking it. They sell their shares, increasing supply sharply. However, no new demand exists to absorb the new shares, and so prices begin to fall. The bullish, euphoric sentiment of the Mark-Up phase collapses, and becomes mixed. This mixture of market sentiment drives volatility. Sharp increases and declines appear as investors try to launch another uptrend, only to have it ended by profit-taking and rational assessment of stock valuations.


Eventually, the market in general recognizes the large-scale overpricing of securities. The Mark-Down phase represents the bursting of the Mark-Up bubble. Wise investors moved out of their long positions long ago, and might now begin short-selling stocks to take advantage of the steady downtrend. Amateur investors, who jumped on the bubble bandwagon either exit their positions early in the Mark-Down phase, having lost only a portion of their investment, or hang on while share prices dwindle to a shadow of their previous highs. Eventually, these amateur investors can take no more, and begin to sell their shares at a huge discount. The increased supply Introduction to Stock Market Analysis


Distribution Mark-Up Mark-Down Accumulation

pushes prices down even further. Valuations reveal that stocks are substantially underpriced, given the business performance of companies. Smart investors recognize this as a buying opportunity, and begin to get into the market as losing investors sell at the bottom. The market cycle begins anew with the Accumulation phase.

Using Market Cycles in Investing

The lesson of market cycles is that investing is a speculative art. Money is made by predicting the future trend of the market, not by reacting to the current, and inevitably outgoing phase. As you will learn in the coming chapters, various investors try to approach the speculative nature of the market through different methods. Investors that focus on fundamental analysis try to avoid the issue altogether by evaluating company performance irrespective of stock price. Fundamental analysts assume that, given a long enough investment strategy, the stock price of highperforming companies will always increase. Technical analysts, however, try to face the speculative nature of the market head-on by anticipating coming market trends as the natural product of current market performance. 78

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A balanced approach to market cycles acknowledges the value of both fundamental analysis and technical analysis. Investors using this balanced approach consider all factors to identify the right time to invest in high-performing companies in industries that benefit from coming market conditions.

Federal Reserve Policy

In addition to the natural market cycles that occur in an economy, external forces and factors can influence the direction and performance of an economy as well. The Federal Reserve is the most powerful force in the U.S. economy, and is charged by the government “to promote sustainable growth, high levels of employment, stability of prices to help preserve the purchasing power of the dollar and moderate long-term interest rates.” Most commonly known simply as “The Fed,” the Federal Reserve is the bank of the U.S. government. The Fed is a complicated system made up of several layers of banks, steering committees, and other bureaucratic elements. For the purposes of investing in the stock market, it is important to understand two of the main duties of the Fed: (1) to establish margin requirements for investors, and (2) to devise and implement monetary policy

Margin Requirements

Stock purchased “on margin” is bought with borrowed money, usually from the broker through which the stock is purchased. Buying stock on margin amplifies both the potential for gain and loss. Margin investments played a key role in the stock market crash of 1929, and the ensuing depression. Because of the added risk associated with margin investments, the Federal Reserve limits the portion of borrowed money that can be Introduction to Stock Market Analysis


used to purchase stocks. Currently, investors can borrow no more than 50% of an investment. If the value of an investment drops to the point where the amount borrowed to purchase the stock is greater than 50% of its value, the brokerage that loaned the money is legally required to issue a margin call to the investor. A margin call forces the investor to repay whatever amount will reduce the debt back to 50% of the investment value. The Federal Reserve changes margin requirements infrequently, and this value is not used to influence economic performance.

Monetary Policy

The main tool that the Federal Reserve uses to influence economic performance is its power to direct monetary policy. Monetary policy includes a set of Fed actions that increase or decrease the supply and demand of both money and credit in the U.S. economy. By manipulating money and credit availability, the Fed can either slow or speed the economy. The Fed uses three specific tools to direct monetary policy: Reserve Requirements, the Discount Rate, and Open-Market Operations.

Reserve Requirements

Of the three tools listed above, the only one that uses any legal authority granted to the Fed is its right to designate bank reserve requirements. Understanding this legal authority is critical to understanding the two other tools used by the Fed to control economic performance. The reserve requirement designated by the Fed is the percentage of deposits that a bank must hold in reserve. The reserve requirement usually hovers around 10%, and is changed infrequently by the Fed. Because it only has to hold 10% in reserve, a bank can loan out the remaining 90% of deposits that it receives from its account holders. This makes money available in the economy for business 80

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loans, mortgages, personal loans, and all other types of economic activity. The reserve requirement set by the Fed balances the performance of the economy as determined by availability of money, against the risk of banks not having available funds to repay depositors.

Discount Rate

If a bank run were to ever occur, however, banks could easily take out loans from the Federal Reserve itself. In fact, banks manage their daily reserve using Fed-issued short-term loans, and loans from other banks. The Fed issues loans at an established “discount rate,” denoting the interest that a bank pays to borrow these funds. The discount rate is used by the Fed to influence another key interest rate called the “Federal Funds Rate” (FFR). The FFR is the interest rate that banks charge one another for short-term loans, which are usually issued to meet reserve requirements at day’s end. The Fed has no direct authority to designate the interest rate banks charge one another. As such, the FFR increases and decreases with supply and demand in the open market. However, the Fed sets a target for the FFR, and alters the discount rate to influence the interest rates banks charge one another in the open market, so that it approximates the targeted FFR. When nightly news programs talk about the Fund “raising the interest rate,” they actually mean that the Fed has changed their targeted Federal Funds Rates, and has likely moved the discount rate to help facilitate this moving target. Because the Federal Funds Rate affects the amount of interest that banks pay to operate, it sends ripples throughout the economy. When the FFR increases, banks likewise increase the interest rates they charge to bank customers seeking loans. This makes money less available in the economy, and slows its growth. Conversely, when the Fed lowers the target for the FFR, banks have easier Introduction to Stock Market Analysis


and cheaper access to loans required to meet their reserve. They pass these savings along to their customers in the form of lower interest rates for loans. The economy grows in response to the easy availability of money and credit.

Open-Market Operations

The Fed also participates in the sale and purchase of U.S. government securities in the open market to influence the availability of money in the economy and to achieve the targeted Federal Funds Rate. When the Fed increases the FFR, it simultaneously sells securities, such as treasury notes, bonds, and bills. When the Fed decreases the FFR, it buys government securities from the open markets. The Fed has the authority to release new money into the economy, and does so when it buys these government securities. The banks that sell the securities to the Fed now have cash on hand, which contributes to the reserves they are required to maintain. The Fed has enormous resources at its disposal, and purchases enough government securities to affect the reserves held by a substantial number of banks nationwide. Because these banks no longer need to borrow money to meet their reserve requirements, the demand for these loans decreases. When demand decreases, the interest rates charged for the loans also decreases. When the Fed sells government securities, the banks that purchase them have less money on hand, with which to meet their reserve requirements. The demand for Federal Funds Rate loans increases, and the Federal Funds Rate itself increases. The Fed attempts to calculate the exact amount of securities it needs to buy or sell to achieve the Federal Fund Rate it has targeted. The Federal Open Market Committee (FOMC) is the entity within the Federal Reserve that is charged with formulating 82

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monetary policy and setting the FFR target. The FOMC meets eight times yearly, and is composed of a seven-member Board of Governors and the presidents of five reserve banks. The Board of Governors is appointed by the President and confirmed by the Senate, and each member serves 14 year terms. The Board Chairman can serve an unlimited number of four-year terms. All FOMC meetings are secret, but speculated on heavily by market watchers and investors. Movements in the Federal Funds Rate target can signal shifts in the direction of the stock market. The Fed attempts to sustain steady economic growth, while maintaining a low rate of inflation. Inflation occurs when the economy grows too quickly, and the purchasing power of the dollar decreases. If the economy slows too dramatically, however, a recession can occur.

Economic Indicators

In addition to market cycles, and Federal Reserve policy, investors make use of economic indicators to evaluate the performance of the economy and stock market. Economic indicators present fundamental data reflecting the health of the economy in the form of indices, earning reports, economic summaries, and statistics. This information lets investors and economists evaluate current economic performance and make predictions of future performance. Economic indicators are generated by various government, private, and academic organizations, including The National Bureau of Economic Research, The Conference Board and The Bureau of Labor Statistics. These organizations release their economic indicators at scheduled dates, some of which seem randomly chosen. For example, the Financial Management Service releases the Monthly Treasury Statement on the 8th workday of the Introduction to Stock Market Analysis


month, every month. Investors eagerly anticipate the release of key economic indicators, because they often reveal information that drives the market in a particular direction and as such, influence investing decisions. Some of the most anticipated economic indicators include the following: • • • • • • • •

Unemployment Housing Starts Consumer Price Index Industrial Production Bankruptcies Gross Domestic Product Retail Sales Money Supply

Economic Indicator Categories

These and other economic indicators are often categorized by their relationship to current activity in the economy as a whole. Leading economic indicators usually change before the general economy, and include stock prices, and the average work hours in the manufacturing sector. Coincident indicators change at the same time as the activity of the general economy, and include payroll statistics and personal income. Lagging indicators change after the economy on the whole has changed. Lagging indicators include unemployment, and the percentage change in the Consumer Price Index. The lead time or lag time of any economic indicator is the period before or after changes in the general economy that the indicator usually changes. Additionally, economic indicators can be classified as pro-cyclical or counter-cyclical. Pro-cyclical indicators increase as the general 84

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economy increases and decrease as the economy decreases. Counter-cyclical indicators increase as the general economy decreases, and decrease as the economy increases. For example, unemployment increases as the economy worsens, and as such is described as a counter-cyclical, lagging economic indicator. Certain economic indicators drive the direction of the Stock Market heavily, and are described in greater detail in the following sections.

Gross Domestic Product (GDP)

The Gross Domestic Product is released quarterly by The Bureau of Economic Analysis, an agency in the Department of Commerce. The GDP can be measured using any of several calculations, each of which intends to most accurately determine the overall size of a country’s economy by determining the market value of all goods and services produced in that country in a given period of time. A common calculation used to determine GDP adds together the following elements of economic activity: Consumption: all disposable income that does not go toward savings, including money spent on food, rent, and medical expenses Investment: money spent by businesses on non-financial products, such as machinery Government Spending: money spent by the government on the salaries of public servants, weapons purchases for the military, and investments Net Exports: money coming into the country from the sale of Introduction to Stock Market Analysis


goods or services to foreign nations, minus money leaving the country from the import of goods and services sold to America by foreign countries There are specific reasons why each of these elements of economic activity is included in the calculation of Gross Domestic Product, and why others are not. For the purposes of learning to invest for profit in the Stock Market, it is important only to understand that growth in the GDP is important for a stable and growing economy. Economists theorize that a growth of 2.5% - 3% annually is a sustainable rate, and has been the historic growth rate of the U.S. economy.

Producer Price Index (PPI)

Published monthly by the Bureau of Labor Statistics, the Producer Price Index measures the average change in prices charged by domestic producers for their output. Prices for over 100,000 products, from 30,000 companies, are tracked. The PPI primarily measures inflation, and its movement can signal coming activity in the Consumer Price Index.

Consumer Price Index (CPI)

Another economic indicator released monthly by the Bureau of Labor Statistics, the Consumer Price Index measures the price of specific goods and services purchased by consumers. As the price of these goods and services increases, the buying power of the dollar decreases, a condition known as inflation. The goods and services measured in the CPI include a standard set of items known as the “Consumer Basket.” The consumer basket is further subdivided to identify the economic areas in which inflation is occurring most rapidly, including: Household Items, Personal Goods and Services, Tobacco, Leisure Goods, Households Services, Housing, Alcoholic Drinks, and others. The “Core CPI” used as the general 86

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measure of inflation excludes food and energy costs, because these typically have high price volatility, and changes in their prices are often short-lived. The CPI is also sub-divided to represent inflation that affects different segments of the population. The CPI-U analyzes the effects of inflation on “All Urban Consumers” and is estimated to represent 87% of the total U.S. population. The CPI-W is a subset of the CPI-U and tracks inflation’s effects on “Urban Wage Earners and Clerical Workers.” The CPI-W represents roughly 32% of the population. A general weakness of the CPI is that it does not track inflation in rural areas. The stock market follows the CPI closely, and expects yearly increases that do not exceed 1% - 2%. Anything larger than this makes investors worry about uncontrolled inflation. Inflation affects the markets in two main ways. First, it decreases the purchasing power of the dollar, limiting the ability of consumers to buy products. Second, inflation causes the Fed to increase interest rates, which slows the growth of companies who are forced to pay higher interest on borrowed money. As such, substantial increases in the Consumer Price Index usually cause proportionate decreases in the stock market.

Consumer Confidence Index

The Conference Board releases the Consumer Confidence Index (CCI) monthly. The CCI surveys 5,000 American households, and asks questions regarding planned spending, expectations of rising wages, and other factors that affect consumer sentiment toward the economy. Results are released for the national economy, and also for regional economies across the country. Decreases in consumer confidence correspond to decreased earning and spending, which lower company profits and stock Introduction to Stock Market Analysis


prices. However, sharp increases in consumer confidence can lead to inflation, which causes the Federal Reserve to increase interest rates, which also decreases stock prices. Ultimately, stable and sustainable increases in consumer confidence please the stock market most. As such, investors should evaluate the long-term trend of the CCI more closely than any month-to-month shift.

Analyzing Sectors

As described in the “Business Categories” section of the previous chapter, the most general category used to subdivide the total stock market is the sector. Most economists divide the market into twelve sectors, each of which is considered either defensive or cyclical. Defensive sectors are very stable, and tend not to move much with fluctuations in the economy or stock market in general. Only two sectors, Utilities and Consumer/Non-Cyclical, exhibit this kind of stable, defensive behavior. Cyclical stocks move considerably with activity in the economy and overall market. Cyclical sectors include the ten non-defensive sectors: • • • • • • • • • •

Basic Materials Capital Goods Conglomerates Consumer Cyclical Energy Financial Healthcare Services Technology Transportation

When using a top-down approach to investing, sectors are analyzed relative to one another after general predictions of the economy’s and total market’s directions have been determined. Comparing 88

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sectors is based on the idea of “sector rotation,” which states that any movement in the market favors industries in a specific sector, and disfavors other sectors. More specifically, certain stages of an economic cycle benefit certain sectors more than they do other sectors. By identifying upcoming market phases, investors can align their investments with sectors that stand to profit from the sector rotation of the coming phase. Theories of sector rotation are based on the research of the National Bureau of Economic Research (NBER), a private nonprofit organization that boasts many researchers who have won the Nobel Prize in Economics. NBER research has identified eleven distinct market cycles in the U.S. economy since 1945. As described in the previous “Market Cycles” section, each cycle has included a distinct period of economic expansion, and a corresponding contraction. As of the writing of this manual, the NBER identifies current market conditions as a period of expansion. Since 1945, individual growth periods have lasted from between 12 and 120 months, and averaged 59 months. The NBER has tracked the performance of individual sectors throughout the stages of market cycles, and identified patterns in which certain sectors perform better at certain periods of the cycle. Their general observations, arranged by market cycle phases, include the following: Mark-Down Phase: Early Mark-Down: Cyclicals and Transports Middle Mark-Down: Technology Late Mark-Down: Industrials Accumulation Phase: Introduction to Stock Market Analysis


Early Accumulation: Industrials Middle Accumulation: Basic Materials Late Accumulation: Energy Mark-Up Phase: Early Mark-Up: Energy Middle Mark-Up: Staples Late Mark-Up: Services Distribution Phase: Early Distribution: Services Middle Distribution: Utilities Late Distribution: Cyclicals and Transports

Analyzing Industries

Each of the twelve sectors in an economy can be further subdivided into industries. Companies within an industry compete with one another to sell the same product or service in the same marketplace. Just as sectors go through periods of increased and decreased performance, industries also observe cycles. However, industry cycles tend to be single events that do not repeat themselves. This is due to the fact that an individual industry usually deals in a single product or service type. Nearly all products and services become outdated as new, competing industries emerge, evolve, and replace the original industry. This transition, and the industry cycle underlying it, might take hundreds of years to complete. For example, the automobile industry has been a major force in the American economy for over a century. However, as new transportation technologies develop, the automobile might conceivably be replaced one day. Alternatively, an entire industry 90

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might bloom and die out in a matter of a few short years, as occurred when Laser Discs were replaced soon after their initial introduction into the market because DVDs offered consumers better video performance at a smaller price. The growth cycle of an industry can be divided into four distinct phases: Emergence, Rapid Growth, Maturity, and Decline.


The Emergence phase of an industry might be kicked off by a single company, or a small group of companies first offering a new product or service to the marketplace. Many times, an industry emerges when a new technology develops, such as when Alexander Graham Bell spawned the modern telecommunications industry with his invention of the telephone. Only rarely will a new invention or technology be entirely developed at the onset of an industry’s emergence. As such, companies establishing a new industry must often invest substantial money into research and development. To pay for this development, companies pursue investment capital through a variety of funding sources, including venture capital firms, business loans, investments from friends and family, and Initial Public Offerings (IPOs). Even successful companies in emerging industries often lose money for months or years before establishing profitability. Because they cannot show profit on accounting statements, fundamental analysis is largely useless in evaluating these companies as potential investments. The peril associated with investments in companies in emerging industries can be seen through the events of the dotcom crash of the early 2000’s. Reality failed to match investor expectations about the profitability of internet-based companies. While many Introduction to Stock Market Analysis


companies, such as Google and Amazon, have established stable markets using the Internet as their sole technological resource, the Internet in and of itself was not enough to guarantee success for any company operating within this new industry. As such, only investors who are comfortable with high investment risk should consider companies in emerging industries.

Rapid Growth

Rapid Growth industries typically offer products or services that are in high demand in the marketplace for any number of reasons. Rapid Growth often occurs when the products and services of an emerging industry establish reliable and stable demand in the marketplace. The rapid growth phase of certain industries can be quite shortlived when the market for a product diminishes as companies supply a one-time consumer demand. Once everyone who wants one has a Nintendo Gaming System, for example, sales inevitably decline. Companies struggle to maintain rapid growth by offering new versions of products regularly, or planning for the usefulness of previous product versions to diminish over time. This “planned obsolescence� is highly visible in the computer industry, as new software requires greater and greater processing and memory performance, which older computers cannot provide. In order to take advantage of new software, consumers must buy correspondingly powerful new computers. Industries that successfully establish ongoing demand for new product releases and versions, and can maintain a rapid growth phase over many years, offer compelling opportunities to investors. 92

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The costs of raw materials and production decrease rapidly when products are in high enough demand to produce in bulk quantities, a concept known as “economies of scale.” Companies in rapid growth industries can take advantage of decreasing production expenses by lowering prices and still increasing margins and profit. However, doing business in a rapidly growing industry does not guarantee success. Companies in rapid growth industries face substantial competition from new companies entering their lucrative market space. As such, establishing market share and “mind share” through a recognizable and trusted brand name become important determinants of company performance. Companies without this name recognition face uphill odds for success. Even though they belong to a rapidly growing industry, the profit from this industry is spread across a disproportionate number of companies competing with one another. Savvy investors profit from rapid growth industries in two ways. First, investors can identify the best performing companies in the industry and invest in them exclusively. Alternatively, investors can invest in the performance of the entire industry through a mutual fund or exchange-traded fund that tracks that industry.


Companies in mature industries offer products and services that typically supply stable marketplace demand. Because demand is relatively consistent, these industries do not offer the substantial growth prospects of companies in rapid growth or emerging industries. However, investors in mature industries also do not face the same risks inevitable in these other highly volatile industries. The stocks of companies in mature industries tend to approximate Introduction to Stock Market Analysis


the performance of the economy in general. There is some variability between companies in the same mature industry, however. Companies compete for marketplace position by distinguishing themselves through enhanced customer experience or lower price. Such tactics are highly visible in mature industries such as insurance and airlines. All things considered, investments in mature industries offer investors a low-risk, and low-growth option that will match the performance of the general economy. As such, some investors prefer mature industries because they are easier to analyze than rapid growth and emerging markets.


Declining industries might result from decreased market demand for a product, or the emergence of a new technology that replaces previous products that do not perform as well. Often, companies with expertise in an industry will migrate their business efforts toward this new, similar technology. As such, companies can remain competitive and profitable despite the decline of their previous industry. In and of themselves, however, declining industries offer investors few opportunities, except to short-sell the stocks of slowly dying companies that refuse to migrate their business efforts elsewhere. While there will always be certain companies that serve as the exception to the rule of a declining industry, it is often difficult for an investor to identify the wheat among the chaff, and risky to assume that a company can keep ahead of decreasing demand.

Profiting from Broad Market Analysis

Once you have determined a market, sector or industry that you predict will benefit from current and short-term future market 94

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conditions, you have two options. First, you can make investments in the market, sector, or industry on the whole. This is described in the section that follows, entitled “Using EFTs to Make Broad Market, Sector, and Industry Investments.” Alternatively, you can perform further analysis of the individual stocks within the sectors and industries you have identified as winners. Additional stock analysis is described in detail in the following chapters, Fundamental Analysis, and Technical Analysis.

Using EFTs to Make Broad Market, Sector, and Industry Investments

As described briefly earlier, Exchange Traded Funds offer investors the combined benefits of mutual funds and stocks. An Exchange Traded Fund bundles together the securities tracked by a specific index, and trades on a stock exchange, giving investors the opportunity to take out long, short, or option positions. ETFs provide the diversity of a mutual fund, and let investors freely piggyback on the professional analysis of the economists that select the index stocks. At the same time, ETFs provide the liquidity, analytical opportunities, and reduced transaction costs of a stock. Perhaps most importantly, ETFs let investors profit by predicting trends in the general direction of the Stock Market or its component sectors and industries. By completing the broad market analysis steps discussed in this chapter, and purchasing ETF shares that match your analytical predictions, there is no need to evaluate the individual stocks within the winning sectors and industries you’ve identified. You can profit from the entire market segment using an ETF. There are hundreds of ETFs that each track an individual index, Introduction to Stock Market Analysis


including indexes representing individual sectors, industries, foreign countries, or the total U.S. stock market. A comprehensive list of Exchange-Traded Funds can be searched based on sector, industry, and many other criteria at The following ETFs track some of the largest indexes, and can be used for a variety of investing purposes:


This exchange-traded fund tracks the Nasdaq-100 Index, which contains the 100 largest non-financial stocks listed on the Nasdaq Exchange. Because financial companies are excluded the Nasdaq 100, and the QQQQ, represent a very heavy technology emphasis. Within the Technology industry, however, the QQQQ provides broad exposure, letting investors conveniently bet on the long-term growth of companies from computer manufacturers to telecommunications and biotechnology firms.


Standard and Poor’s Depositary Receipts, commonly called “spiders,” are traded on the American Stock Exchange (AMEX) and track the S&P 500, or a subset of this complete market index. “Select Sector” SPDR funds, such as Financial, Energy, Consumer Staples, or Healthcare, bundle a portion of the S&P 500 companies into an individual fund.


Barclay’s Global Investors offers over 100 individual exchangetraded funds, collectively called iShares ETFs. iShares track a wide variety of indexes, including many created by Dow Jones and Company, Goldman Sachs, Lehman Brothers, Morningstar, and MSCI. iShares also track other large, well-known indexes such as 96

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Nasdaq, NYSE, Russell, and S&P offerings. All iShares ETFs are traded on the AMEX.


Vanguard offers 27 exchange-traded funds, collectively called Vanguard Index Participation Receipts, or “Vipers.� Vipers are available that track individual sector indexes, such as the Vanguard Industrials ETF that follows the performance of the MSCI US Investable Market Industrials Index. Other Vipers track indexes that aim to achieve a specific investment objective, such as the Vanguard Dividend Appreciation ETF that tracks the Dividend Achievers Select Index.


Also called Dow Diamonds, or the Diamonds Trust Series 1, DIAMONDs track the Dow Jones Industrial Average. DIAMONDs are traded on the AMEX.

Introduction to Stock Market Analysis



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