Stock Investing For Dummies - Paul Mladjenovic | Summarized Books

Stock Investing For Dummies

Successful stock investing takes diligent work and knowledge

Stock investing for dummies is designed to give you a realistic approach to making money in stocks. The book provides the essence of sound, practical stock investing strategies, and insights that have been market-tested and proven from more than 100 years of stock market history.

Successful stock investing takes diligent work and knowledge, like any other meaningful pursuit. This book can definitely help you avoid the mistakes others have made and can point you in the right direction. It gives you a heads up about trends and conditions that are found in a few other stocks investing guides. Explore the pages of this book and find the topics that most interest you within the world of stock investing.

The stock market has been a cornerstone of the investor’s passive wealth-building program for over a century and continues in this role. The past few years have been somewhat a huge roller coastal for stock investors. With all the media attention and all the talking heads on radio and television, the investing public still didn’t avoid losing trillions in a historical stock market debacle.

Unfortunately, many stock investment experts didn’t see the economic and geopolitical forces that acted as a tsunami on the market. Knowledge of these forces could have informed investors to hold on to their hard-earned stock market fortunes.

Cheer up, though: This book gives you an early warning on those megatrends and events that will affect your stock portfolio. While other books may tell you about stocks, this book tells you about stocks and what affects them.

Before you invest, you need to understand the fundamentals of stock investing

Stock is a type of security that indicates ownership in a corporation and represents a claim on a part of that corporation’s assets and earnings. The two primary types of stocks are common and preferred:

Common stock: This type of stock, which is covered throughout this book, entitles the owner to vote at shareholders’ meetings and receive any dividends that the company issues.

Preferred stock: This type of stock doesn’t usually confer voting rights, but it does include some rights that exceed those of common stock. Preferred stockholders, for example, have priority in certain conditions, such as receiving dividends before common stockholders in the event that the corporation goes bankrupt.

Information is critical in your stock – investing pursuits, you should gather information on your stock picks two times: before you invest and after. You need good information before investing, you also need to be informed about the company whose stock you buy as well as about the industry and the general economy.

How market capitalization affects stock value. A company’s value (and thus the value of its stock) can be determined in many ways. The most basic way is to look at the company’s market value, also known as market capitalization (or market cap).

Calculating the market cap is easy: for example, if a company has 1 million shares outstanding and its share price is $10, the market cap is $10 million.

Here are the 5 basic stock categories of market capitalization:
• Microcap (less than $250 million): These stocks are the smallest, and hence the riskiest, available.
• Small-cap ($250 million to $1 billion): These stocks fare better than the micro caps and still have plenty of growth potential.
• Mid-cap ($1 billion to $10 billion): For many investors, this category offers a good compromise between small caps and large caps. These stocks have some of the safety of large caps while retaining some of the growth potentials of small caps.
• Large-cap ($10 billion to $50 billion): This category is usually best reserved for conservative stock investors who want steady appreciation with greater safety. Stocks in this category are frequently referred to as blue chips.
• Ultra-cap (more than $50 billion): These stocks are also called mega-caps and obviously refer to companies that are the biggest of the big. Stocks such as Google and Apple are examples.

To succeed in the world of stock investing, keep in mind these key success factors.

Understand why you want to invest in stocks. Are you seeking appreciation (capital gains) or income (dividends)?

Do some research. Look at the company whose stock you’re considering to see whether it’s a profitable business worthy of your investment dollars.

Prepare and review your personal balance sheet to find out about how much money you can invest

Investing in stocks requires balance. Investors sometimes tie up too much money in stocks, putting themselves at risk of losing a significant portion of their wealth if the market plunges. Then again, other investors place little or no money in stocks and therefore miss out on excellent opportunities to grow their wealth. Investors should make stocks a part of their portfolios. A disciplined investor also has money in bank accounts, investment-grade bonds, precious metals, and other assets that offer growth or income opportunities.

Whether you already own stocks or are looking to get into the stock market, you need to find out about how much money you can afford to invest. No matter what you hope to accomplish with your stock investing plan, the first step you should take is to figure out how much you own and how much you owe. To do this, prepare and review your personal balance sheet.

Composing your balance sheet is simple. Pull out a pencil and a piece of paper. For the computer-savvy, a spreadsheet software program accomplishes the same task. Gather all your financial documents, such as bank and brokerage statements and other such paperwork; you need figures from these documents. Then follow the steps below:

Step 1: Make sure you have an emergency fund. First, list cash on your balance sheet. Your goal is to have a reserve of at least three to six months’ worth of your gross living expenses in cash and cash equivalents. The cash is important because it gives you a cushion.

If your monthly expenses (or output) are $2,000, have at least $6,000 in a secure, FDIC-insured, interest-bearing bank account (or another relatively safe, interest-bearing vehicle such as a money market fund). Consider this account an emergency fund, not an investment.

Step 2: List your assets in decreasing order of liquidity. Liquidity refers to how quickly you can convert a particular asset (something you own that has value) into cash. If you know the liquidity of your assets, including investments, you have some options when you need cash to buy some stock (or pay some bills).

Step 3: List your liabilities. Liabilities are simply the bills that you’re obligated to pay. Whether it’s a credit card bill or a mortgage payment, a liability is an amount of money you have to pay back eventually (usually with interest).

Step 4: Calculate your net worth. Your net worth is an indication of your total wealth. You can calculate your net worth with this basic equation: total assets less total liabilities equal net worth (net assets or net equity).

Step 5: Analyze your balance sheet. After you create a balance sheet (based on the steps above) to illustrate your current finances, take a close look at it and try to identify any changes you can make to increase your wealth.

Sometimes, reaching your financial goals can be as simple as refocusing the items on your balance sheet, here are some brief points to consider:

Can you replace depreciating assets with appreciating assets? Say that you have two stereo systems. Why not sell one and invest the proceeds? You may say, “But I bought that unit two years ago for $500, and if I sell it now, I’ll get only $300.” That’s your choice. You need to decide what helps your financial situation more — a $500 item that keeps shrinking in value (a depreciating asset) or $300 that can grow in value when invested (an appreciating asset).

Can you pay off any high-interest debt with funds from low-interest assets? If, for example, you have $5,000 earning 2% in a taxable bank account and you have $2,500 on a credit card charging 18 % (which is not tax-deductible), you may as well pay off the credit card balance and save on the interest.

Can you sell any personal stuff for cash? You can replace unproductive assets with cash from garage sales and auction websites.

Make a diligent effort to control and reduce your debt; otherwise, the debt can become too burdensome. If you don’t control it, you may have to sell your stocks just to stay liquid.

Did you know? Debt is one of the biggest financial problems in the United States today. Companies and individuals holding excessive debt contributed to the stock market’s painful plunge in 2008 and 2009. If individuals and companies manage their liabilities more responsibly, the general economy would be much better off.

You will better understand companies’ finances by picking up information in accounting and economics

Low earnings and high debt are examples of financial difficulties that can affect both people and companies. You can better understand companies’ finances by taking the time to pick up some information in two basic disciplines: accounting and economics. These two disciplines play a significant role in understanding the performance of a firm’s stock.

Accounting is the language of business, three are the three essential principle:
1. Assets minus liabilities equals net worth. A company’s balance sheet shows you its net worth at a specific point in time (such as December 31). The net worth of a company is the bottom line of its asset and liability picture, and it tells you whether the company is solvent (has the ability to pay its debts without going out of business).

2. Income minus expenses equal net income. A company’s profitability is the whole point of investing in its stock. As it profits, the business becomes more valuable, and in turn, its stock price becomes more valuable. To discover a firm’s net income, look at its income statement. Try to determine whether the company uses its gains wisely, either by reinvesting them for continued growth or by paying down debt.
3. Do a comparative financial analysis. If you know that the company you’re looking at had a net income of $50,000 for the year, you may ask, “Is that good or bad?” Obviously, making a net profit is good, but you also need to know whether it’s good compared to something else. If the company had a net profit of $40,000 the year before, you know that the company’s profitability is improving. But if a similar company had a net profit of $100,000 the year before and in the current year is making $50,000, then you may want to either avoid the company making the lesser profit or see what (if anything) went wrong with the company making less.

Many investors get lost on basic economic concepts. Understanding these concepts will help you filter the financial news to separate relevant information from the irrelevant in order to make better investment decisions.

Supply and demand: The ageless concept of supply and demand can be simply stated as the relationship between what’s available (the supply) and what people want and are willing to pay for (the demand). This equation is the main engine of economic activity and is extremely important for your stock investment analysis and decision – making process.

Cause and effect: If you pick up a prominent news report and read, “Companies in the table industry are expecting plummeting sales,” do you rush out and invest in companies that sell chairs or manufacture tablecloths? Considering cause and effect is an exercise in logical thinking, and this logic is a major component of sound economic thought.

Economic effects from government actions: Political and governmental actions have economic consequences. As a matter of fact, nothing has a greater effect on investing and economics than the government. Government actions usually manifest themselves as taxes, laws, or regulations. They also can take on a more ominous appearance, such as war or the threat of war.

Here are some typical events that can cause a stock’s price to rise:
1. Positive news reports about a company: The news may report that the company is enjoying success with increased sales or a new product.
2. Positive news reports about a company’s industry: The media may be highlighting that the industry is poised to do well.
3. Positive news reports about a company’s customers: Maybe your company is in industry A, but its customers are in industry B. If you see good news about industry B, that may be good news for your stock.

Did you know? Opportunities to make money in the stock market will always be there, no matter how well or how poorly the economy and the market are performing in general. There’s no such thing as a single (and fleeting) magical moment, so don’t feel that if you let an opportunity pass you by, you’ll always regret that you missed your one big chance.

When it’s time to invest, you need a broker to actually buy the stock

When you’re ready to dive in and start investing in stocks, you first have to choose a broker. The broker’s primary role is to serve as the vehicle through which you either buy or sell stock. These are companies like Charles Schwab, TD Ameritrade, E*TRADE, and many other organizations that can buy stock on your behalf.

The difference between institutional stockbrokers and personal stockbrokers: Institutional stockbrokers make money from institutions and companies through investment banking and securities placement fees (such as initial public offerings and secondary offerings), advisory services, and other broker services. While a personal stockbroker generally offers the same services to individuals and small businesses.

Any broker (some brokers are now called financial advisors) you deal with should be registered with the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC).

In addition, to protect your money after you deposit it into a brokerage account, that broker should be a member of the Securities Investor Protection Corporation (SIPC).

Stockbrokers fall into two basic categories:
Full-service brokers are suitable for investors who need some guidance and personal attention.
Discount brokers are better for those investors who are sufficiently confident and knowledgeable about stock investing to manage with minimal help (usually through the broker’s website).

Before you deal with any broker (either full-service or discount), get a free report on the broker from FINRA by calling 800-289-9999 or through its website at www.finra.org. Through its service called BrokerCheck, you can get a report on either a brokerage firm or an individual broker.

Choosing your broker. Before you choose a broker, you need to analyze your personal investing style, and then you can proceed to find the kind of broker that fits your needs. It’s almost like choosing shoes; if you don’t know your size, you can’t get a proper fit.

When it’s time to choose a broker, keep the following points in mind.

1. Match your investment style with a brokerage firm that charges the least amount of money for the services you’re likely to use most frequently.

2. Compare all the costs of buying, selling, and holding stocks and other securities through a broker. Don’t compare only commissions; compare other costs, too, like margin interest and other service charges.

3. Use broker comparison services available in financial publications such as Kiplinger’s Personal Finance and Barron’s (and, of course, their websites) as well as online sources.

The various types of brokerage accounts.

Cash accounts. A cash account (also referred to as a Type 1 account) means just what you’d think. You must deposit a sum of money along with the new account application to begin trading. The amount of your initial deposit varies from broker to broker. Some brokers have a minimum of $10,000; others let you open an account for as little as $500.

Margin accounts. A margin account (also called a Type 2 account) allows you to borrow money against the securities in the account to buy more stock. Because you can borrow in a margin account, you have to be qualified and approved by the broker. After you’re approved, this newfound credit gives you more leverage so you can buy more stock or do short selling.

Options accounts. An options account (also referred to as a Type 3 account) gives you all the capabilities of a margin account (which in turn also gives you the capabilities of a cash account) plus the ability to trade options on stocks and stock indexes. To upgrade your margin account to an options account, the broker usually asks you to sign a statement that you’re knowledgeable about options and familiar with the risks associated with them.

Brokers also offer the following services:
1. Providing advisory services: Investors pay brokers a fee for investment advice. Customers also get access to the firm’s research.
2. Offering limited banking services: Brokers can offer features such as interest-bearing accounts, check-writing, electronic deposits and withdrawals, and credit/debit cards.
3. Brokering other securities: In addition to stocks, brokers can buy bonds, mutual funds, options, exchange-traded funds (ETFs), and other investments on your behalf.

Factors to consider when investing for long – term growth

What’s the number-one reason people invest in stocks? To grow their wealth (also referred to as capital appreciation). People interested in growing their wealth see stocks as one of the convenient ways to do it. Growth stocks tend to be riskier than other categories of stocks, but they offer excellent long-term prospects for making the big bucks. In doubt? Just ask Warren Buffett, Peter Lynch, and other successful, long-term investors.

A stock is considered a growth stock when it’s growing faster and higher than the overall stock market. Basically, a growth stock performs better than its peers in categories such as sales and earnings. Value stocks are stocks that are priced lower than the value of the company and its assets — you can identify a value stock by analyzing the company’s fundamentals and looking at key financial ratios, such as the price-to-earnings (P/E) ratio. Growth stocks tend to have better prospects for growth in the immediate future (from one to four years), but value stocks tend to have less risk and steadier growth over a longer term.

The following tips will come in handy when choosing growth stocks.

Look for leaders in megatrends. A strong company in a growing industry is a common recipe for success. If you look at the history of stock investing, this point comes up constantly. Investors need to be on the alert for megatrends because they help ensure success. A megatrend is a major development that has huge implications for much (if not all) of society for a long time to come. Good examples are the advent of the Internet and the aging of America. Both of these trends offer significant challenges and opportunities for the economy.

Compare a company’s growth to an industry’s growth. You have to measure the growth of a company against something to figure out whether its stock is a growth stock. Usually, you compare the growth of a company with growth from other companies in the same industry or with the stock market in general. In practical terms, when you measure the growth of a stock against the stock market, you’re actually comparing it against a generally accepted benchmark, such as the Dow Jones Industrial Average (DJIA) or the Standard & Poor’s 500 (S&P 500).

Consider a company with a strong niche. Companies that have established a strong niche are consistently profitable. Look for a company with one or more of the following characteristics:

A strong brand: Companies such as Coca-Cola and Microsoft come to mind.

High barriers to entry: United Parcel Service and Federal Express have set up tremendous distribution and delivery networks that competitors can’t easily duplicate.

Checking out a company’s fundamentals. When you hear the word fundamentals in the world of stock investing, it refers to the company’s financial condition and related data. When investors (especially value investors) do fundamental analysis, they look at the company’s fundamentals — its balance sheet, income statement, cash flow, and other operational data, along with external factors such as the company’s market position, industry, and economic prospects.

Note the following:
• Pick a company that has strong fundamentals, including signs such as rising sales and earnings and low debt.
• Make sure that the company is in a growing industry.
• Fully participate in stocks that are benefiting from bullish market developments in the general economy.
• During a bear market or in bearish trends, switch more of your money out of growth stocks (such as technology) and into defensive stocks (such as utilities).
• Monitor your stocks. Hold on to stocks that continue to have growth potential, and sell those stocks with declining prospects.

Did you know? A growth stock is called that not only because the company is growing, but also because the company is performing well with some consistency. Having a single year where your earnings do well versus the S&P 500’s average doesn’t cut it.

Dividend Paying Stocks : The Basics

Investing for income means investing in stocks that provide you with regular cash payments (dividends). Income stocks may not be known to offer stellar growth potential, but they’re good for a steady infusion of cash. If you have a low tolerance for risk or if your investment goal is anything less than long-term, income stocks are a better bet than growth stocks.

Dividends are sometimes confused with interest.However, they are different.

A stock investor is considered a part-owner of the company he invests in and is entitled to dividends when they’re issued. A bank, on the other hand, considers you a creditor when you open an account. The bank borrows your money and pays you interest on it.

What type of person is best suited for income stocks?

Conservative and novice investors: Conservative investors like to see a slow-but-steady approach to growing their money while getting regular dividend checks. Novice investors who want to start slowly also benefit from income stocks.

Retirees: Growth investing is best suited for long-term needs, whereas income investing is best suited to current needs. Retirees may want some growth in their portfolios, but they’re more concerned with regular income that can keep pace with inflation.

Dividend reinvestment plan (DRP) investors: For those investors who like to compound their money with DRPs, income stocks are perfect.

Dividend rates aren’t guaranteed — they can go up or down, or in some extreme cases, the dividend can be suspended or even discontinued. Fortunately, most companies that issue dividends continue them indefinitely and actually increase dividend payments from time to time. Historically, dividend increases have equaled (or exceeded) the rate of inflation.

Advantage of income stocks. Income stocks tend to be among the least volatile of all stocks, and many investors view them as defensive stocks. Defensive stocks are stocks of companies that sell goods and services that are generally needed, no matter what shape the economy is in.

Disadvantages of income stocks. Income stocks can go down as well as up, just as any stock can. The factors that affect stocks, in general, can affect income stock. Income stocks can be sensitive to rising interest rates. When interest rates go up, other investments (such as corporate bonds, U.S. Treasury securities, and bank certificates of deposit) are more attractive.

Ten Indicators Of Great Stock

If you have a stock that has all the following features, back up the truck and get as much as you can. Seriously, it’s almost impossible to find a stock with all ten hallmarks described in this chapter, but a stock with even half of them is a supersolid choice.

1. The company has rising profits. The very essence of a successful company is its ability to make a profit. In fact, profit is the single most important financial element of a company. Profit is the single most important element of a successful economy. Without profit, a company goes out of business.

2. The company has rising sales. Looking at the total sales of a company is referred to as analyzing the top – line numbers. A company (or analysts) can play games with many numbers on an income statement; there are a dozen different ways to look at earnings. Earnings are the heart and soul of a company, but the top line gives you an unmistakable and clear number to look at.

3. The company has low liabilities. Too much debt will kill an otherwise good company. Debt can consume you, and as you read this, debt is consuming many countries across the globe. Because a company with low debt has borrowing power, it can take advantage of opportunities such as taking over a rival or acquiring a company that offers an added technology to help propel current or future profit growth.

4. The stock Is at a bargain price. Price and value are two different concepts, and they aren’t interchangeable. A low price isn’t synonymous with getting a bargain. Just as you want the most for your money when you shop, you want to get the most for your money in stock investing.

You can look at the value of a company in several ways, but the first thing to look at is the price-to-earnings ratio (P/E ratio). It attempts to connect the price of the company’s stock to the company’s net profits quoted on a per-share basis.

5. Dividends are growing. Long-term investing is where the true payoff is for today’s investors. But before you start staring at your calendar and dreaming of future profits, take a look at the company’s current dividend picture.

6. The market is growing. In this context, the market is growing means the market of consumers for a given product. If more and more people are buying widgets, for instance, and the sales of widgets keep growing, that bodes well for companies that sell (or service) widgets.

7. The company is in a field with a high barrier to entry. A high barrier to entry simply means that companies that compete with you will have a tough time overcoming your advantage. This gives you the power to grow and leave your competition in the dust.

8. The company has a low political profile. We live in times that are politically sensitive. All too often, politics affects the fortunes of companies and, by extension, the portfolios of investors. Yes, sometimes politics can favor a company (through back-room deals and such), but politics is a double-edged sword that can ruin a company.

9. The stock is optionable. An optionable stock (which has a call and put options available on it) means that you have added ways to profit from it (or the ability to minimize potential losses). Options give stockholder ways to enhance gains or yield added revenue.

10. The stock is benefiting from favorable megatrends. A megatrend is a trend that affects an unusually large segment of the marketplace and may have added benefits and/or pitfalls for buyers and sellers of a given set of products and services. The problem is that when a stock has little substance behind it (the company is losing money, growing debt, and so on), it’s up move will be temporary, and the stock price will tend to reverse in an ugly pullback.

Did you know? Too many investors buy stocks that have no P/E ratio. These stocks may have the P (price of the stock), but they have no E (earnings). If you invest in a company that has losses instead of earnings, then you aren’t an investor; you’re a speculator

Some investments and strategies that go great with stocks

Some type of stock exposure is good for virtually any portfolio. But you must diversify your assets besides stocks, so you’re not 100 % tied to the whims and machinations of the stock market. The following are investments and strategies that complement your stock investing pursuits.

Covered call options. Writing a covered call option is a great strategy for generating income from a current stock position (or positions) in your portfolio.

The buyer pays what’s called the premium to the call seller (referred to as the call writer). The call writer receives the premium as income but, in return, is obligated to sell the stock to the buyer at the agreed-upon price (called the strike price) if called upon to do so during the life of the option.

Covered call writing is a conservative way to make extra cash from just about any listed stock of which you own at least 100 shares. Whether your stock has a dividend or not, this could boost income by 5 % or more.

Put options. A put option is a bet that a stock or ETF will fall in price. If you see the fortunes of a company going down, a put option is a great way to make a profit by speculating that the stock will go down. Many uses puts to speculate for a profit, while others use put options as a hedging vehicle or a form of “portfolio insurance.”

Cash. Having some money in the bank or just some cash in your brokerage account comes in handy no matter what’s happening with the stock market’s gyrations. What’s that? The stock market is plunging? Whew! Good to have some cash on the sidelines so you can do some bargain-hunting for good value stocks.

EE Savings Bonds. An EE savings bond is issued by the U.S. Treasury and is a great vehicle, especially for small investors (you can buy one for as little as $25). It’s a discount bond, meaning that you buy it at below its face value (the purchase price is 50 % of the face value) and cash it in later to get your purchase price back with interest.

I Bonds. In the age of low-interest rate debt investments (such as bonds in general), the I savings bond (the “I” stands for inflation) is a different wrinkle altogether. This is a “sister” to the EE savings bond, and it’s also issued by the U.S. Treasury. The twist here is that the interest rate is tied to the official inflation rate (the Consumer Price Index, or CPI). If the CPI goes to 3%, then the interest rate on the I bond goes to 3%. The interest rate gets adjusted annually.

Sector Mutual Funds. A mutual fund is a pool of money that’s managed by an investment firm (such as Fidelity, Vanguard, or T. Rowe Price); this pool of money is invested in a portfolio of securities (such as stocks or bonds) to reach a particular objective (such as aggressive growth, income, or preservation of capital). The investment firm actively manages the fund by regularly making buy, sell, and hold decisions in the fund’s portfolio.

Motif Investing. Starting with only a few hundred bucks, you can have a theme-based portfolio that can augment your portfolio of individual stocks. Motif Investing is a relatively new twist on investing (or speculating if you choose a risky motif). It gives you the convenience of investing in a pre-structured portfolio that’s designed to do well given a particular expected event, trend, or worldview that will unfold.

Did you know? A sector mutual fund limits its portfolio and investment decisions to a particular sector such as utilities, consumer staples, or healthcare. It’s your task to choose a winning sector, and the job of choosing the various stocks is left to the investment firm.

Conclusion

Today’s stock market is a little puzzling... but it can still be rewarding. Having read this book seriously, you’ll do much better than the average investor. Just keep in mind that patience and discipline count now more than ever. Remember, the purpose of this book is not only to tell you about the basics of stock investing but also to let you in on solid strategies that can help you profit from the stock market. Before you invest, understand the fundamentals of stock investing, then put your money where it will count the most.

Try this: Gather information!

Gathering information is critical in your stock-investing pursuits. You should gather information on your stock picks two times: before you invest and after. Obviously, you should become more informed before you invest your first dollar, but you also need to stay informed about what’s happening to the company whose stock you buy as well as about the industry and the general economy