CFS-557
Before investing in the stock market you'll need a basic understanding of what stocks are and how to buy them. Begin by looking at newspaper stock tables. These contain a wealth of information regarding particular stocks. The following chart can help you understand these tables.
1. The composite, or consolidated, table for the New York Stock Exchange, which takes into account prices paid on that exchange and on others where a stock may have been traded that day.
2. The highest price per share paid in the past 52 weeks. Most stock prices are quoted in terms of dollars and eighths of dollars (12 1/2 cents) or in multiples of 1/8.
3. The lowest price paid in 52 weeks.
4. The company's name, usually abbreviated. In this case, Getty Corporation.
5. The regular annual dividend per share the company is paying based on the latest quarterly or semiannual amount.
6. The yield--the dividend divided by the current stock price, expressed as a percentage.
7. The PE ratio--the stock's price divided by the company's annual earnings per share of stock outstanding. The PE, or multiple, is one of the most widely used tools for analyzing stocks. Companies whose earnings per share are growing or expected to grow at a fast rate normally command higher multiples than corporations with slower growth.
8. The number of shares sold that day, in hundreds.
9. The highest price paid for the stock that day.
10. The lowest price paid that day.
11. The last price paid.
12. The net change in the dosing price from the previous days closing price.
Now that you feel fairly comfortable with reading stock tables, your next question probably is what really is a stock investment? Stock is ownership in a corporation. When a business incorporates, owners receive stock to indicate their holdings in the company. Usually, most stockholders only own a small fraction of a company. For example, 100 shares of IBM represents only a .00002% ownership in the company. Because they represent ownership, stocks are often referred to as equities. A stock certificate shows the number of shares held. The certificate may be made out for one share or a number of shares. The owner's name appears on the stock certificate and is recorded on the stock books of the issuing corporation. These certificates are only evidence of stock ownership: should they be lost or destroyed, new ones can be obtained.
A company may issue two types of stock, common stock and preferred stock. Preferred stock, as the name implies, gives the owner superior rights on dividend distribution. Dividends must be paid to preferred stockholders before they are paid to common stockholders. Also, in cases of bankruptcy, preferred stockholders have a prior claim on a company's assets (if there is anything left) after all debts have been paid. Preferred stock has a fixed rate of return which is established when the stock is issued. Preferred and common stocks are similar in that their owners are entitled to one vote for each share they own in corporation elections.
The vast majority of stocks are common stocks and when people speak of stocks they are usually referring to common stocks. Common stock gives its owners a variable rate of return, depending on how well a company did in a given year. After a corporation has deducted all its expenses, paid its income taxes and preferred dividends the amount left is considered the earnings on the common stock. This amount, when divided by the total number of shares of common stock gives the earnings per share on the common stock. The per share earnings are the source from which dividends on common stock are paid.
Corporations may keep some earnings and pay out some earnings in dividends. For example, if a corporation earns $6 per share on its stock in one quarter, they may pay out only $4 per share in dividends in that quarter. Yet, the undistributed earnings of $2 per share is technically the stockholder's property. By retaining part of current earnings, a company may be able to increase its future earnings through investments or the retained earnings may make it possible for the company to pay dividends in later years when there may be no profits.
The rate of dividends varies among companies. Many companies pay about 50% of their earnings in dividends and retain the balance. Also, the earnings per share are instrumental in determining the price of a stock. Stocks of companies with high earnings will be desired by investors so their price will increase.
Instead of, or in addition to, a cash dividend, a company may pay its shareholders a dividend in the form of stock, called a stock dividend. Stock dividends usually lower the value of a single share of stock because there are more shares in existence. For example, a share that was worth $100 may be only worth $50 if you receive one stock dividend for each share of stock you own. Thus, you do not directly gain anything from the stock dividend. Before you owned one share of stock with $100 and now you own two shares of stock worth $100. Yet, often stockholders do benefit from stock dividends; the two shares of stock may be worth $60 each so your total stock is now worth $120. Also, a dividend paid in stock only is not taxable. However, if shareholders have the option of taking either a cash or stock dividend, then the dividend is taxed no matter what the stockholder chooses. A dividend paid in stock to preferred stockholders instead of their cash dividend is taxable no matter what.
Common stock has both advantages and disadvantages. Its advantages are twofold. First, its returns in the form of both dividends and price appreciation may be quite good.
The main disadvantage of common stock is its risk. Although the returns on common stock may be high, the risk or uncertainty associated with the receipt of this expected return is also great. Generally, the higher the expected return, the greater the risk involved in actually receiving the return. Because of the risk associated with common stock, it is probably not the best investment if a steady income is desired.
Technically, you may purchase stock directly from its owner. You then send the shares to the company with instructions to reissue the shares in your name. Yet, when buying stock you will probably buy through stockbrokers that have access to the stock you want in stock exchanges and over-the-counter market. The exchanges provide a central market place for brokers to handle transactions. Buy orders come from broker's offices and are executed by member brokers of the exchange at the trading posts for particular stocks. You can find advertisements of brokers in newspaper financial pages or in the yellow pages under "Stock & Bond Brokers."
There are eighteen stock exchanges in the United States, the principal one being the New York Stock Exchange which accounts for over 80% of the total stock sold in a year. Each exchange has its own requirements for the companies it lists. In 1977, the New York Stock Exchange required each company it listed to demonstrate an earning power of at least $2.5 million before federal income taxes, assets of $16 million, market value for publicly held common stock of $8 to $16 million by at least 2,000 shareholders, and at least one million shares of stock publicly held.
If a company cannot meet the exchange requirements, it can sell its stock in the over-the counter market. The procedure for buying over-the-counter stock is just about the same as for buying stocks traded on an exchange.
The essential difference between the exchanges and the over-the-market counter is that in the exchanges the price of stock is determined by auction and in the over-the-counter market by negotiation. The over-the-counter market also has no central meeting place, but operates over a coast-to-coast network of telephones and teletypes.
When you buy stock in either type of market, you may buy on a cash basis or on margin. Buying on margin means you put up 50% in cash (or securities acceptable to the broker) and borrow the rest from the brokerage firm. If the stock's price falls below a certain point, you will get a margin call which is a request from the broker for an additional deposit. Since the stockbrocker charges interest for the 50% loan, buying on margin is better for you if you are looking for a quick profit rather than long term investments.
Usually, you will place a buy order at market. This authorizes the broker to buy the shares at the best obtainable price at the time the purchase is executed. The market price should be fairly close to the price given in the newspaper that day. Also, you can place a limit order with your broker specifying the maximum price you will pay. The broker will not execute the order if the stock's price goes beyond the maximum price you are willing to pay. You can make the limit order good until canceled, authorizing the broker to buy the shares when they fall to or below a certain price.
Although there is no minimum amount of shares you must buy, brokers have minimum commissions so it is expensive to purchase just a few shares. Most commissions are negotiable and vary from firm to firm. Some brokerage firms offer a wide variety of services. Such firms offer information on particular stocks and make recommendations to buy certain stocks that they have carefully analyzed.. Also, these firms can offer you the type of information that is most relevant to your investment goals (i.e., high dividends or growth in stock price). Prices for such services are not cheap. Costs are often based on a flat service fee plus a percentage charge figured on the basis of total money invested in stocks.
If you do not need the fringe services provided by a full service stock brokerage firm, you may consider the use of a discount broker. These firms have no large staff of salespeople, investment analysts, or fancy offices. They just buy and sell stock for you. On average they charge 40%-50% of the commissions charged by full service firms.
Most types of brokerage firms will hold your stock certificates in their safe for you. Such stocks held by a firm are said to be held in street name since the broker can sell them for you without having to obtain your signature. If your broker cannot return the stocks in your account you are protected against the loss by the Securities Investor Protection Corporation, an agency of the federal government that insures accounts against the financial failure of the brokerage firm. Accounts are insured up to $500,000, including $100,000 in cash. Almost all stockbrokers who are registered with the Securities and Exchange Commission are legally required to join the corporation. Some big brokerage firms buy additional insurance from private insurance companies. Settling the accounts of a failed broker takes time, so if you plan to buy stocks only occasionally you may want to forgo the convenience of having the broker hold your stock and keep the certificates yourself.
As a final thought, it is recommended that you only invest in stock and assume its risks if you are insulated against the normal financial risks of day-to-day living. In particular, you should only invest in stocks if you meet the following criteria:
1. Income is enough to meet current expenses and planned future expenses such as replacing appliances, cars, etc.
2. Credit payments are up-to-date. This doesn't mean you should pay off all debts before investing--a home mortgage is an investment itself. But debt consolidation loans and second mortgages should be paid off before investing in stocks.
3.You have an emergency fund of 3 to 6 months salary in a safe, relatively liquid savings instrument.
4. Insurance protection is adequate to guard against financial losses due to death, disability, illness, property damage, and liability.
For more information on stocks contact stockbrokers, individual corporations for their annual reports, your local librarian for references on stock investments, the New York Stock Exchange at 11 Wall St., New York, NY 10005, business and investor periodicals and newspapers such as The Wall Street Journal, Barron's and Forbes.
Some examples of common stocks are blue-chip stocks, cyclical (Or smokestack) stocks, income stocks, growth stocks, utility stocks, and speculative stocks.
Blue-chip stocks are issued by major companies which have long and unbroken records of earnings and dividend payments.
Cyclical stocks are stocks of companies in basic industries whose earnings vary with the business cycle. Examples of industries which may be regarded as cyclical are steel, cement, airlines, railroads, and automobiles.
Income stocks are those that yield generous current returns. These stocks are bought particularly by the elderly and retired for current income.
Growth stocks are those of a company whose sales and earnings are expanding faster than the general economy and the average of the industry.
Speculative stocks can usually be recognized by their very high price earnings ratio. An example of this high-flying glamour stock are penny mining stocks.
Utility stocks are generally regarded as defensive stocks. These stocks, in a period of deteriorating business, are likely to do better than average, from an earnings and dividend point of view.
Stop Order. An order to buy or sell conditioned upon a specific price. May be used in an effort to protect a paper profit or try to limit a possible loss. For example, an individual may have purchased, at $15, a share of stock she believes will rise to about $20, and she puts in a stop order at $20. The stock will automatically be sold at $20. Or a person may have purchased a stock at $15 and it may have risen to $30. The purchaser may have reason to believe that it will go even higher, but to protect himself in the event of a downward movement, he may place a stop order at $25. Thus, if the stock goes down to $25 per share, the order will be executed immediately.
Stop-limit Order. Enables the investor to specify the maximum or minimum price satisfactory for purchase or sale. If the specialist cannot execute at that price or better, transaction does not take place.
Discretionary Order. Allows the broker to determine when to buy and sell, what to buy and sell, and in what quantity. It must be given in writing by the customer and approved by a member of the firm. A long and close relationship with a reputable broker is a basic requirement for the use of such orders.
Bull Market. A rising market. A "bull" in Wall Street is an optimist, one who expects the market to go up.
Bear Market. A falling market. A "bear" is one who expects stock prices to decline.
Securities and Exchange commission. Established by congress to administer the law to help protect investors.
Over-the-counter Market. A network of trading rooms all over the country, connected by telephone and electronic communications. Encompasses all securities not traded on national securities exchanges.
A wealth of information is available in the publication of the investment advisory services. Major services are:
Moody's Investor Services (owned by Dun & Bradstreet), 99 Church Street, New York, NY 10007. Ask for "How Moody's Can Help You," a booklet describing a list of publication services.
Standard & Poor's Corporation (owned by McGraw-Hill), 345 Hudson Street, New York, NY 10014. Ask for "Standard & Poor's Services and Publications Cover Every Financial Information Need."
The Value Line Investment Survey (owned by Arnold Bernhard & Co.), 5 East 44th Street, New York, NY 10017
For a listing of publications that are available from the New York Stock Exchange, without charge, write to the Director of Educational Relations, New York Stock Exchange, 11 Wall Street, New York, NY 10005.
You can subscribe to part or all of the publications.
*Adapted by Dixie Johnson, Extension Specialist, Consumer Economics, and Irma Huffman, Graduate Student.
Reviewed by Richard Widdows, Ph.D., Consumer Sciences and Retailing, Purdue University, West Lafayette, IN 47907.
Reprinted by permission of Cornell University, Ithaca, NY 14853.
RR 8/86
Cooperative Extension Work in Agriculture and Home Economics, State of Indiana, Purdue University and U.S. Department of Agriculture Cooperating. H.A. Wadsworth, Director, West Lafayette, IN. Issued in furtherance of the Acts of May 8 and June 30, 1914. It is the policy of the Cooperative Extension Service of Purdue University that all persons shall have equal opportunity and access to our programs and facilities.