Stocks

WHAT

When a company is first founded, the only shareholders to raise capital (Money or other assets owned by a person/organization) are the co-founders and early investors.

  • e.g., if a startup has two founders and one investor, each may own one-third of the company’s shares, the investor does not own the company
    • So if you, a shareholder, own 33% of the shares of a company, you own one-third of the company’s shares.
    • You also have voting rights in corporate policy & members composition of board of directors (the more you own, the more powerful you are)
      • This becomes most apparent when one company buys another: the acquiring company doesn’t go around buying up the building, the chairs, the employees; it buys up all the shares. 
      • The board of directors is responsible for increasing the value of the corporation, and often does so by hiring professional managers, or officers, such as the Chief Executive Officer, or CEO.

Investment Paths – Individual Stocks, ETFs, Mutual Funds

Individual Stocks

INDEX: Measure of the relevant portion/section of the stock market.

There are two share/stock/equity types:

CommonPrivilege/Preferred/Preference
Share that gives the stockholder the right to share in the profits of the company, and to vote on matters of corporate policy and the composition of the members of the board of directors.Same as common stocks plus having the primary right to dividends (sum of money from profit) (sometimes reinvested for company growth)Stockholder cannot be paid dividends until all preferred stock dividends are paid in full

List of Securities: stock, bond, option, ETF, Mutual Fund, Future

Bond (debt)Option
loan between an investor and a corporationinvestor gives the corporation a specific amount of money for a specific period of time in exchange for periodic interest payments at designated intervalsAn option is a contract that allows an investor to buy/sell an underlying stock (stock that can be bought/sold from the time the contract starts to its expiration)
Strike: The price at which the option holder can purchase (for call option) or sell (for put option) the underlying asset.LongTo be long an option means to have purchased it and therefore own or hold it.ShortTo be short an option means to have sold it.PremiumThe price of an option contract.
stocks give you a small piece of ownership in a companyoptions are contracts that give you the right to buy or sell the stock at a specific price by a specific date
Exchange Traded Fund (ETF)
Key advantages of ETF: Simple, High Liquidity, Diversified
ETF is traded in baskets which contain assets (stocks, bonds, etc.)
Mutual FundFutures 
Future is a contract that requires a buyer to purchase shares, and a seller to sell them, on a specific future date unless the holder’s position is closed before the expiration date.
Exchange Traded Fund (ETF)
Popular Sector ETFsPopular Industry ETFsBasic Materials (XLB), Consumer Discretionary (XLY), Consumer Staples (XLP), Energy (XLE), Financial (XLF), Healthcare (XLV), Industrial (XLI), Technology (XLK), Utilities (XLU)Gold (GLD), Silver (SLV), Oil (USO), Real Estate (IYR, VNQ)
Types of ETFSector ETFs give you exposure to an entire sector, e.g. “Technology Sector ETF”Most sector ETFs are market-cap weightedEqual weight ETFs contain equal dollar amounts of each stock and therefore need to be rebalanced periodically.Leveraged and leveraged inverse ETFs use options and futures contracts rather than stocksQuant strategy sector ETFs provide exposure to US sectors via a basket of stocks determined by rules-based quantitative analysis, such as “overweight stocks with low P/E ratios” or “overweight stocks that have been beaten earnings estimates for three quarters running”List of Sector ETFs: http://seekingalpha.com/article/30062-a-guide-to-sector-etfsETFs with highest volume: http://www.etfchannel.com/type/etfs-with-most-volumeTop ETF Providers (remaining 28% by Vanguard(12%) and 26 other sponsors(16%)):49$ – iSharesManaged by BlackRock> 500 funds> 275 ETFs in the US> $645 billion in assets under management23% – State Street Global AdvisorsManaged ETFs in US & Canada known as Spiders (SPDR’s)Owns SPY – largest ETF in the USUS$102 billion in assets under managementETF vs Mutual FundCategoryETFMutual FundSIMILARITYProfessionally ManagedYesYesDiversifiedYesYesDIFFERENCESBuying & SellingCan do yourselfNeeds agentPriceFluctuates during business daysCalculated once a day after market closesManagement FeeLowHighCommissionLowHighBuy on MarginYesNoShortableYesNo
  • Stock price can vary significantly (from US$0.01 to over $2,000). 
  • Leverage instruments (e.g. CFD (usually 10% of stock price), Options (dependant on expiry & Strike Price)) can be used to improve smaller accounts affordability.

Corporations are treated as legal persons. In other words, corporations file taxes, can borrow, can own property, can be sued, etc.

As the company grows, it considers an initial public offering, or IPO, transforming it from a private to a public company. After transforming, its shares become public and can be traded (as baskets of share, Note: A basket is a single unit of at least 15 stocks) for money on a stock market..

Creditors are given legal priority over other stakeholders in the event of a bankruptcy and will be made whole first if a company is forced to sell assets in order to repay them.

Shareholders, on the other hand, are last in line and often receive nothing, or mere pennies on the dollar, in the event of bankruptcy. This implies that stocks are inherently riskier investments that bonds.

The same is true on the upside: bondholders are only entitled to receive the return given by the interest rate agreed upon by the bond, while shareholders can enjoy returns generated by increasing profits, theoretically to infinity. 

In short: Investors ← [Buys/Sells Stocks/Bonds/Options/etc.] → Businesses/Companies

money being the middleperson, the flow.

The price of a stock represents the “value” of the corporation. At its most basic level, this value is computed by dividing the dollar value of the company, known as the market capitalization (or “market cap”) by the number of shares outstanding. For example, if XYZ Corp. is valued at $1,000,000 and it has 100,000 shares outstanding, the price of each share is $10.00. Working backwards, one can determine the market value of a company thus by multiplying the share price by the number of shares. The question then becomes what causes fluctuations in the value of the corporation?

But what does a company’s value represent? A company has stuff and it sells stuff. The stuff it has – buildings, machinery, patents, money in the bank, etc. – constitute its book value, or the amount of money a company would get if they sold all that stuff at once. But companies are primarily in business of trying to make a profit, and in doing so they earn cash by selling products or services, so the total value of a company has to do with the stuff it owns now and the cash flows it will receive in the future. The value of the stuff it owns now is fairly easy to determine, but the value of all the future cash flow streams is a bit trickier to nail down – and it is this piece that is responsible for market gyrations.

Because of the time value of money, profits to be earned in the future must be discounted back to represent today’s dollars – just as a dollar put into a bank account today will be worth more in the future after it has earned some interest, but in reverse. How much to discount these future cash flows depends on a lot of things including the cost of capital (which is the cost to borrow or find investment, and this depends on interest rates), the riskiness of the business (in the stock market this is often estimated using beta), and the foregone cost of doing nothing and keeping your money in the bank (the opportunity cost or risk-free rate).

Once an appropriate discount rate has been estimated, the hard part is to figure out what future cash flows will be – a month from now, a year from now, five years from now. Sentiment and expectations are a big component of these predictions, and financial analysts try to figure these amounts out in a number of ways accounting for both company-specific factors and macro factors such as overall economic health. Fortunately, the stock market reflects the expectation of future cash flows in an easy to compute ratio of price-to-earnings, also known as the P/E ratio. A P/E ratio of 10x means that a company is being valued today at 10x its current earnings. A P/E ratio of 20x for the same company would mean that given the same amount of earnings, the market is giving it twice as much value, indicating that those future cash flows are going to be larger. Of course, there are a number of sophisticated pricing models that analysts can use in addition, or instead of, the P/E ratio such as using dividend discount models or free cash flow models.

WHERE

There are x places to trade stocks/bonds/options/etc.

  • IPO
  • Stocks – Stock Market & Broker or Brokerage Firm
  • Options – Options Market

IPO

Companies can raise money without incurring any debt (such is the case of a loan) by issuing shares of their company to the public in what is known as an Initial Public Offering (IPO)

Stock Market

Stock markets (is a secondary market e.g. NYSE & NASDAQ; primary is the IPO) are venues where buyers and sellers of shares meet and decide on a price to trade. The stock market is mutually beneficial to businesses and investors because:

  • Companies raise money to (try to) make their businesses grow
  • Investors invest in businesses to (try to) make their money grow

At the most fundamental level, stock prices change moment to moment i.e. goes up and down according to supply and demand. If more people want to buy a stock at a given moment (demand) than sell it (supply), then the price moves up. E.g. buying Apple Inc. (AAPL) stock with a market order (request by an investor to buy/sell stock at the best price), the purchase caused the price to increase to $140.05. Conversely, if more people are motivated to sell a stock than buy it, there would be greater supply than demand, and the price would fall.

Two types of stock market: bull and bear market:

Bull Market

A bull market is when everything in the economy is running objectively well: people are finding jobs and unemployment is low, the economy is growing as measured by gross domestic product (GDP), and stocks are rising. Picking stocks during a bull market is arguably easier because everything is going up. If a person is optimistic and believes that stocks will go up, he or she is called a bull and is said to have a bullish outlook. Bull markets cannot last forever though, and sometimes they can lead to dangerous situations if stocks become overvalued. In fact, one severe form of a bull market is known as a bubble, where the upward trajectory of stock prices no longer conforms to fundamentals, and optimistic sentiment completely takes over. Bubbles always burst when reality catches up with overinflated prices, and people often realize bubbles in hindsight (understand an event or situation only after it has happened). It is difficult to recognize when investors are in a bubble and even harder to predict when it will pop.

Bear Market

A bear market is informally defined as a 20% drop in broad indices. Bear markets happen when the economy appears to be in or near recession, unemployment rises, corporate profits fall, and GDP contracts. Bear markets make it tough for investors to pick profitable stocks. One solution to this is to profit from when stocks are falling via short selling. Another strategy is to wait on the sidelines until you feel that the bear market is nearing its end, only starting to buy in anticipation of a bull market.

Bear markets are typically associated with an increase in stock market volatility (pace at which prices move higher or lower, and how wildly they swing), since investors typically fear losses more than they appreciate gains at an emotional level. People are not always rational actors – especially when it comes to money and investments. During bear markets, prices do not drop in an orderly or rational way to some fundamental level of price-to-earnings, but rather market participants often overreact in panic and send prices below reasonable valuations.

Bulls are optimistic and bull markets are defined by increasing stock prices. 

Bears are pessimists and bear markets occur when prices fall.

Because the future is unknown today, various peoples’ estimates will be different from one another, giving some a higher expected stock price and some a lower stock price. If the current price is lower than their expected price, people will buy it. If it is higher, people will sell it. When an economy is growing, people are spending and profits are rising. Companies invest in projects, expand their businesses and hire more people. Investors are optimistic and expectations of future cash flows rise, and stocks enter a bull market. Simply put, stock markets can fall when expectations of future cash flows decrease, making the prices of companies seem too high, therefore causing people to sell shares. If many more people come to this decision than there are people to buy those shares, the price will fall until it reaches a level where people will begin to believe that they are fairly valued.

The important things to grasp about this complicated subject are the following:

1. At the most fundamental level, supply and demand in the market determines stock price in any given moment.

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. It is investors’ sentiments, attitudes and expectations that ultimately affect stock prices.

4. There are many competing theories that try to explain the way stock prices move the way they do. Unfortunately, there is no one theory that can explain everything.

The Main US Stock Exchanges

Stock ExchangeLocationLink
New York Stock Exchange (NYSE)New York Citywww.nyse.com
NASDAQNew York Citywww.nasdaq.com
American Stock ExchangeNew York Citywww.amex.com

Note: S&P 500 stocks are listed on NYSE & NASDAQ

Floor trading – trading on the floor

Open Outcry or Pit Trading – open shout when trading on the floor

Index

Indices represent aggregated prices of a number of different stocks, and the movement of an index is the net effect of the movements of each individual component. When people talk about the stock market, they often are actually referring to one of the major indices such as the Dow Jones Industrial Average (DJIA) or the S&P 500.

Top 3 Major Indices in the US:

  • Dow Jones Industrial Average (DJIA) – consists of only 30 significant companies (except transportation & utility) stocks traded on the NYSE or NASDAQ
  • Standard & Poor 500 – based on the market capitalizations of 500 leading companies having common stock listed on the NYSE or NASDAQ – widely regarded as the best single gauge (captures 80% of available market capitalization)
  • NASDAQ
    • Nasdaq Composite – all stocks of NASDAQ stock exchange
    • NASDAQ 100 – top 100 largest non-financial companies from Nasdaq
  • Market-Cap Weighted – larger companies have greater weightage of the index, and if a stock price rises, its weighting in the index rises.

Dow Jones Industrial Average (DJIA) Index

  • Consists of 30 major large companies based in the United States excluding transportation & utility sectors.
  • Main drawbacks:
    • Only represents 30 companies so not representative of the economy
    • Uses a price-weighted system with a scaled average to take care of stock splits and other adjustments, i.e. the higher the stock price, the greater the percentage of the stock – so companies with huge stock prices dominate even if the size is not large.

S&P 500 Index

  • Widely regarded as the best single gauge of the large-cap US equities
  • Includes 500 leading companies in leading industries of the U.S. economy
  • Captures 80% of the available market capitalization
  • Has over US$ 7.8 trillion benchmarked to the index, with index assets comprising approx. US$ 2.2 trillion of this total.
  • Components are chosen by the S&P Index Committee. Anywhere from 25-50 changes are made every year because of mergers or fallouts like Enron.
  • Is a market capitalization-weighted index, i.e. every stock in the index is represented in proportion to its market capitalization.
  • Advantages over DJIA:
    • More representative of the US economy
    • Weights companies by value so the largest companies have more influence on the index
  • Membership Criteria:
    • Location: US Companies – determined by location of assets & revenue, corporate structure, its SEC filing type and its exchange listings.
    • Sector Balance – Companies’ industry classifications contribute to the maintenance of a sector balance that is in line with the sector composition of the universe of eligible companies within the defined market cap range.
    • Market Capitalization – More than US$ 6.1 billion
    • Pubic float – at least 50% of share are publicly traded
    • Financial Viability – At least 4 consecutive quarters of positive reported earnings (excluding extraordinary items and discontinued operations).
    • Liquidity – Annual ratio of dollar value to float adjusted market capitalization is at least 1
    • Trading activity – Minimum monthly trading volume of 250,000 shares in each for the 6 months leading to the evaluation date
    • Listing – All companies listed in the NYSE and NASDAQ stock market

S&P 500 Business Membership Criteria

Location: US CompaniesDetermined by location of assets & revenue, corporate structure, its SEC filing type and its exchange listings.
Sector BalanceCompanies’ industry classifications contribute to the maintenance of a sector balance that is in line with the sector composition of the universe of eligible companies within the defined market cap range.
Market CapitalizationMore than USD 6,100,000,000
Public FloatAt least 50% of share are publicly traded.
Financial ViabilityAt least 4 consecutive quarters of positive earnings (excluding extraordinary items and discontinued operations).
LiquidityAnnual ratio of dollar value to float adjusted market capitalization is at least 1.
Trading ActivityMinimum monthly trading volume of 250,000 shares in each for the 6 months leading to the evaluation date.
ListingAll companies listed in the NYSE and NASDAQ stock market.

NASDAQ

NASDAQ Composite Index

  • Contains all of the companies that trade on the NASDAQ
    • Most are technology & internet-related, others are financial, consumer, industrial companies
      • Selection criteria: If a stock trades on the NASDAQ, it is included in the index – with certain restrictions on security types such as close-end funds, preferred stocks, rights, warrants, convertible debentures.
  • Is a capitalization-weighted index with each company weighting being proportionate to its market value

NASDAQ 100 Index

Graham made his money by keeping his money there and let it grow. That’s is what Graham has been teaching to investors all his life. 

The DJIA is a price-weighted index of 30 large American corporations. Because of its weighting scheme and that it only consists of 30 stocks – when there are many thousand to choose from – it is not really a good indicator of how the stock market is doing. The S&P 500 is a market cap-weighted index of the 500 largest companies in the U.S., and is a much more valid indicator. 

Indices can be broad such as the Dow Jones or S&P 500, or they can be specific to a certain industry or market sector. Investors can trade indices indirectly via futures markets, or via exchange traded funds (ETFs), which trade like stocks on stock exchanges.

The prices of shares on a stock market can be set in a number of ways, but most the most common way is through an auction process where buyers and sellers place bids and offers to buy or sell.

A lot of today’s trading takes place online, rather than on trading floors on Wall Street. The Electronic Communication Network (ECN) connects traders and brokers over the Internet instead of on the trading floor.

Top 2 largest markets in the world (in order): 

  1. NYSE (New York Stock Exchange) – location address: 11 Wall Street, Lower Manhattan, New York City, New York, USA
  2. Nasdaq – located in New York City, New York, USA

HOW

We want to use US market – Why US Market?

ISThe key mover for rest of the World Market
HASThe highest volume/liquidity for both Stocks & OptionsThe most successful global CompaniesThe most online research Material & News coverageHigh Market Capitalization to reduce market manipulationGood Securities Commision Control on transparency
US will remain the top for a long enough time because:
China’s 16.5% is higher than US’ 16.3%  (difference of US$0.2 trillion), BUT….
US’ economy dwarfs China’s @ US$17.4 trillion to US$ 10.4 trillion (diff. US$7 trillion)

US (NYSE/CBOE) Stock Market Open Hours (M’sia time)
9.30pm – 4.00am (+1hr @ 4th Nov ‘18 – 9th Mar ‘19)

Main Characteristics of the US Stock Markets

  • US regulatory boards:
    • FED (Federal Reserve System) – similar to BSN Malaysia
      • Central banking system of the US
      • Established 3 key objectives for monetary policy:
        • Maximum employment
        • Stable prices
        • Moderate long-term interest rates
    • SEC (Securities & Exchange Commission) 
      • Primarily responsible for:
        • Enforcing the federal securities laws 
        • Regulating the securities industry, the nation’s stock and options exchanges, and other electronic securities in the US
    • CFTC (Commodity Futures Trading Commission)
      • Regulate futures and options markets
    • FINRA (Financial Industry Regulatory Authority)
      • Ensures that securities industry operates fairly & honestly
      • Oversees nearly 3,985 securities firm with 641,761 brokers

Guide to Invest

3 key lessons

3 key lessons from Graham’s book, to help you start investing: 

  1. There are 3 principles to intelligent investing. 
  2. Never trust Mr. Market. 
  3. Stick to a strict formula, and you’ll do fine. 

#1 The 3 principles to intelligent investing

  1. An intelligent investor always analyzes the long-term evolution and management principles of a company before investing. 
  2. An intelligent investor always protects him- or herself from losses by diversifying investments. 
  3. An intelligent investor never looks for crazy profits, but focuses on safe and steady returns. 

Nobody can predict the next Facebook, but everyone can protect themselves against losses. 

  • By doing a thorough analysis, intelligent investors find stocks with a gap between their current price and the intrinsic value the company holds and will eventually unlock. This is based on the evidence collected from looking at the company’s history and their management values. 
    • The intelligent investor invests in a few of those companies, in order to not lose everything when things go wrong and then sits back, being perfectly happy with collecting 10%, 12% or even 15% a year in returns.

#2 Never trust Mr. Market

Picture the entire stock market as a single person. 

If you imagine Mr. Market showing up on your doorstep every day, quoting you different prices for various stocks, you’d be best off ignoring him altogether, day in and day out. Sometimes the prices he’d tell you would seem suspiciously cheap, sometimes astronomically high. That’s because Mr. Market is not very clever, totally unpredictable and suffers from serious mood swings. 

For example about a month before a new iPhone is released, stocks rally while people cue in line in front of the Apple store. But when the new phone is not exactly as expected, stocks can plummet the very next day.

If you want to be an intelligent investor, rely on your own research and ignore the market altogether

In Chapter, 8 Graham talks about Mr. Market.

He illustrates that someone knocks on your door every day and that someone is Mr. Market. 

Mr. Market comes at the same time every day and he tells you, 

“I have these companies and I want to sell them to you.” 

He goes on to say,

“This XYZ Company is 35 dollars today and yesterday it was only 30 dollars. I have another company, ABC Company, which was 90 dollars yesterday and today it is a 100 dollars.” 

Each day he goes back and comes back with different prices, sometimes higher and sometimes way less. 

This is how the market waves hit at us every day. Being the calm, competent, consistent, and balanced thinker that you are, you are going to listen to the offer and make a conscious decision of what something is worth. 

Therefore, based on what Mr Market says of a company’s worth, if you think it’s a heck of a deal, maybe an investor needs to buy some as he is offering it to you at a great price. 

This is probably the kind of example, Graham would use in his classes which inspired and produced a prodigy like Warren Buffet. So, it’s really about the choice you are making to determine whether you think it’s a good offer or not. The price is just an offer; you don’t get upset or angry with Mr Market. The Intelligent Investor must now get to work, using his or her own analysis and call the shots of what something is worth or valued i.e. the intrinsic value of a stock. 

What Graham is trying educate the readers here is to really get back to the fundamentals of the content of the book. Are you speculating or are you investing? If you are investing, then you must do things that are necessary to protect the principal. He went on to say that as long as you find a good bargain, time will take care of the rest. Don’t put your money into things that you have no idea of what could go wrong. 

In the preface of this book, Warren Buffet states explicitly to pay attention to the valuable advice provided in Chapters 8 and 20. This is why Chapter 8 is so important. It shifts your behaviour, attitude and thoughts about the price movement of stock. Therefore, I urge readers not to miss the story of Mr Market and the other inestimable thoughts in Chapter 8. 

#3 Stick to a strict formula, and you’ll do fine

Always stick to a strict formula when investing. 

Graham calls it formula investing, but it’s more widely known as dollar cost averaging. 

Invest the same amount again and again – no more when stocks are cheaper, no less when stocks are expensive, e.g.:

It’s a great way to protect yourself against losses, which could happen if you invest a big sum right before a crash. 

Reading a stock quote:

Columns 1 & 2: 52-Week High and Low – These are the highest and lowest prices at which a stock has traded over the previous 52 weeks (one year). This typically does not include the previous day’s trading.Column 3: Company Name & Type of Stock – This column lists the name of the company. If there are no special symbols or letters following the name, it is common stock. Different symbols imply different classes of shares. For example, “pf” means the shares are preferred stock.
Column 4: Ticker Symbol – This is the unique alphabetic name which identifies the stock. If you watch financial TV, you have seen the ticker tape move across the screen, quoting the latest prices alongside this symbol. If you are looking for stock quotes online, you always search for a company by the ticker symbol. If you don’t know what a particular company’s ticker is you can search for it on our markets page.Column 5: Dividend Per Share – This indicates the annual dividend payment per share. If this space is blank, the company does not currently pay out dividends. Column 6: Dividend Yield – The percentage return on the dividend. Calculated as annual dividends per share divided by price per share.
Column 7: Price/Earnings Ratio – This is calculated by dividing the current stock price by earnings per share from the last four quarters. For more detail on how to interpret this, see our P/E Ratio tutorial. Column 8: Trading Volume – This figure shows the total number of shares traded for the day, listed in hundreds. To get the actual number traded, add “00” to the end of the number listed. Column 9 & 10: Day High and Low – This indicates the price range at which the stock has traded at throughout the day. In other words, these are the maximum and the minimum prices that people have paid for the stock.Column 11: Close – The close is the last trading price recorded when the market closed on the day. If the closing price is up or down more than 5% than the previous day’s close, the entire listing for that stock is bold-faced. Keep in mind, you are not guaranteed to get this price if you buy the stock the next day because the price is constantly changing (even after the exchange is closed for the day). The close is merely an indicator of past performance and except in extreme circumstances serves as a ballpark of what you should expect to pay. Column 12: Net Change – This is the dollar value change in the stock price from the previous day’s closing price. When you hear about a stock being “up for the day,” it means the net change was positive.

Choosing the Right Stocks- Tops Down Approach Funnel

5000+ Stocks @ NYSE & NASDAQ => Filter through Fundamental Criterias @ Growth Screening Handout => Filter down to ~15 stocks => Compare+Contrast to 4-6 stocks => Invest

  1. Why S&P 500?
    1. Top 500 stocks listed in the US Stock Exchange
    2. Higher volume
      1. More Institutional Funds participation
      2. High Market Capitalization – less manipulation
    3. More availability in CFD & Options
    4. More analyst coverage
  2. Which Sectors & Industries should you choose?
    1. Always start with a Sector and an Industry that you can understand, so that you can evaluate the following:
      1. Business Model
      2. Growth Opportunities
      3. Top Risk
      4. News that may affect the company share price
  3. What drives a Company’s Fundamental Value?
    1. The value of a company will grow depending on these basic criteria:
      1. Profitability – how much money you make from every share
      2. Growth
      3. Sustainability
    2. In the short term, the Share Price may not reflect the Fair value of due to many factors
    3. However, in the long run, share price tends to reflect the company value

Stock Screening Criteria

US Market Capitalization Categories

Mega-cap> US$200 bilFOCUS
Large-cap> US$10 bilFOCUS
Mid-cap~ US$ 2-10 bilFOCUS
Small-cap~ US$250mil – US$2 bilIGNORE
Micro-cap< US$250 milIGNORE
Nano-cap< US$50 milIGNORE

We ONLY want to invest in companies with Mid to Mega Capitalizations

  1. Top-Down Approach 
    1. How to select the right stocks
      1. For 10 minutes:
        1. Filter ~15 stocks out from 5000+ stocks @ NYSE & NASDAQ through Fundamental Criterias
      2. The next 30 minutes: Do comparison check to select 4-6 stocks
    2. Screening Stocks:
      1. Strong Growth Stocks with Good Fundamentals
        1. High Profitability & High Growth
        2. Strong Institutional Participation
        3. Good times, Growth Stocks perform better
        4. Bad times, Value Stocks perform better
      2. Mature Companies with Good Fundamentals – for beginners/conservative
        1. High Profitability & Reasonable Growth
        2. Strong Institutional Participation
      3. Emerging Stocks – for advanced investors; usually starts with negative
        1. Growing Sales & Improved Earnings
        2. Strategic Market Leadership & Innovation

Fundamental & Technical Analysis

Fundamental AnalysisTechnical Analysis
STARTS
WITH/FROM
> Financial Statements> Economic FactorsStock from the charts
STOCKS TO BUYKnows whichKnows when
Fundamental AnalysisEverything that can potentially affect a company’s value.Can include both macro & micro economic factors including past performances & future forecasts.
Liquidity is the amount of money that can be readily available whenever necessary. e.g. cash, treasury bills, notes and bonds, and any other asset that can be sold quickly without drastic change in their market price. =================================Solvency is the degree to which the current assets of an entity exceed the current liabilities of that entity.———————————————————-Solvency is the ability of a company to meet its long-term financial obligations.
Capitalization > The provision of capital for a company> The conversion of income or assets into capital.

Liability, in general, is an obligation to or something that you owe somebody else. Liabilities are defined as a company’s legal financial debts or obligations that arise during the course of business operations. In general, a liability is an obligation between one party and another not yet completed or paid for. 

Earnings Per Share (EPS)

EPS = (Net Income – Preferred Stock Dividend)/(Average Outstanding Shares) = $______

  • EPS indicates the company profit allocated to each outstanding share of common stock.
    •  For example, company A without preferred stock makes $100,000 profit and has 50,000 outstanding common stock – so the EPS = $2 per share
  • EPS plays a major role in determining share price
  • Limitation – EPS can be manipulated/impacted by share buyback and extraordinary item (e.g. asset write off, lawsuit, selling company assets, etc).
    • extraordinary item – not standard/ordinary s oshouldn’t use to do projection for future investments
  • Two companies may generate the same EPS but one of them may use much higher capital than the other. Therefore, EPS alone should not be used to compare different companies profitability.
  • EPS should be used together with other criteria to provide better clarity about a company’s fundamental.

Profit after tax deducted divided per share (e.g. for 1,000 shares at $1 each: profit earned after tax deduction is $5,000 so each share will receive +$5 — ($5 EPS))

Return on Equity (ROE) – Good Profitability 

ROE = (Net income)/(Shareholder’s Equity) — measured in %

  • Investors are mainly concerned about the return the company can generate for every $1 they invested in the company. This is measured by ROE.
  • ROE measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested.

You want minimum 15% and EPS growth of > 10%

So if Capital per Share = $1, EPS per Year = $0.33, Growth/Profit after 3 years will be $1

Return on Assets (ROA) – Good Profitability 

ROA = (Net income)/(Total Assets)

Assets = Shareholder equity + loan

  • ROA indicates how efficient management is at using its assets to generate earnings. The higher the ROA number, the better, because it shows that the company is earning more money using less capital.
  • It is best to compare against a company’s previous ROA numbers or the ROA of a similar company

Invest: In good times, finance with debt (20% debt considered healthy)

In bad times, finance with equity

Earnings Growth

  • Is one of the main factors driving stock price growth in the long run
  • 2 main factors for earnings growth:
    • Sales Growth (more solid growth) – if you have more sales more income
    • Operations Efficiency improvement – cost cutting
  • May use historical earnings performance to gauge the feasibility of the EPS growth forecasted by analyst. (Typically this is more accurate for non cyclical industries)
  • If you understand the industry/company business model well, you can gauge the earnings growth potential better.
Financial Year Cut Off & EPS Growth

Assume Company A’s financial year cut off date is December and we are now in January 2018

  • Forecasted EPS Growth next 5 years = 15%, i.e. grow at 15%/year for the next 5 years

Through research, replace research’s exercise value with the above to understand

Technical AnalysisPrice Pattern studyPattern: Trends that tend to occur repeatedly.

Fundamental Criterias – Stock Screening Process Summary

  1. Select these criterias in the finviz.com “Descriptive” tab
    1. Index = S&P 500
    2. Sector = (What you can understand, example)
      1. Consumer Goods (staples)
      2. Services
      3. Finances
      4. Technology
    3. Analyst Recommendation = Buy or Better
    4. Country = USA
    5. Option/Short = Optionable

Select these in the “Fundamentals” tab

ProfitabilityVery GoodGood
RoE (Return on Equity)> *30%> 15%
RoA (Return on Assets)> 20%> 10%

*every dollar makes 30 cent

EPS Growth*Very GoodGood
EPS Growth This Year> 20%> 10%
EPS Growth Next Year> 20%> 10%
EPS Growth Next 5 Years> 15%> 8%**

*analyst consensus forecast

**over 5% because in options no 8%

Very GoodGood
Institutional Ownership> 80%> 60%

If the results have too many companies, can do this in stages to shortlist top few:

  • Sort by highest EPS Growth next 5 years & highest ROE
  • Can increase EPS Growth next 5 years: > 10%
  • Can increase RoE: > 20%

Growth is more important than RoE. At this point, the filtered ones (all) are OK to invest in (since they meet the criterion) – you want to have balance in your portfolio.

5. Track Record & Sustainability (Intermediate – Advance Level)

5.1 Check the following lines in www.stockrow.com (not www.morningstar.com ?)

Revenue (Sales)Prefer at least > 5% growth
Operating Income/ProfitPrefer at least > 5% growth (depend on RoE)
EPSPrefer at least > 10% growth
Gross Margin*
Operating Margin*
Operating Cashflow (ensure positive & growing)

For beginners, look for consistent growth

5.2 If there is an abnormal figure, check the “Financial” menu*

(select “Statement Type” = Quarterly, “Period” = 5 Quarters)

  • See which quarter is impacted and check earnings report or news for that quarter to find out why
  • If you want to use EPS to forecast future stock price, you need to replace the outlier with the normal figure without extraordinary item

* Optional for beginners

6. Valuation check & margin of safety

6.1 Is the stock over-value now considering this years earnings? P/E < 15 typically means under-value now

6.2 Is the stock over-value considering next years earnings? Forward P/E < 15 typically means under-value considering next year earnings

6.3 PE is not suitable to value high growth stock especially emerging companies

If PE is high (>15) for high growth stocks (stocks with EPS growth > 10%) then check PEG ratio. Traditionally:

  • PEG Ratio = 1 (Fair Value)
  • PEG Ratio < 1 (under-value considering growth rate)
  • PEG Ratio < 1.5 (in good times, most PEG are also high, so you can look out for those closest to fair value)

6.4 What is the Dividend Yield?

This is additional income usually given by mature companies

Take note that many high growth companies don’t give dividends as they need to retain the profits for expansion or acquisition.

7. Forecast Future Stock Price

7.1 Mid Term Trading Forecast (for beginners):

  • To estimate how much the stock price can grow in the mid-term (about 6 months), you can use the Analyst’ Mean Target Price
  • Check whether there is any latest Analyst update to the Rating or Target Price in finviz.com especially after earnings announcement date

7.2 Intermediate-Advance Level

For Long Term investment, you can use the Year on Year EPS projection & a forecasted future PE to estimate the forecast Stock Price for the next 1-5 years. (refer to the Watchlist file)

  • For Stock in our watchlist – use the Your Forecast Template tab
  • For Stock not in our watchlist or if you want to revise the EPS or EPS Growth Rates, use the Flexible Template tab
  • Go to www.stockrow.com (not morningstar?), click on “Valuation” menu to find the past 10 years PE ratio. Then fill up the PE column in the template

Note: When assumptions change, forecast changes to, so use as guide and do your own forecast.

8. Health Check just before Buying (Intermediate – Advance Level)

8.1 Check the following in www.finviz.com :

  • When is the next earnings date? (more accurate date & time from finance.google.com) – for beginners
  • Any recent Upgrades/Downgrades to the Analyst Rating?
  • Any recent revisions to Analyst Target Price?
  • Any recent significant Insider Buying/Selling?
    • More than 5% selling is a warning (e.g. -5%)
    • If significant, check www.form4oracle.com, if rating is -ve (-1,-2,-3) means significant selling, check who is selling (e.g. CEO, CFO, COO)
    • If Insider is Buying, it’s good
  • Any recent significant Institutional Buying/Selling?
    • More than 5% selling is a warning (e.g. -5)
  • Is the Debt/Equity ratio justified for the industry? (>0.5 is a warning)

8.2 Check any recent news that may affect the stock

  • Subscribe to www.seekingalpha.com & install the Smartphone Apps
  • Create a portfolio for the stock you want to monitor
  • Set the frequency of the alerts you want to receive

9&10. Opportunities & Risks (Advance Level)

Find out what the company do (Company profile) & key opportunities & potential risks:

  • Use the criterias #9 & #10 in the manual as a guide
  • Source of information
    • Seekingalpha.com
      • Competitive Analysis
      • Industry Analysis
      • Recent Opportunity & Risks
    • Earnings Report (refer to {Company Specific – Biggest Price Movers: (Intermediate – Advance Level)} below or seekingalpha.com on what to look out for)
    • Company Investor Relations website (search Google: “Company Name” “Investor Relations”)
      • Webcast Presentation on latest earnings conference call
      • Presentations on company growth
      • Annual Reports

Where to Invest – Sectors & Industries

Sector Section of the economyTechnology, Utilities, Finance, Health Care, etc.
Industry Sub-Sector Banks (Finance), Electric (Utilities), etc.)

Sector

Top 10 Sectors by S&P 500 (as of 29th Mar ‘18)
1Technology24.9%
2FinancialsReal Estate14.7%2.8%
3Health Care13.7%
4Consumer Discretionary12.7%
5Industrials10.2%
6Consumer Staples7.7%
7Energy5.7%
8Utilities2.9%
9Materials2.9%
10Telecommunication1.9%

Industry

RANKSECTORINDUSTRY
1TechnologyBusinesses revolving around the manufacturing of electronics, creation of software, computers or products and services relating to information technology.
2FinancialsReal EstateFirms that provide financial services to commercial and retail customers; this sector includes banks, investment funds, insurance companies and real estate.
3Health CareThe healthcare sector consists of companies that provide medical services, manufacture medical equipment or drugs, provide medical insurance, or otherwise facilitate the provision of healthcare to patients.
4Consumer DiscretionaryConsumer discretionary goods include durable goods, apparel, entertainment and leisure, and automobiles.
5IndustrialsCompanies involved with aerospace and defense, industrial machinery, tools, lumber production, construction, waste management, manufactured housing, cement and metal fabrication.
6Consumer StaplesCompanies whose primary lines of business are food, beverages, tobacco and other household items.
7EnergyCompanies involved in the exploration and development of oil or gas reserves, oil and gas drilling and refining, or integrated power utility companies – including renewable energy and coal.
8UtilitiesCompanies such as electric, gas and water firms, and integrated providers.
9MaterialsCompanies involved in the discovery, development and processing of raw materials which includes mining and refining of metals, chemical products and forestry products.
10TelecommunicationCompanies that provide communications services primarily through a fixed-line, cellular, wireless, high bandwidth and/or fibre optic cable networks.

Company Specific – Biggest Price Movers: (Intermediate – Advance Level)

  • Earnings Estimates Revisions (Current & Forecast)
  • Actual Earnings Surprises
  • Analyst Target Revision
  • Analyst Upgrades/Downgrades
  • Sales Growth
  • Operating Margin Growth
  • Earnings Growth (comparing with same qtr of prev. year)
  • Earnings Momentum (Comparing with prev. qtr)
  • Return of Equity change
  • Other Catalysts
    • Stock Buyback
    • Mergers & Acquisitions
    • Product Announcement
    • Stock Splits/Merge
    • Dividends change (only if significant)

Institutional Ownership (at least 60%)

  • Institutional ownership refers to the ownership stake in a company that is held by large financial organizations, pension funds or endowments. Institutions generally purchase large blocks of a company’s outstanding shares and can exert considerable influence upon its management.
  • It is important to have a High Institutional Ownership due to the following:
    • Institutional employ many full time analysts to analyze potential companies to invest
    • High Institutional Ownership shows strong interest in the shares
    • Analyzing the changes to Institutional Ownership can give hints to major buying or selling activities. Since institutions trade in high volume, their activities can cause large movements in share price.

Fundamental analysis is a method of evaluating a security in an attempt to assess its intrinsic value, by examining related economic, financial, and other qualitative and quantitative factors. 

Intrinsic value is the security value perceived or calculated through fundamental analysis without reference to its market value (market value is the security’s price sold in the market).

Margin of safety is when market price is significantly below its intrinsic value. Purchase here.

Discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity. DCF analysis uses future free cash flow projections and discounts them to arrive at a present value estimate, which is used to evaluate the potential for investment.

When there is high inflation, everything demands a high return on our capital. When we compare risk and the discount rate that we are using, there is no finite number that is the perfect measure of risk. 

Successful investing is about managing risk, not avoiding it.

Calculation example – how Dow Jones Index is calculated (simplified): 

StocksDay 1Day 2Day 3
AAPL$120$125$125
NKE$115$120$120
V$75$80$80
KO$40$35$40
MSFT$50$50$50
25 Stocks$600$600$570
Total10001010985
  1. Index Change: 1010 – 1000 = 10 points
  2. Index Change: 985 – 1010 = -25 points
Fundamental AnalysisTechnical Analysis
STARTS
WITH/FROM
> Financial Statements> Economic FactorsApproaches stock from the charts
STOCKS TO BUYKnows whichKnows when

Technical Analysis Overview

Technical Analysis: 

  • Study 
    • of stock charts & technical indicators 
    • to analyze past stock price movements to anticipate future market trends
  • NOT study 
    • of stock value

Technical Analysis

  • Studies price pattern
    • Operating under the premise that trends tend to occur repeatedly

Can be used to assess

  • Trend in the stock price: Uptrend/Downtrend/Sideways
  • Risks of potential price reversal
  • Strength of the Trend; sustainability of: Uptrend/Downtrend
  • Potential breakout from a trend

The above assessments are very useful to determine:

  • When to Buy/Sell
  • The reward over risk to know When and When Not to Trade

Stock chart – graphical representation of prices over a period of time

There are many types of stock charts, notably Bar (OHLC) and Candlestick charts. We’re using Candlestick:

Stock Symbol – AAPL (Apple, Inc)

Chart Period – AAPL (Daily) i.e. for Daily, each bar represents 1 day

Last Change – Chg +21.48 (+3.78%) i.e. represents the most current change (Gain US$21.48, Increased 3.78% (increased 3.78% from $568.10 to $589.58))

Volume – 50.6M (50,568,4XX) shares i.e. total number of shares traded

White/Green – Bullish: Price went UP

Black/Red – Bearish: Price went DOWN

DAILY MSFT CHARTWEEKLY MSFT CHART
Each candlestick represents 1 dayEach candlestick represents 1 week.1 week is 5 days (unless there are holidays)

Practise:

Ref: https://www.investopedia.com/university/simulator/

  • Market Hours Mon-Fri: 9:30am – 4:00pm EST == M’sia time 9.30pm – 4.00am
  • Know {which -> when } to buy/sell (stocks)

Keys to Investing Success

>>>>>>>>>>>>>>>>>>>>>>>>>>Consistency
Compounding Effect
Risk Management
1. You start with $10,000 capital
2. 20% return consistently every year
3. After 3 years you will have:$10,000 x (1 + 20%)3 = $17,280

Determine Who You Are

INVESTINGTRADING
PERIODLong-termShort-term
AIMCreating wealth over a long period of time by buying and holding.Generating profit by frequent buying and selling of stocks.
Daily market fluctuations do not affect investors as they aim for long-term.They tend to get benefit of the daily market fluctuations by buying and selling stocks
Investors enjoys perks like the bonus, dividends, stock split etcTrades hold the stocks only for short interval and hence doesn’t enjoy these perks.
PROTECTIVE ELEMENTInvesting in the fundamentally strong company that will bounce back to true value over time and losses will be recovered.Stop loss is used to limit the losses.
INDICATORSFundamental indicators like Earnings per share, Price to earnings, current ratio etc are used.Technical indicators like moving averages, stochastic oscillators, RSI etc are used.
STRATEGYCreating wealth by compound interest and dividendTiming the market (finding the right time to enter and exit a stock)
INFLUENCE FACTORSBusiness fundamentals like industry, economy, financials, market, competitors etcTechnical indicators, psychology of the market, money management, risk-reward 
EXPECTED RETURN8-10% return per month15-20% return per annum (compounded).
BROKERAGE CHARGESVery fewer brokerage charges are involved due to buying and holding strategyTrading involves high brokerage due to frequent buying and selling.
INVOLVEMENT REQUIREDInvestors make the sound investment after deep study of a company and relax afterwardRequire active involvement in the market to find the correct time to enter and exit in order to book profits.
ValuePrice
FundamentalsTechnicals
RISKHigh risk but higher potential return in short term.Low risk but low potential return in short term. Good returns in long term.
GoalsP/L
SaveBorrow
NeedWant
SignalNoise
Time Spent RequiredFew hours before decidingDaily continuous tracking of stock
CostRelatively lowerHigher due to frequency
RiskRelatively lowerHigh
ReturnsHigherLow
If you buy a stock today and commits to holds the stock for the next 5 years, then you are investing. Here you believe that the price of that stock will be way higher after 5 years than what it is today.If you buy a stock today morning and commits to sell the stock by evening (before the market closes), then you are trading. Here you believe to make a profit by the difference in your buying and selling price.
Investors are inclined towards stress-free sound investment for wealth creation over long-term.Traders tend to make big profits in short period of time. They also have a love for the game of trading and find it entertaining.

Investor vs Speculator

Two common uses of the stock market: investing and speculation.

INVESTOR – – understands the whySPECULATOR – ignores the why
expect a reasonable return taking into consideration numerous things such as holding time, current available options, risk or the margin of safetyHand over your money to a company so that it is put to use for productive projects such as growth or expansion – with the expectation that the outcome will be worth more than the original investment. When you invest, your money is intended to be put to work increasing value.seek a massive amount of return in a short period of timeAkin to gambling, speculators purchase something with the hope that they can soon sell it at a higher price without necessarily understanding/caring about why the price should go up. 

To be a successful investor, stay away from speculation and protect the principal.

Pay attention to protection of the principal (original invested sum) – never lose it but promote its safety; always expect reasonable return. 

RETAIL INVESTORINSTITUTIONAL INVESTOR
You

Puts in money @ market for themselvesSmall volumes

Less control over the market (less research in decisions)Liquidity

Free form regulation
Large firms like banks, investment companies, mutual funds, etc.Invest pools of money on behalf of their investorsMajority of volume (# of shares traded) @ stock marketMarket maker (can move the market with trades)Low liquidity(hard to buy & sell positions)Forced to disclose info to Securities Exchange Commision

 

Passive & Active Investors

An important point from Chapters 1 – 7 is investors are divided into two categories:

Passive (defensive) InvestorsActive (aggressive) Investors
wants freedom from effort, annoyance, and the need for making frequent decisions.value their time and freedom more than extra investment returnswilling “to devote time and care to the selection of securities [investments] that are both sound and more attractive than the average.”

As noted, there are benefits and drawbacks to each, so no right/wrong for either.

Once Used to Trading:

Graham’s criteria for a stock pick

I. Look for a company that has a quality rating that is average or better. An investor need not find the best quality companies. He recommends using Standard & Poor’s rating system and requires companies to have an S&P Earnings and Dividends Rating of B or better.

II. Buy into companies with Total Debt to Current Asset ratios of less than 1.0. In value investing, it is important at all times to invest in companies with a low debt load. 

III. Check the Current Ratio (current assets divided by current liabilities) to find companies with ratios over 1.50 to make sure a company has enough cash and other current assets to weather stormy economic conditions. 

IV. Find companies with positive earnings per share growth during the past five years with no earnings deficits. Earnings need to be higher in the most recent year than five years ago. Avoiding companies with earnings deficits during the past five years will help you stay clear of high-risk companies.

V. Invest in companies with price to earnings per share (P/E) ratios of 9.0 or less. I am looking for companies that are selling at bargain prices. Finding companies with low P/ Es usually eliminates high growth companies, which should be evaluated using growth investing techniques. 

VI. Find companies with price to book value (P/BV) ratios less than 1.20. P/E ratios, mentioned in rule 5, can sometimes be misleading. P/BV ratios are calculated by dividing the current price by the most recent book value per share for a company. Book value provides a good indication of the underlying value of a company. Investing in stocks selling near or below their book value makes sense. 

VII.Invest in companies that are currently paying dividends. Investing in undervalued companies requires waiting for other investors to discover the bargains you have already found. Sometimes your wait period will be long and tedious, but if the company pays a decent dividend, you can sit back and collect dividends while you wait patiently for your stock to go from undervalued to overvalued.

Broker or Brokerage Firm

A licensed broker is an agent that buys stocks on your behalf  on the stock exchange while getting a certain percentage of profit and the firm is where you meet the agent.

The most important thing to look at when choosing a broker is the structure of their commission fees

Individuals typically buy and sell shares by using a licensed brokerage firm or broker (or online trading platform) who makes the actual trade. 

With the broker from the stock quote select the trade type and make the trade:

#1 Stock Quote:

Reading a stock quote ((carries a lot of information including the current bid and offer (sometimes called the ask) prices as well as the last price that traded; the bid is the highest price that somebody in the market is willing to pay at a given time, while the offer is the lowest price that somebody is willing to sell) is obtained. When the bid and offer coincide, a trade is made).

#2 Trade Types:

  • Market Order – order that instructs the broker to buy or sell shares at the best available price. If you wanted to buy 100 shares of AAPL at market, and the quote shows: Bid: $139.80 (100), Offer: $140.00 (50), Last: $139.95 (250). This tells us that the last trade was 250 shares at $139.50 and it indicates 50 shares are offered at $140.00. Suppose another 200 are offered at $140.05. Your market order would buy the 50 shares at $140.00 and then purchase 50 more at the next best price at $140.05 so when you buy the 50 shares offered at $140.00, the new quote would be Bid: $140.00 (50), Offer: $140.05 (200), Last: $140.00 (50).
  • A limit order can also be designated all-or-none (AON), meaning that you won’t agree to buy your shares unless you can get all 100 that you want. 
  • With a Stop order a.k.a. stop-loss order, your trade will be executed only when the security you want to buy or sell reaches a particular price (the stop price) and the stop order essentially becomes a market order and is filled. For instance, if you own stock ABC, which currently trades at $20, and you place a stop order to sell it at $15, your order will only be filled once stock ABC drops below $15. 
    •  This type of order can also be used to guarantee profits. For example, assume that you bought stock XYZ at $10 per share and now the stock is trading at $20 per share. Placing a stop order at $15 will guarantee profits of approximately $5 per share, depending on how quickly the market order can be filled. Stop orders are particularly advantageous to investors who are unable to monitor their stocks for a period of time, and brokerages may even set these stop orders for no charge.
    • One disadvantage of the stop order is that the order is not guaranteed to be filled at the preferred price the investor states. Once the stop order has been triggered, it turns into a market order, which is filled at the best possible price. This price may be lower than the price specified by the stop order. Moreover, investors must be conscientious about where they set a stop order. It may be unfavorable if it is activated by a short-term fluctuation in the stock’s price. For example, if stock ABC is relatively volatile and fluctuates by 15% on a weekly basis, a stop-loss set at 10% below the current price may result in the order being triggered at an inopportune or premature time.
    • Orders may also be tagged with instructions regarding how long an order is good for. An immediate-or-cancel (IOC) order is cancelled if the order isn’t executed right away. This is typically used in conjunction with a limit order. When an IOC order is combined with an AON order, it is designated fill-or-kill (FOK). A day order is a limit or stop order that is cancelled at the end of the trading day, and will not be active the next morning. A good-til-canceled​ (GTC) order is active until the instruction is given to cancel it, and may remain active for many days at a time or longer.
  • margin trading – investors borrow money to buy shares in excess of the amount of cash in their account; Margin also allows for short selling (investors borrow shares they do not own in order to sell them with the hope of buying them back in the future at a lower price). 
    • Buying on margin is borrowing money from a broker to purchase stock.
    • A short seller is betting that the price of a stock will go down, rather than up.
    • Shorting, or short-selling, is when an investor borrows shares and immediately sells them, hoping he or she can scoop them up later at a lower price, return them to the lender and pocket the difference.

There are many stock, option and future exchanges in the US – we can profit from Buy Long or Sell Short (dependant on broker’s availability).

List of Brokerages

Many brokerages offer their services online, so you can trade directly from your computer without any hassle. Types of brokers: https://www.investopedia.com/ask/answers/108.asp

Online Brokerages

Here are a few online brokerages you can use to kick off your stock-trading career:

TD Ameritrade is one of the most popular online brokerages out there. They offer a variety of trading services and research tools. The typical fee for a stock purchase is $9.99 per trade, and the minimum account deposit is $2,500.

OptionsHouse is a discount brokerage, offering much lower commission fees. Stocks will run you a fee of $3.95 per trade. The minimum account balance is also lower, at $1000. However, you’ll get less research and analytics on this platform.

tradeMONSTER finds itself in the middle of the first two, in terms of fees and services. Trade  Monster charges a fee of $7.50, and the minimum account balance is $2,000.

eToro is an excellent trading platform for new investors. Considered the “social trading platform”, eToro really simplifies the stock trading process, and allows you to follow and copy expert investors.

You can use www.StockBrokers.com to compare special offers, commission rates, and other services of more online brokerages to find the perfect one for you.

In addition to using a brokerage, there are two less common ways to own shares: dividend reinvestment plans (DRIPs) and direct investment plans (DIPs). DIPs are plans by which individual companies, for a minimal cost, allow shareholders to purchase stock directly from the company. DRIPs are where the dividends paid by shares are automatically used to purchase more of those shares (including fractions of a share).

Options Market

Place where option stocks are traded. SL Goh recommended you to start here due to lower capital than stock market.

Notable High-Achieving Investors

BENJAMIN GRAHAMOver 20yrs: ~21% per yr
PHILIP FISHER
WARREN BUFFET(Berkshire Hathaway)1965-2006: 21.4% return1965-2012: 19.7% returnNet Worth: ~US$50 BILLION“I am 15% Fisher and 85% Graham”
PETER LYNCH(Fidelity Magellan Fund)
13 yrs: ~29% return
GEORGE SOROS(Quantum Fund)
1969-2000: ~30%/yr
MICHAEL STEINHARDTFor 28 yrs: 24.5% return
30 minutes – 30 days
Stocks, Bonds, Options, Currencies
SMITA SADANA(Sunrise Capital LLC)Over 13 yrs + 2 bear markets: ~39% gainDec 2000-2010: ~19% return vs S%P500 performance

RECAP

Let’s recap some of the main points we’ve learned in this tutorial:

  • Stocks are claims to a company’s profit stream and are granted voting rights in installing its board of directors or in approving large corporate actions such as being acquired. Shareholders are not owners of a corporation’s assets and do not involve themselves with corporate management.
  • Stock is equity, bonds are debt. Bondholders are guaranteed a return on their investment and have a higher claim in recovery from a bankruptcy than shareholders. This is generally why stocks are considered riskier investments and require a higher expected rate of return.
  • You can lose all of your investment with stocks. The flip-side of this is you can make a lot of money if you invest in the right company.
  • The two main types of stock are common and preferred. It is also possible for a company to create different classes of stock.
  • Stock markets are places where buyers and sellers of stock meet to trade. Most trading takes place today via electronic trading.
  • Stock market indexes give an overview to how the stock market is “doing.”
  • Stock prices change moment to moment according to supply and demand. There are many factors influencing prices, the most important of which is expectations about earnings. Still, there is no consensus as to why stock prices move the way they do.
  • To buy stocks you can either use a brokerage or a dividend reinvestment plan (DRIP).
  • There are a number of different order types, and the type of order you use will depend on whether you are more concerned with price or with completing your order.
  • Stock tables/quotes actually aren’t that hard to read once you know what everything stands for!
  • Bulls are optimistic and bull markets are defined by increasing stock prices. Bears are pessimists and bear markets occur when prices fall.

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A bull market is when everything in the economy is running objectively well: people are finding jobs and unemployment is low, the economy is growing as measured by gross domestic product (GDP), and stocks are rising. Picking stocks during a bull market is arguably easier because everything is going up. If a person is optimistic and believes that stocks will go up, he or she is called a bull and is said to have a bullish outlook. Bull markets cannot last forever though, and sometimes they can lead to dangerous situations if stocks become overvalued. In fact, one severe form of a bull market is known as a bubble, where the upward trajectory of stock prices no longer conforms to fundamentals, and optimistic sentiment completely takes over. Bubbles always burst when reality catches up with overinflated prices, and people often realize bubbles in hindsight. It is difficult to recognize when investors are in a bubble and even harder to predict when it will pop.

A bear market is informally defined as a 20% drop in broad indices. Bear markets happen when the economy appears to be in or near recession, unemployment rises, corporate profits fall, and GDP contracts. Bear markets make it tough for investors to pick profitable stocks. One solution to this is to profit from when stocks are falling via short selling. Another strategy is to wait on the sidelines until you feel that the bear market is nearing its end, only starting to buy in anticipation of a bull market.

Bear markets are typically associated with an increase in stock market volatility, since investors typically fear losses more than they appreciate gains at an emotional level. People are not always rational actors – especially when it comes to money and investments. During bear markets, prices do not drop in an orderly or rational way to some fundamental level of price-to-earnings, but rather market participants often overreact in panic and send prices below reasonable valuations.

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Stockholders do not own corporations; they own shares issued by corporations. 

When a company is first founded, the only shareholders are the co-founders and early investors. For example, if a startup has two founders and one investor, each may own one-third of the company’s shares. As the company grows and needs more capital to expand, it may issue more of its shares to other investors, so that the original founders may end up with a substantially lower percentage of shares than they started with. During this stage, the company and its shares are considered private. In most cases, private shares are not easily exchanged, and the number of shareholders is typically small.

As the company continues to grow, however, there often comes a point where early investors become eager to sell their shares and monetize the profits of their early investments. At the same time, the company itself may need more investment than the small number of private investors can offer. At this point, the company considers an initial public offering, or IPO, transforming it from a private to a public company. After transforming, its shares become public and can be traded on a stock market

Corporations are treated as legal persons. In other words, corporations file taxes, can borrow, can own property, can be sued, etc. 

So if you own 33% of the shares of a company, you own one-third of the company’s shares. 

Owning stock gives you the right to vote in shareholder meetings, receive dividends (which are the company’s profits in which is the foundation of a stock’s value; the more shares you own, the larger the portion of the profits you get) if and when they are distributed, and it gives you the right to sell your shares to somebody else.

If you own a majority of shares, your voting power increases so that you can indirectly control the direction of a company by appointing its board of directors. This becomes most apparent when one company buys another: the acquiring company doesn’t go around buying up the building, the chairs, the employees; it buys up all the shares. The board of directors is responsible for increasing the value of the corporation, and often does so by hiring professional managers, or officers, such as the Chief Executive Officer, or CEO.

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Many stocks, however, do not pay out dividends, and instead reinvest profits back into growing the company. These retained earnings, however, are still reflected in the value of a stock.

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There are important distinctions between whether somebody buys shares directly from the company when it issues them (in the primary market) or from another shareholder (on the secondary market). When the corporation issues shares, it does so in return for money.

There are two main types of stock that companies can issue: common stock and preferred shares.

Common Stocks – When people talk about stocks they are usually referring to common stock. In fact, the great majority of stock is issued is in this form. Common shares represent a claim on profits (dividends) and confer voting rights. Investors most often get one vote per share-owned to elect board members who oversee the major decisions made by management.

Over the long term, common stock, by means of capital growth, has tended to yield higher returns than corporate bonds. This higher return comes at a cost, however, since common stocks entail the most risk including the potential to lose the entire amount invested if a company goes out of business. 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 functions similarly to bonds, and usually doesn’t come with the voting rights (this may vary depending on the company, but in many cases preferred shareholders do not have any voting rights). 

Bonds – Companies can instead raise money through borrowing, either directly as a loan from a bank, or by issuing debt, known as bonds. Bonds are fundamentally different from stocks in a number of ways. First, bondholders are creditors to the corporation, and are entitled to interest as well as repayment of principal. 

Creditors are given legal priority over other stakeholders in the event of a bankruptcy and will be made whole first if a company is forced to sell assets in order to repay them.

Shareholders, on the other hand, are last in line and often receive nothing, or mere pennies on the dollar, in the event of bankruptcy. This implies that stocks are inherently riskier investments that bonds.

The same is true on the upside: bondholders are only entitled to receive the return given by the interest rate agreed upon by the bond, while shareholders can enjoy returns generated by increasing profits, theoretically to infinity. 

The greater risk attributed to stocks has generally been rewarded by the market. Stocks have historically returned around 8-10% annualized, while bonds return 5-7%.

With preferred shares, investors are usually guaranteed a fixed dividend in perpetuity. This is different from common stock which has variable dividends that are declared by the board of directors and never guaranteed. In fact, many companies do not pay out dividends to common stock at all.

Another advantage is that in the event of liquidation, preferred shareholders are paid off before the common shareholder (but still after debt holders and other creditors). Preferred stock may also be “callable,” meaning that the company has the option to re-purchase the shares from preferred shareholders at any time for any reason (usually for a premium). An intuitive way to think of these kinds of shares is to see them as being somewhat in between bonds and common shares.

Other classes of share: Mutual Fund, ???

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In addition to individual stocks, many investors are concerned with stock indices (also called indexes). Indices represent aggregated prices of a number of different stocks, and the movement of an index is the net effect of the movements of each individual component. When people talk about the stock market, they often are actually referring to one of the major indices such as the Dow Jones Industrial Average (DJIA) or the S&P 500.

The DJIA is a price-weighted index of 30 large American corporations. Because of its weighting scheme and that it only consists of 30 stocks – when there are many thousand to choose from – it is not really a good indicator of how the stock market is doing. The S&P 500 is a market cap-weighted index of the 500 largest companies in the U.S., and is a much more valid indicator. 

Indices can be broad such as the Dow Jones or S&P 500, or they can be specific to a certain industry or market sector. Investors can trade indices indirectly via futures markets, or via exchange traded funds (ETFs), which trade like stocks on stock exchanges.

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Stock prices change often (sometimes many times a minute) as the result of market forces. By this we mean that share prices change because of fluctuations in their supply and demand. If more people want to buy a stock at a given moment (demand) than sell it (supply), then the price moves up. In our previous example of buying Apple Inc. (AAPL) stock with a market order, the purchase caused the price to increase to $140.05. Conversely, if more people are motivated to sell a stock than buy it, there would be greater supply than demand, and the price would fall. Of course, for any trade to actually happen there needs to be exactly one buyer and one seller – so the number of buyers and sellers is technically the same. What we mean here is the number of motivated buyers or sellers, i.e. those that are willing to buy for higher or sell for lower.

The price of a stock represents the “value” of the corporation. At its most basic level, this value is computed by dividing the dollar value of the company, known as the market capitalization (or “market cap”) by the number of shares outstanding. For example, if XYZ Corp. is valued at $1,000,000 and it has 100,000 shares outstanding, the price of each share is $10.00. Working backwards, one can determine the market value of a company thus by multiplying the share price by the number of shares. The question then becomes what causes fluctuations in the value of the corporation?

But what does a company’s value represent? A company has stuff and it sells stuff. The stuff it has – buildings, machinery, patents, money in the bank, etc. – constitute its book value, or the amount of money a company would get if they sold all that stuff at once. But companies are primarily in business of trying to make a profit, and in doing so they earn cash by selling products or services, so the total value of a company has to do with the stuff it owns now and the cash flows it will receive in the future. The value of the stuff it owns now is fairly easy to determine, but the value of all the future cash flow streams is a bit trickier to nail down – and it is this piece that is responsible for market gyrations.

Because of the time value of money, profits to be earned in the future must be discounted back to represent today’s dollars – just as a dollar put into a bank account today will be worth more in the future after it has earned some interest, but in reverse. How much to discount these future cash flows depends on a lot of things including the cost of capital (which is the cost to borrow or find investment, and this depends on interest rates), the riskiness of the business (in the stock market this is often estimated using beta), and the foregone cost of doing nothing and keeping your money in the bank (the opportunity cost or risk-free rate).

Once an appropriate discount rate has been estimated, the hard part is to figure out what future cash flows will be – a month from now, a year from now, five years from now. Sentiment and expectations are a big component of these predictions, and financial analysts try to figure these amounts out in a number of ways accounting for both company-specific factors and macro factors such as overall economic health. Fortunately, the stock market reflects the expectation of future cash flows in an easy to compute ratio of price-to-earnings, also known as the P/E ratio. A P/E ratio of 10x means that a company is being valued today at 10x its current earnings. A P/E ratio of 20x for the same company would mean that given the same amount of earnings, the market is giving it twice as much value, indicating that those future cash flows are going to be larger. Of course, there are a number of sophisticated pricing models that analysts can use in addition, or instead of, the P/E ratio such as using dividend discount models or free cash flow models.

Because the future is unknown today, various peoples’ estimates will be different from one another, giving some a higher expected stock price and some a lower stock price. If the current price is lower than their expected price, people will buy it. If it is higher, people will sell it. When an economy is growing, people are spending and profits are rising. Companies invest in projects, expand their businesses and hire more people. Investors are optimistic and expectations of future cash flows rise, and stocks enter a bull market. Simply put, stock markets can fall when expectations of future cash flows decrease, making the prices of companies seem too high, therefore causing people to sell shares. If many more people come to this decision than there are people to buy those shares, the price will fall until it reaches a level where people will begin to believe that they are fairly valued.

The important things to grasp about this complicated subject are the following:

1. At the most fundamental level, supply and demand in the market determines stock price in any given moment.

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. It is investors’ sentiments, attitudes and expectations that ultimately affect stock prices.

4. There are many competing theories that try to explain the way stock prices move the way they do. Unfortunately, there is no one theory that can explain everything.

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Let’s recap some of the main points we’ve learned in this tutorial:

  • Stocks are claims to a company’s profit stream and are granted voting rights in installing its board of directors or in approving large corporate actions such as being acquired. Shareholders are not owners of a corporation’s assets and do not involve themselves with corporate management.
  • Stock is equity, bonds are debt. Bondholders are guaranteed a return on their investment and have a higher claim in recovery from a bankruptcy than shareholders. This is generally why stocks are considered riskier investments and require a higher expected rate of return.
  • You can lose all of your investment with stocks. The flip-side of this is you can make a lot of money if you invest in the right company.
  • The two main types of stock are common and preferred. It is also possible for a company to create different classes of stock.
  • Stock markets are places where buyers and sellers of stock meet to trade. Most trading takes place today via electronic trading.
  • Stock market indexes give an overview to how the stock market is “doing.”
  • Stock prices change moment to moment according to supply and demand. There are many factors influencing prices, the most important of which is expectations about earnings. Still, there is no consensus as to why stock prices move the way they do.
  • To buy stocks you can either use a brokerage or a dividend reinvestment plan (DRIP).
  • There are a number of different order types, and the type of order you use will depend on whether you are more concerned with price or with completing your order.
  • Stock tables/quotes actually aren’t that hard to read once you know what everything stands for!
  • Bulls are optimistic and bull markets are defined by increasing stock prices. Bears are pessimists and bear markets occur when prices fall.

Reference