The stock markets are a means to buy and sell, but they are a market place: when, what, and how often and how much one buys, accumulates or sells is NOT the province of the market: that is the province of the field of investment which is covered elsewhere. Investment in general is a rich and complex field as it serves all kinds of investors, government, corporations, services, groups and individuals: each investor has her own objective, her own access to capital which to invest. Indeed, the subject of investing can well be approached from the investors point of view. Given that I am writing this here in a wiki, an information forum open to and created by the community of the world, it might be appropriate to direct this summary to the individual small investor, who invests as part of a long term and life long plan of savings for herself, her family and heirs. Again, the market is a place where one trades (buys and sells) financial instruments, such as stock, bonds and the many forms of these instruments, and is not itself concerned with investing, ie, the strategy for making a profit under many many varied desires and circumstances. This section under the stock market should be dry, technical and thorough, and should serve as a reference. However, to understand the vehicles, form a coherent view of ones own objectives and the appropriate vehicles: stocks (common, preferred) bonds (convertible or not) one should start with an introduction to investing, and most likely, focusing at first on individual investing, which should be the most straight forward and the most useful.
Traditionally the US stock exchange has given an annual average return of seven percent after adjusting for inflation. This makes it one of the most lucrative investments available. Granted, there is no guarantee that the market will behave in the future as it has in the past, but it has been consistent in some respects over its 70+ year history.
The challenge and lure of Investing come from the fact that it is an inexact science. In physics, there are a few laws which govern a large variety of physical phenomena. In Investing, there are no such comparable laws. Investing is all about predicting the future. Since, there are a large number of factors influencing the future price of a stock, there is always a degree of uncertainty with any position.
Stocks are just one kind of financial instruments. The field is complicated by the fact that there are mutual funds, Exchange Traded Funds (ETFs), Real Estate Investment Trusts (REITs), options, futures , bonds and several other kind of financial instruments. It takes almost a year to just familiarize oneself with the jargon of the field.
Finding a broker[edit | edit source]
There are several options to consider when finding a broker. These include but are not limited to the following: Full service brokers, discount brokers, and financial advisors. Each have their advantages and disadvantages. Transaction cost, experience, history and strategy are all factors to consider when hiring a broker.
A full service broker is a broker that will generally come with the highest up front costs. These costs are probably the full service broker's biggest disadvantage. However, the broker history plays a large role in the weight of this disadvantage. If the full service broker proves to have a history of high returns, they may be worth the initial fee, with the assumption they may be able to make you more than your average expected return after the fees are paid. When choosing a full service broker, one should interview several brokers. This serves as a good way to view their history, ask about their experience, costs and finally their strategy. Their strategy is what stocks and funds they are most familiar with and their justification as to why they pick the stocks they do. If one is adverse to larger transaction costs and doesn't mind using a more hands on approach, then he may want to look at more cost effective methods, such as a discount broker. Generally these brokers will be cheaper than their full service cousins (hence the name 'discount'), but they may require more interaction from the user.
Ameritrade, Brown & Co, and Interactive Brokers are some of the most cost effective brokers around. Barron's and Forbes periodically compare these brokers.
Understanding Stock Fundamentals
Stock market prices fluctuate everyday, and no stock is completely safe. However, there are certain things that you can look at to try to determine the best stocks. The price of stocks is based on two things: hype, and the fundamental value of the company. You must be careful about stocks with lots of hype that lack strong fundamentals, because they have strong potential to lose much of their value rather quickly.
When looking at a company, you will first notice its price. The listed price is generally taken as the most recent trade price on an open market. If you multiply the total shares outstanding by the price per share, you get the market capitilization (abbreviated market cap), which reflects the current market value of the company. The book value is the value of the various assets that make up the company. Many companys' market values are many times the book value, which reflects non-tangible assets like customer relationships.
What really drives the prices, however, is earnings. The earnings are the money made, which is the sales or revenue minus the costs of doing business, among other things. Earnings are analyzed in relation to price by a value called the P/E or price to earnings ratio. The primary way to use the P/E ratio is in a relative valuation. That means, how cheap is this company/stock compared to similar companies. If company A and B are equally profitable, have similar levels of assets and debt, and are growing at similar rates, then the stock with the lower P/E would appear to be a "better deal" or is possibly undervalued. The major pitfall in this approach comes when both companies A and B are presently overvalued, which could precede a drop in the stock price. There were numerous examples of this during the dot-com "bubble" and it's subsequent "burst".
Again, as a warning, it is imperative to note that one of the major conditions for determining relative value using P/E ratios is the growth rate of a company. If company A has a higher P/E ratio than company B, it is highly likely that the higher ratio is justified by a higher growth rate of company A's earnings.