The Mystery of Stocks Explained

The Role of a Stock Exchange

Why did businessmen in the 1500s and 1600s gather themselves into exchanges? Such an organization brings with it the advantage of uniform guidelines, regulations and third-party observations to reduce chances of fraud or deceit. A stock market serves to bring people together who want to buy and sell investments such as stocks, bonds and currencies in a fair and open system.

If you are looking for a book, you have a better chance finding what you want in a bookstore rather than calling out the title as you roam the street hoping to find a seller. Similarly, the early exchanges were a place to concentrate buyers and sellers in an era where advanced communication technology consisted of looking somebody in the eye. Such concentration also allows for the establishment of ground rules by which everybody will agree to abide.

The Mysterious and Magical Share

Since stocks represent ownership in a company, you can imagine that there are different types of ownership. In the case of stocks, shares can be voting, non-voting, common, preferred, or one of many other permutations.

Common stock is almost always voting stock, that is, shares that carry with them voting rights, proportional to the number of shares owned, for events such as the election of the Board of Directors. But common stocks give holders, in the event a company liquidates, rights to the company’s assets only after debt holders, bond holders and preferred stock holders have been satisfied. So common stock gives you the right to vote for directors who will lead the company wisely, but if they don’t, you are last in line to get your money.

Preferred stock, obviously, takes precedence over common stock. But preferred stock owners typically do not enjoy the voting rights of common stockholders; also, preferred stock pays a fixed dividend that does not fluctuate, which is either bad or good depending on what the fluctuating dividend is doing. The company can cease payment of the dividend if financial constraints demand such, but preferred stockholders always receive their dividends first. Preferred stock comes in four varieties: cumulative, non-cumulative, participating and convertible.

Cumulative preferred stock, the kind of preferred shares most often issued, is stock on which dividends accrue to the stockholder in the event that the company does not make timely dividend payments.

Logically then, non-cumulative preferred stocks are shares which unpaid dividends do not accrue to the shareholder.

Participating preferred stocks are those that benefit not only from a regular dividend, but which also receive a bonus dividend when the underlying common stock dividends exceed some pre-determined amount.

Convertible preferred stocks are shares that can be converted into a specified amount of common stock at the stockholder’s option.

As a practical matter, as a small individual investor, you will almost certainly be buying common stock. Wall Street does not think you are important enough to warrant preferred stock. Even from the beginning the odds are stacked against small investors.

Placing Value on Stocks

Stocks have two types of valuations, but neither is a perfect reflection of underlying worth. The fundamental valuation is created using cash flow, sales or earnings analysis in an attempt to correlate stock value with the intrinsic value of the issuing company. The most common metric for this type of analysis is the Price to Earnings Ratio, known on the street as the P/E ratio. By using this measure analysts try to assign stock value based on some measurable and supposedly objective attributes, including historic performance. The idea is that a high ratio, meaning the price of the stock is high relative to the company’s earnings, is an indication that the stock might be overpriced. Inversely, a low ratio might indicate a good opportunity to buy below true market value. This form of valuation is typically what drives long-term stock prices because this is what analysts have decided is important. Whatever. As you would learn in my book, I have little respect for this type of analysis as a means of choosing stocks.

The simple rules of supply and demand dictate the other type of value. How much an investor is willing to pay for a stock (and obviously how much other investors are willing to sell a stock for) indicate real market value at any given time. The more people who want to buy a particular stock (the greater the demand), the higher the price will be that the stock will command. Conversely, if more people want to sell than buy, the price will be lower. This form of valuation is volatile, and is what tends to drive short-term stock market trends, including those driven by “irrational exuberance.”

Trading Mechanics

You open and fund an account with XTRADE with a check for $5000. XTRADE deposits the check into a trading account listed under your name. You log onto XTRADE and place an order to buy 100 shares of a stock in Wild Widgets, Inc., which is currently trading at $2.50. XTRADE uses its network to tell the appropriate exchange (NASDAQ for example) that there is demand for 100 shares of Wild Widget’s stock. The exchange plays its proper role by finding someone willing to sell 100 shares of that stock. When they do, the exchange instantaneously executes the trade between you (the buyer) and the seller. The details of this trade are sent to a clearinghouse, where the information is processed (see below). At the clearinghouse shares will now be registered to you in your name. The clearinghouse simply designates 100 shares of Wild Widget stock to XTRADE, which in turn promptly designates those 100 shares as yours, placing them in your account.

Unlike in the old days, the actual stock certificates are typically held by the broker with a designation indicating your ownership. You can request that the stock certificates be transferred to your name, but that is rarely done. How do you prove you own the stock? The same way you prove you have money in your bank account - with your account statement. Just as you don’t demand a certificate proving ownership of the money in your bank account, there is no need to demand a certificate proving ownership of the stock in your account. You do, however, want to deal only with reputable brokerage houses.

Clearinghouses

A clearinghouse is a vital cog in the wheel of stock trading. The clearinghouse acts as a third party to every transaction and is the guarantor of every trade. Basically, a clearinghouse acts as the bank for stock brokerage firms, carrying the liability of the stock purchase until funds are collected and transferred to the brokerage firm. In another analogy, a clearinghouse is like an escrow company in a real estate transaction: the buyer puts up the money for the house, but first places his money with the escrow company for safe keeping. Only when the buyer and seller have fully satisfied their contractual obligations does the escrow company transfer funds to the seller’s account. The clearinghouse basically does the same thing for those buying and selling stock.

This function is essential to ensure that the markets function with integrity. At the end of each session, the clearinghouse must reconcile the stocks bought and sold, and settle each trader’s account to the market. As a trader you will have no direct contact with a clearinghouse, but without it your trades would be vulnerable to theft, loss or error.

A clearinghouse functions by pooling the risk of default or error with clearing member margin deposits, called clearing margins. These margins are essentially a guarantee fund supported by member deposits, that is, the exchanges that are members of the clearinghouse. These procedures and guarantee funds provide the necessary financial support to ensure integrity in the market.

Trade Executions: Open Outcry and Electronic Trading

I implied above that when you bought your first share of Wild Widgets, Inc. you did so through electronic trading by logging onto your account and placing your order over the Internet. If you are happy pushing a button and getting the result, that is OK; but you might want to understand exactly what really happens when XTRADE matches a seller to you as a buyer. And what happens depends on where your stocks are traded.

New York Stock Exchange

The NYSE trades in a continuous auction format. There is one specific location on the trading floor where each listed stock trades. Exchange members interested in buying and selling a particular stock on behalf of investors gather around the appropriate post where a specialist broker acts as an auctioneer in an open outcry auction market environment to bring buyers and sellers together and to manage the actual auction. You will recognize this from the chaotic shouting and pushing you see in movies that depict the stock market as a frenzied commotion of outstretched arms and strained vocal chords.

Each specialist (auctioneer) conducts the stock trading for one big company, such as IBM, or a number of companies with lighter trading volumes. Each trading post has a computer terminal on a pedestal, surrounded by “floor brokers” representing the big brokerage houses.

Each floor broker wears a different color jacket so that the specialist knows what firm he represents. As soon as the market opens, the colored jackets start yelling what their clients want to buy and the price they are bidding, and others yell out what their customers have to sell, along with the price they are asking. The buyer and seller each of course want to get the best possible price. With all the noise, hand signals soon became an important means of communication, and are now an important part of floor culture.

This style of trading is designed to produce the fairest price for both parties. Supporters of open outcry emphasize the human interaction and expert judgment that is incorporated into the system. However, over the past decade this floor auction system using human traders has been under heavy competitive pressure from the all-electronic NASDAQ Stock Market (see below) and other electronic trading platforms. While the NYSE is proud of its auction system, which in fact helps reduce price volatility, modern stock traders have been drawn more and more to the higher transaction speed made possible with electronic trading.

Right now, when you place an order for a stock traded on the NYSE, even if you execute your order electronically, the order is still delivered to the floor, ultimately executed the old fashioned way through the floor brokers. But in order to stay competitive, the NYSE is heading toward true electronic trading. In February 2006, Federal regulators approved the merger of the New York Stock Exchange with electronic rival Archipelago Holdings Inc. Time will tell how competition between the exchanges ultimately shakes out.

National Association of Securities Dealers (NASDAQ)

The NASDAQ owes its existence to the large size of the NYSE and the American Stock Exchange. Companies that were too small to be listed and traded on the big exchanges were bought and sold by securities dealers in a market known as “over the counter” or OTC, so named because they were not traded on the “floor” of an exchange.

If an investor asked his or her broker to buy shares in a company, the broker would call a few dealers to find the lowest price for his customer. If the investor wanted to sell his shares, the broker would call the same dealers trying to get the highest price for his client. This was not horribly efficient. So in 1971, the National Association of Securities Dealers unveiled a computerized quote system in which each dealer could post his buy and sell prices. Initially only 100 companies were automated in the new exchange.

Each dealer changes his prices throughout the day, depending on the changing volume and ratio of buyers to sellers. He quickly changes his prices to adjust for the buying or selling trend at any given moment. The system is actually very simple. The dealers buy at the lowest competitive price, and sell to you at the highest price you are willing to pay.

Unlike the NYSE, the NASDAQ is not a physical entity, a point most traders fail to understand. Yes, the exchange has its well-known Market Site in Times Square, but the fact is that little is done there relevant to trading. Because the NASDAQ is an OTC market that depends on market makers (dealers) rather than specialists and floor brokers, there is no need for a physical location to bring together buyers and sellers. NASDAQ is really nothing more than a vast communications network of computers linked together to match buyers and sellers, virtually instantaneously. Instead of brokers calling out orders, dealers place their name on a list of buyers and sellers, which is distributed by the exchange instantaneously to thousands of other computers. If you want buy a stock that trades on the NASDAQ, your broker will either call up a dealer with the information of your trade or enter your order directly into a NASDAQ-sponsored online execution system. Because the transaction can be entirely electronic, the time to execute the trade is significantly shorter than what is seen in an open outcry system.

While electronic trading lacks the romance and excitement of open cry trading, that is offset by efficiency and speed. For that very reason, many institutional traders such as pension funds and mutual funds prefer electronic trading. Also, given its more recent history and emphasis on modern means of electronic trading, NASDAQ is now home to technology giants such as Microsoft, Cisco, Intel, Oracle, and Sun Microsystems.

For you as an individual investor, electronic trading provides the benefit of almost instant confirmations on your trades. You have more control over the execution of your trades because you are one step closer to the market. Unfortunately, you still need a broker to handle your trades. Entrenched self-interests prevent individuals from having direct access to electronic markets. Instead, your broker accesses the exchange network on your behalf when you place an order; but at least all those steps are electronic.

For more information, go to www.mytradingstocks.com

About the Author

Dr. Schneider is a recognized expert in building personal wealth, with his best selling books “Beyond No Money Down” and “Trading Futures: Only One Way to Win” and Beat The Street: How to Make Millions in the Stock Market With No Risk.” Practicing what he preaches, he now lives in a beautiful waterfront home in central Texas, and owns and operates his own jet.

The Mystery of Stocks Explained

The Role of a Stock Exchange

Why did businessmen in the 1500s and 1600s gather themselves into exchanges? Such an organization brings with it the advantage of uniform guidelines, regulations and third-party observations to reduce chances of fraud or deceit. A stock market serves to bring people together who want to buy and sell investments such as stocks, bonds and currencies in a fair and open system.

If you are looking for a book, you have a better chance finding what you want in a bookstore rather than calling out the title as you roam the street hoping to find a seller. Similarly, the early exchanges were a place to concentrate buyers and sellers in an era where advanced communication technology consisted of looking somebody in the eye. Such concentration also allows for the establishment of ground rules by which everybody will agree to abide.

The Mysterious and Magical Share

Since stocks represent ownership in a company, you can imagine that there are different types of ownership. In the case of stocks, shares can be voting, non-voting, common, preferred, or one of many other permutations.

Common stock is almost always voting stock, that is, shares that carry with them voting rights, proportional to the number of shares owned, for events such as the election of the Board of Directors. But common stocks give holders, in the event a company liquidates, rights to the company’s assets only after debt holders, bond holders and preferred stock holders have been satisfied. So common stock gives you the right to vote for directors who will lead the company wisely, but if they don’t, you are last in line to get your money.

Preferred stock, obviously, takes precedence over common stock. But preferred stock owners typically do not enjoy the voting rights of common stockholders; also, preferred stock pays a fixed dividend that does not fluctuate, which is either bad or good depending on what the fluctuating dividend is doing. The company can cease payment of the dividend if financial constraints demand such, but preferred stockholders always receive their dividends first. Preferred stock comes in four varieties: cumulative, non-cumulative, participating and convertible.

Cumulative preferred stock, the kind of preferred shares most often issued, is stock on which dividends accrue to the stockholder in the event that the company does not make timely dividend payments.

Logically then, non-cumulative preferred stocks are shares which unpaid dividends do not accrue to the shareholder.

Participating preferred stocks are those that benefit not only from a regular dividend, but which also receive a bonus dividend when the underlying common stock dividends exceed some pre-determined amount.

Convertible preferred stocks are shares that can be converted into a specified amount of common stock at the stockholder’s option.

As a practical matter, as a small individual investor, you will almost certainly be buying common stock. Wall Street does not think you are important enough to warrant preferred stock. Even from the beginning the odds are stacked against small investors.

Placing Value on Stocks

Stocks have two types of valuations, but neither is a perfect reflection of underlying worth. The fundamental valuation is created using cash flow, sales or earnings analysis in an attempt to correlate stock value with the intrinsic value of the issuing company. The most common metric for this type of analysis is the Price to Earnings Ratio, known on the street as the P/E ratio. By using this measure analysts try to assign stock value based on some measurable and supposedly objective attributes, including historic performance. The idea is that a high ratio, meaning the price of the stock is high relative to the company’s earnings, is an indication that the stock might be overpriced. Inversely, a low ratio might indicate a good opportunity to buy below true market value. This form of valuation is typically what drives long-term stock prices because this is what analysts have decided is important. Whatever. As you would learn in my book, I have little respect for this type of analysis as a means of choosing stocks.

The simple rules of supply and demand dictate the other type of value. How much an investor is willing to pay for a stock (and obviously how much other investors are willing to sell a stock for) indicate real market value at any given time. The more people who want to buy a particular stock (the greater the demand), the higher the price will be that the stock will command. Conversely, if more people want to sell than buy, the price will be lower. This form of valuation is volatile, and is what tends to drive short-term stock market trends, including those driven by “irrational exuberance.”

Trading Mechanics

You open and fund an account with XTRADE with a check for $5000. XTRADE deposits the check into a trading account listed under your name. You log onto XTRADE and place an order to buy 100 shares of a stock in Wild Widgets, Inc., which is currently trading at $2.50. XTRADE uses its network to tell the appropriate exchange (NASDAQ for example) that there is demand for 100 shares of Wild Widget’s stock. The exchange plays its proper role by finding someone willing to sell 100 shares of that stock. When they do, the exchange instantaneously executes the trade between you (the buyer) and the seller. The details of this trade are sent to a clearinghouse, where the information is processed (see below). At the clearinghouse shares will now be registered to you in your name. The clearinghouse simply designates 100 shares of Wild Widget stock to XTRADE, which in turn promptly designates those 100 shares as yours, placing them in your account.

Unlike in the old days, the actual stock certificates are typically held by the broker with a designation indicating your ownership. You can request that the stock certificates be transferred to your name, but that is rarely done. How do you prove you own the stock? The same way you prove you have money in your bank account - with your account statement. Just as you don’t demand a certificate proving ownership of the money in your bank account, there is no need to demand a certificate proving ownership of the stock in your account. You do, however, want to deal only with reputable brokerage houses.

Clearinghouses

A clearinghouse is a vital cog in the wheel of stock trading. The clearinghouse acts as a third party to every transaction and is the guarantor of every trade. Basically, a clearinghouse acts as the bank for stock brokerage firms, carrying the liability of the stock purchase until funds are collected and transferred to the brokerage firm. In another analogy, a clearinghouse is like an escrow company in a real estate transaction: the buyer puts up the money for the house, but first places his money with the escrow company for safe keeping. Only when the buyer and seller have fully satisfied their contractual obligations does the escrow company transfer funds to the seller’s account. The clearinghouse basically does the same thing for those buying and selling stock.

This function is essential to ensure that the markets function with integrity. At the end of each session, the clearinghouse must reconcile the stocks bought and sold, and settle each trader’s account to the market. As a trader you will have no direct contact with a clearinghouse, but without it your trades would be vulnerable to theft, loss or error.

A clearinghouse functions by pooling the risk of default or error with clearing member margin deposits, called clearing margins. These margins are essentially a guarantee fund supported by member deposits, that is, the exchanges that are members of the clearinghouse. These procedures and guarantee funds provide the necessary financial support to ensure integrity in the market.

Trade Executions: Open Outcry and Electronic Trading

I implied above that when you bought your first share of Wild Widgets, Inc. you did so through electronic trading by logging onto your account and placing your order over the Internet. If you are happy pushing a button and getting the result, that is OK; but you might want to understand exactly what really happens when XTRADE matches a seller to you as a buyer. And what happens depends on where your stocks are traded.

New York Stock Exchange

The NYSE trades in a continuous auction format. There is one specific location on the trading floor where each listed stock trades. Exchange members interested in buying and selling a particular stock on behalf of investors gather around the appropriate post where a specialist broker acts as an auctioneer in an open outcry auction market environment to bring buyers and sellers together and to manage the actual auction. You will recognize this from the chaotic shouting and pushing you see in movies that depict the stock market as a frenzied commotion of outstretched arms and strained vocal chords.

Each specialist (auctioneer) conducts the stock trading for one big company, such as IBM, or a number of companies with lighter trading volumes. Each trading post has a computer terminal on a pedestal, surrounded by “floor brokers” representing the big brokerage houses.

Each floor broker wears a different color jacket so that the specialist knows what firm he represents. As soon as the market opens, the colored jackets start yelling what their clients want to buy and the price they are bidding, and others yell out what their customers have to sell, along with the price they are asking. The buyer and seller each of course want to get the best possible price. With all the noise, hand signals soon became an important means of communication, and are now an important part of floor culture.

This style of trading is designed to produce the fairest price for both parties. Supporters of open outcry emphasize the human interaction and expert judgment that is incorporated into the system. However, over the past decade this floor auction system using human traders has been under heavy competitive pressure from the all-electronic NASDAQ Stock Market (see below) and other electronic trading platforms. While the NYSE is proud of its auction system, which in fact helps reduce price volatility, modern stock traders have been drawn more and more to the higher transaction speed made possible with electronic trading.

Right now, when you place an order for a stock traded on the NYSE, even if you execute your order electronically, the order is still delivered to the floor, ultimately executed the old fashioned way through the floor brokers. But in order to stay competitive, the NYSE is heading toward true electronic trading. In February 2006, Federal regulators approved the merger of the New York Stock Exchange with electronic rival Archipelago Holdings Inc. Time will tell how competition between the exchanges ultimately shakes out.

National Association of Securities Dealers (NASDAQ)

The NASDAQ owes its existence to the large size of the NYSE and the American Stock Exchange. Companies that were too small to be listed and traded on the big exchanges were bought and sold by securities dealers in a market known as “over the counter” or OTC, so named because they were not traded on the “floor” of an exchange.

If an investor asked his or her broker to buy shares in a company, the broker would call a few dealers to find the lowest price for his customer. If the investor wanted to sell his shares, the broker would call the same dealers trying to get the highest price for his client. This was not horribly efficient. So in 1971, the National Association of Securities Dealers unveiled a computerized quote system in which each dealer could post his buy and sell prices. Initially only 100 companies were automated in the new exchange.

Each dealer changes his prices throughout the day, depending on the changing volume and ratio of buyers to sellers. He quickly changes his prices to adjust for the buying or selling trend at any given moment. The system is actually very simple. The dealers buy at the lowest competitive price, and sell to you at the highest price you are willing to pay.

Unlike the NYSE, the NASDAQ is not a physical entity, a point most traders fail to understand. Yes, the exchange has its well-known Market Site in Times Square, but the fact is that little is done there relevant to trading. Because the NASDAQ is an OTC market that depends on market makers (dealers) rather than specialists and floor brokers, there is no need for a physical location to bring together buyers and sellers. NASDAQ is really nothing more than a vast communications network of computers linked together to match buyers and sellers, virtually instantaneously. Instead of brokers calling out orders, dealers place their name on a list of buyers and sellers, which is distributed by the exchange instantaneously to thousands of other computers. If you want buy a stock that trades on the NASDAQ, your broker will either call up a dealer with the information of your trade or enter your order directly into a NASDAQ-sponsored online execution system. Because the transaction can be entirely electronic, the time to execute the trade is significantly shorter than what is seen in an open outcry system.

While electronic trading lacks the romance and excitement of open cry trading, that is offset by efficiency and speed. For that very reason, many institutional traders such as pension funds and mutual funds prefer electronic trading. Also, given its more recent history and emphasis on modern means of electronic trading, NASDAQ is now home to technology giants such as Microsoft, Cisco, Intel, Oracle, and Sun Microsystems.

For you as an individual investor, electronic trading provides the benefit of almost instant confirmations on your trades. You have more control over the execution of your trades because you are one step closer to the market. Unfortunately, you still need a broker to handle your trades. Entrenched self-interests prevent individuals from having direct access to electronic markets. Instead, your broker accesses the exchange network on your behalf when you place an order; but at least all those steps are electronic.

For more information, go to www.mytradingstocks.com

About the Author

Dr. Schneider is a recognized expert in building personal wealth, with his best selling books “Beyond No Money Down” and “Trading Futures: Only One Way to Win” and Beat The Street: How to Make Millions in the Stock Market With No Risk.” Practicing what he preaches, he now lives in a beautiful waterfront home in central Texas, and owns and operates his own jet.

In a previous article, we discussed Ben Graham’s Net Current Asset Value
(NCAV) strategy and how it works. Here we will revisit Graham’s rules, which
were fairly severe in their original form in that they required the price of the
stocks under consideration to be trading at less than two-thirds of their NCAV
or Graham’s Number. These he considered to be “Bargain Issues”, and to
quote him: “Our purchases were made typically at two-thirds or less of such
stripped-down asset value. In most years we carried a wide diversification here–
at least 100 different issues.”

In a previous article, we discussed Ben Graham’s Net Current Asset Value
(NCAV) strategy and how it works. Here we will revisit Graham’s rules, which
were fairly severe in their original form in that they required the price of the
stocks under consideration to be trading at less than two-thirds of their NCAV
or Graham’s Number. These he considered to be “Bargain Issues”, and to
quote him: “Our purchases were made typically at two-thirds or less of such
stripped-down asset value. In most years we carried a wide diversification here–
at least 100 different issues.”

Such a wide diversification may seem excessive for most investors, but
with such low-priced stock there were evidently going to be a few bankruptcy
candidates. Graham considered this strategy to be suitable for what he called
“defensive” investors. He did acknowledge, however, that there were some
“enterprising” investors who could afford to be more aggressive from the point
of view of risk. To this end, he suggested a series of less onerous criteria
for selecting stocks which is outlined below.

First, list all stocks with Price/Earnings ratios below 9. Note: Graham was
writing in 1970 when P/E’s as a whole were not as elevated by technology
stocks as they are today. Readers who are less risk-averse or who just want
to consider a wider range of stocks may wish to vary the P/E in order to see
what comes up — perhaps up to 80 percent of the average P/E of the S&P 500
would be a good start. Currently the operating average is around 18 and 85
percent of that figure is just over 15. Graham did not state if he was using a
Trailing or Forward P/E ratio, but most likely he was using Trailing P/Es. I
personally prefer to use Forward P/E ratios, especially if they are significantly
lower than the Trailing P/E as this implies expected earnings growth and
therefore possible increase in the stock price.

Once we have a list of stocks meeting the P/E criterion, we consider the financial
condition of each stock, referring to the most recent balance sheet:
Initially, Current Assets must be at least 1.5 times Current Liabilities. This can
also be gleaned via a stock screener by displaying stocks with “Current Ratio”
>= 1.5. Total Debt must not be greater than 110% of Net Current Assets (i.e.
the sum of Cash & Cash Equivalents, Inventory, Accounts Receivable).

Looking further back, we need to find evidence of Earnings Stability, with no
deficit in the last five years, i.e. no evidence of an annual loss. Additionally,
evidence of earnings growth over a five-year period is a must. This can simply
be the consideration, for example, that 2004 earnings were greater than 2000
earnings.

There should be some current dividend payout. Finally, the current price of the
stock should be less than 120% of the NCAV per share or Graham’s Number.
Where to find this number? From the balance sheet, subtract Total Liabilities
from Current Assets, and divide the result by the number of shares outstanding.
Assuming you have a positive number that is greater than zero, the stock’s price
should not be greater than 120% of this number.

At grahaminvestor.com, we list stocks that are trading within 120% of the NCAV
per share. Since this was an important measure for Graham, you can start there
and work your way backwards through the other criteria.

Graham did not set any lower limit on market capitalization. “Small companies
may afford enough safety if bought carefully and on a group basis.” He meant
that a well diversified portfolio with a fair number of such companies stock would
protect the enterprising investor from the bankruptcy of one or two companies.

(c) 2005 The Graham Investor
You may use this article, as-is, provided this copyright notice is kept intact.

ABOUT THE AUTHOR

With so many stock market scandals and the daily fluctuations of various securities, it might seem as though there is no simple method of investment that allows you to avoid the major risks of the market. Luckily, things are not always as they seem… some stocks, dubbed “safety stocks” by some investors, are stable enough that they tend to hold their value even when the rest of the market is in shambles. While these stocks aren’t immune to the changes and fluctuations in the stock market, they usually weather the changes well and are much less prone to sudden drops in value.

If you’ve never heard of safety stocks or would like to know more, the information below is designed to give you some information on these relatively stable investments.

Safety in a turbulent market

Though no stocks are completely immune to the daily changes in the stock market, some manage to do better than others. Some of these companies have been around for a long time and that produce everyday items that are known around the world (such as the first aid and baby care manufacturer Johnson & Johnson), and aren’t likely to encounter major scandals to bring down their prices. While these stocks aren’t known for major increases in value, they don’t perform poorly… instead, they offer a slow-but-steady increase that’s much more stable than many other investment opportunities.

Safety stocks and diversification

Because of their general consistency, safety stocks are considered a must-have by many serious investors. They are great tools for diversification, allowing investors to use their stability to offset some of their more volatile investments. This effect can be increased even further by making investments in precious metals or the diamond market, both of which tend to offer a similar stability that works well with that of the safety stocks. A diverse investment portfolio with a strong base of safety stocks and precious metal and diamond investments is likely to weather even the most turbulent market with minimal long-term losses.

Safety stocks and high-risk investments Even without using safety stocks for true diversification, it’s possible to use these stocks to offset higher-risk investments. When investing in high-risk stocks, a smart investor might buffer their investment with a secondary investment in one or more safety stocks which will help to minimize any losses that might occur. If the higher-risk stock performs well and is sold at a good price, then the safety stocks may either be sold or kept since they’re not likely to drop significantly in value. Should the higher-risk stock not perform well and ends up being sold low, then the value of the safety stocks as they slowly but surely show an increase will help to offset any losses.

Safety stocks and long-term investment

Obviously, safety stocks are great for long-term investments. Purchasing safety stocks over the course of several years is much more likely to show a definite improvement than other stocks that aren’t nearly as stable. When combined with precious metals or the diamond market as mentioned above, the effects can be even more noticeable due to the similar nature of the two types of investments.

Safety stocks can also be combined with bonds or other types of investments that do well in the long term, either using the stocks in smaller amounts to accentuate the earnings of the other investments or as simply another long-term investment among many. This can make safety stocks ideal for retirement plans or any other long-term financial planning.

You may freely reprint this article provided the following author’s biography (including the live URL link) remains intact:

About the Author

John Mussi is the founder of Direct Online Loans who help homeowners find the best available loans via the www.directonlineloans.co.uk website.

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+ $ Profitable momentum trading without technical analysis.

+ $ What kind of stocks and “opportunities” to avoid and why. Save thousands in losses from trades gone bad in the future.

+ $ The “little details” you should look for before you consider a momentum daytrade.

+ $ Things to consider when trading low float momentum stocks

+ $ Buying micro cap and small cap stocks with momentum.

+ $ Trading NASDAQ stocks or OTCBB - OTC stocks ?

+ $ Getting ready for the trading breakout. Position your self for success.

+ $ Will my market rally last more than 5 minutes or less? What to do

+ $ It’s all about the stock rally. The rest is just a bunch of elegant B.S. Learn to focus on what matters.

+ $ How to lock in profits on the way up

+ $ Should I hold overnight trading positions for a possible gap up ?

+ $ What to do if the stock rally stops moving. Cash in your pocket !

+ $ Level 2 trading ( L 2 ) strategies for momentum stocks.

+ $ Time frames for trading stocks with momentum, Pros and Cons

+ $ Premarket stock trading strategies and tips.

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+ $ After hours trading tactics and tips. Super value, yours included !

+ $ Become an expert of your hotstock watch list.

+ $ You don’t need to watch the stock market all day. Profitable stock traders have a better way.

+ $ Stock trading is not a job. Save money and don’t make it another rat race.

+ $ Watching charts and stocktrading all day ? Overtrading is not the way to go. Learn why !

+ $ Testing the high probability trading plan

+ $ Stress free day trading tips and strategies for beginners and experienced stock traders. Your time is here!

+ $ Real examples of recent on-line trading opportunities. Learn in a practical way.

+ $ Powerful stock market resources and tools for day trading with our strategy. Discover momentum stocks in a snap and choose only the best every day. No waisting time. Its all about results !

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About the Author

Momentum Stock Trading helps day traders and investors choose hot stock trading opportunities in a practical way every day at http://www.MomentumStockTrading.com
Dividend Paying Stocks

by: Charles M. O’Melia

I would like to share with the reader an article printed in the financial section of U.S.A. Today on March 7, 2003 which exemplifies the awesome power of a stock dividend.

MICROSOFT TO ISSUE FIRST DIVIDEND TODAY:

After reading this article I couldnt help thinking about a report, which I believe stated that there were an estimated 33 million people in America living under the official poverty level. Bill Gates, by giving away his Microsoft dividend to those living under the poverty level could begin to create 96 millionaires, year after year after year. What a boost to the economy that would be! Imagine all those new millionaires every year spending money on something other than food, Salvation Army clothing and shelter.

Bill Gates (by giving away his Microsoft dividend) could begin to eliminate all the hardships for those people currently living under the poverty level. Of course, I would probably start feeling sorry for all those people who were living right at the poverty level. I could almost hear Ma telling Pa now, If we only didnt sell those $40.00 worth of aluminum cans, we could have been millionaires right now. Then again, those newly created millionaires would probably begin buying computers filled with Microsoft software and Bill Gates would start getting his money back. And, if that wasnt enough, the newly created millionaires probably hadnt read my book! They would probably start using their computers to start day trading in the stock market and end up right back where they started. Holy moly! I better finish this book or they wont stand a chance!

(Note: Bill Gates and family have already given millions and millions to charity. It was announced on CNBC that on April 24, 2003 Bill Gates had just donated 28 million dollars to S. Africas AIDS program.)

Microsoft had just recently (10/15/03) raised their dividend from eight cents a share to sixteen cents a share, giving Bill Gates, I would imagine, a 96.5 million dollar a year raise.

As an individual investor in the stock market for almost 40 years I have found that companies that raise their dividend every year outperform those companies that stop or trim their dividends. For example, Dominion Resources had raised their dividend from 1984 to 1994 every year, and then stopped in 1994. Since then the company continues to pay a 64 cent a share dividend, with a dividend yield of around 4 percent a year. The stocks performance since 1994 has been mediocre, rising in price from the 40 dollar range in 1994 to the 60 dollar range in 2004. Now compare that stocks performance with Comerica, a company that has raised their dividend for the past 35 consecutive years. In April of 2003, Comericas stock price was around 37 dollars a share, paying a dividend yield of around 5%. Today, July 20, 2004 the stock closed at $58.28 a share, paying a dividend yield of 3.57%. A $21.00 a share move in the stock in 1 year and 3 months and in March of 2005 the company will probably raise their dividend again for the 36th consecutive year. (By the way, Comericas stock performance for the past 14 years has returned a little better than 15% a year, compounded annually.) The simple point Im trying to make is too invest in those companies that have a history of raising their dividend every year. There are hundreds of them. A company that just pays a dividend is not good enough; find those companies with a historical record of raising their dividend every year.

For more excerpts from The Stockopoly Plan please visit www.thestockopolyplan.com