Wall Street came by its name honestly: In 1685, it was positioned behind a 12ft stockade wall designed to protect the local Dutch settlers from the dangers of Native American and British attacks.
All around the world, more than 600K companies are publicly traded, with billions of shares changing hands every day.
Though technically these IPO shares are sold to the public, it’s not to the general public; rather, these shares are mainly sold to large institutional investors that have the kind of capital the issuing company is trying to raise.
Though stocks are often perceived as risky investments, over time they’ve performed better than any other type of security, even better than gold. Over the course of more than 200 years, stocks have returned an average 6.6% annually, while bonds have returned 3.6%, and gold only 0.7%. For long-term real returns, you really can’t beat the stock market.
With literally thousands of publicly traded companies trading in the US alone, there’s a huge variety of stocks to choose from, making it easy to have a diversified portfolio.
The Big Board is not a place for small companies. Among other requirements for inclusion on the NYSE, a company must have at least 1.1M publicly traded shares of stock outstanding, with a market value of at least $100M. It must show pretax income of at least $10M over the 3 most recent fiscal years, and have had earnings of at least $2M in the 2 most recent years.
With more than $19T in total market capitalization listed, the NYSE is the largest stock exchange in the world by market cap, which is the market value of a company in terms of its outstanding shares. The NYSE holds more than a quarter of the total worldwide equities market. Everyday on the NYSE, more than 450B shares are available for trading.
That realistic portrayal of the NYSE auction market system (before computers took over), where sellers announce asking prices and buyers put forth bids, show how the market works: The highest bid gets matched with the lowest ask, and the auction trade is completed.
A customer contacts a broker with a trade request. The broker connects with the floor trader. A floor trader follows the wishes of the broker and looks for the best bid or ask offer from the specialists. A specialist’s job is to make sure the trading traffic flows smoothly by making it easy to trade a particular stock, and most specialists handle somewhere between 5-10 stocks on any given day. A specialist is responsible for posting bid and ask prices (or quotes), maintaining an inventory of the stocks (to facilitate trading), and actually executing the trades. Specialists act like matchmakers for bidders and askers, connecting as many as possible. If necessary, they will even buy for and sell from their own supply of shares.
These market makers compete against one another to offer the best bid and ask prices (or quotes) over the NASDAQ’s complex electronic network, which joins buyers and sellers from all over the world. In fact, market makers must offer firm bid and ask prices, creating what’s called the “two-way” market. In other words, market makers have to trade shares at the bid and ask prices they have quoted. Between the 2 amounts is the bid-ask spread, the mathematical difference between the 2 quotes, and the spot where these market makers can make a lot of money. To level the playing field for investors, market makers are legally required to fill market orders at the best bid or ask price for the customer.
When a company gets kicked off a major exchange, a process known as delisting, it lands on the pink sheets. This happens when the corporation no longer meets the minimum listing requirements, often as a result of unfortunate financial event that endangers the company’s future. Investors who think the company will turn around can scoop up shares on the pink sheets, often at a fraction of its original listed share price.
Since every country has its own set of laws, customs, and regulations, a company operating in more than 1 country needs to bring in teams of lawyers and managers to make sure they’re correctly and properly following local rules. As laws everywhere are subject to change any time, multinational corporations have to pay close attention to events in the nations where they have operations and adapt as necessary.
In 1982, though, the market took a turn toward the bull. With the Dow returning, on average, nearly 17% annually during this bull market, investors were flying high. Interest rates were down, but corporate profits were soaring, and so were their share prices. This exuberant market lasted until 2000, when the dot-com bubble burst.
When the market crashed in 2000 following the implosion of the dot-com bubble, it set off a secular bear market that resulted in crippling losses.
Though the core of a bubble comes from over inflated asset prices with no basis in reality, the events that spur the irrational price hikes are very real. Bubbles can be set off by things like shifting interest rates, free-flowing credit, and new innovative developments in technology. Once people start to catch the new fever, the bubble begins its tenuous growth, and prices take baby steps upward.
Prices begin to gather momentum as more people jump on the bandwagon. Media coverage increases, which draws in even more excited participants hoping to get in on this strike-it-rich opportunity.
With market values out of control, traders, advisors, and talking heads cook up reasons to justify continued investment.
As prices reach their tipping point, smart investors realize it’s time to get out and they try to clear profits before everyone else catches on. But when markets act in irrational way, it’s virtually impossible to make a clean getaway. All it takes is the tinniest pin to pop a bubble, immediately and forever halting its expansion, and setting off its inevitable unraveling.
During that time, IPOs emerged like ants at a picnic. They commanded huge prices from day one, and some of them saw their share prices gain 100% on that very first day. Hundreds of those companies, almost as soon as they went public, garnered billion-dollar valuations.
While the housing market was flying high, these risky loans seemed risk-free. After all, it was as easy to sell a house as it was to buy milk, and homes were constantly increasing in value. So borrowers appeared to have equity in their homes because the houses were suddenly worth more. That situation was about to change, but not until a lot of investment banks and investors bet big on a new fad known as mortgage-backed securities (MBS). Basically, an MBS is a bond backed by mortgages, and bondholders get paid as mortgage payments come in. As long as people are paying their mortgages, these securities work.
Before that terrible crash, the market and its investors were flying high. After emerging victorious from WW1, Americans were full of confidence and hope, and believed the stock market would make everyone filthy rich. They didn’t see any risk, and weren’t worried about a downside. So they poured all of their money into the market without asking any questions. In fact, most of them didn’t really know how the market worked at all.
During a panic, investors just want out, no matter how little money they can get for their shares. They trade on emotion rather than information. In the worse cases, panic selloffs results in market crashes.
Most major stock exchanges have some kind of safety net in place to curb panic selling and to give investors time to absorb the fast-flying information. The hope here is that after a brief pause, the market can return to trading more normally.
Investments open to accredited investors that are not available to the general public include:
- Private equity
- Hedge funds
- Venture capital
- Unregistered securities
Typically, deflation is brought on by a widespread reduction in personal or government spending, drying up demand for goods and services. This unfortunate economic state comes with tighter credit policies (make it harder for people and companies to borrow money) and rampant unemployment.
Though the Dow follows the stocks of only 30 US companies, they are among the largest and most influential corporations. All of the stocks that comprise the Dow are considered blue chips, the most prestigious, reliable corporations, and they’re all actively traded on the NYSE.
The Russell 2000 is home to small-cap corporations, companies with market capitalization between $300M and $2B. In contrast, large-cap companies like those counted in the SP500 have market capitalization of at least $10B.
The category a company falls into tells you a lot about its prospects. Large-cap companies, for example, are usually rock-solid businesses you can rely on, but don’t have a lot of room for growth. Small-cap companies, on the other hand, may be poised to explosive growth, but that potential for growth is tempered by the lower market share and fewer assets, and the risk that they could easily miss the mark and disappear.
When you buy stock, you’r actually buying a portion of a corporation. If you wouldn’t want to own the entire company, you should think twice before you consider buying even a piece of it.
It should be increasingly clear that making money through investing requires work. The more research and thought you put into your strategy, the more likely you are to reap rewards.
The board’s responsibilities include duties such as:
- Communicating directly with corporate executives.
- Framing and tracking high level corporate strategies.
- Making sure the corporation and its management operate with integrity.
- Approving the overall corporate budget.
- Hiring the corporation’s upper management team.
Though it seems crazy, CEO compensation is based on how they’re expected to perform, rather than on how well they actually do their jobs. This seemingly bizarre norm exists because corporations want to attract the best candidates to fill their top management spots.
When a public corporation goes bankrupt, it follows the same basic steps as any other company. First, the firm must sell all of its assets. With those proceeds, the company then pays off any and all debts, starting with money owed to the US government (usually back taxes, interest, and penalties). Once creditors have been satisfied, the company must pay its bondholders; not all corporations issue bonds, so some skip this step. Next on the list are preferred stockholders, with common stockholders bringing up the rear.
Much of the time, common stockholders end up with nothing.
There are some drawbacks to owning preferred stock, though. As the owner of preferred stock, you normally don’t have the rights that come with common stock ownership, like voting. In addition, when a company’s common stock price experiences strong growth, preferred prices tend to hold steady. Finally, when a corporation has a phenomenal year and pays out giant dividends on its common shares, preferred share dividend payments are usually locked in, and those shareholders don’t get to share in the company’s windfall.
Not all shares of stock are created equal. Aside from the fundamental difference between common and preferred stocks, corporations can issue customized classes of stock with special features in pretty much any way they want. The main reason a corporation would do this is to concentrate power in a particular group of shareholders, which is why the most common class distinction has to do with voting rights.
Growth-company stocks rarely pay significant dividends, and growth investors don’t expect them to. Instead, growth companies plow their earnings right back into the business to promote even more growth.
Cyclical industries include car manufacturers, hotels, and airlines — things that could be considered luxuries rather than necessities. When the economy is flying high, people buy more cars and take more vacations, and these cyclical industries benefit, and cyclical stock prices rise.
Making money with cyclical stocks can be very tricky, and is wholly dependent on getting in and out at just the right time.
Tech stocks typically trade for more than the corporations are worth on paper, with a lot of value placed on their expected future innovations and success. With limited cash and capital assets standard for the category, these companies trade on ideas and development. Sometimes that pays off, other times they miss the mark and the companies just disappear.
One of the most interesting — and alarming — aspects of penny stock dealing is that brokers are not always acting as a 3rd party but instead set prices and act as the principals in the transaction. Penny stocks most often do not have a single price but a number of different prices at which they can be purchased or sold.
When a company decides to pay dividends, the payout is based on its shares outstanding. The term “shares outstanding” refers to the number of shares a company has issued to the general public, including its employees. More shares outstanding can mean smaller dividends per shareholder; there’s only so much money to go around, after all.
There are 2 main reasons a corporation would split its stock: to lower the share price or to increase the liquidity.
Similar to blackmail, greenmail is used by a corporate raider to force a target company to buy back its own shares at highly inflated prices in order to prevent a hostile takeover. It begins with a corporate raider buying up target company shares, accumulating enough stock to become a viable threat.
Once the target company board realizes its position, the raider announces the greenmail demand.
Most educators will tell you that 75% of all learning is gained by doing homework. This is true of investing as well. When you are interested in investing, it’s important that you do your homework in the form of research, analysis, and investigation. An educated investors is more likely to be a patient and relaxed investor.
Knowing when to hold and when to sell a particular stock is an art in itself. You may have every intention of sticking with your investments for the long haul, but maybe the first sign of turbulence sends you into a panic to sell. History has revealed that holding on to solid stocks for a minimum of 5-10 years has produced the best results.
These people go beyond handling your investments — they aid you in matters relating to insurance, taxes, trusts, and real estate. The cost of doing business with a financial planner can vary considerably.
Selling short means selling shares that you don’t already own: You sell them first, then plan to buy them when the price drops. In the middle is your broker, who loans you the shares to sell, and whom you pay back with the shares you buy. When you place the original order, you must be explicit: You’re legally required to identify a short sale trade when you place the order. When you short a stock, you also must use a margin account. That account must be worth 150% of the value of the securities you’re shorting. That 150% includes the short position.
Most people would rather walk over hot coals than peruse the endless rows of numbers found in financial documents. Corporations understand that, and so they fill their annual reports with glossy color photos and colorful commentary. Corporations also know that a lot of people assume that a heavy, glossy report means a successful. The numbers inside, though, may tell a completely different story. It’s up to you to get comfortable with the numbers.
Profits don’t mean cash.
Just because a company reports profits on its income statement doesn’t mean that the company has cash. Profits and cash are not the same thing, and a company can have one without the other.
There’s a common saying among financial professionals: Accountants hide the problems in the footnotes. The truth is, many (if not most) of us don’t have the patience to get all the way through it. Corporations know that, and use it to their advantage.
That sounds shady, but it’s not. In fact, it’s perfectly legal. Moreover, it is extremely common for corporations to disclose important information in the footnotes to their financial statements.
One thing that puzzles stock market newcomers: Why doesn’t this morning’s open always match yesterday’s close? The open and close both reflect the price people are willing to pay for a particular stock, and a lot can change between 4PM one day and 9:30AM the next. The 24-hour news cycle combined with an upsurge in after-hours trading can cause some pretty big differences between the 2 prices.
Ticker tape was first created in 1867, thanks to the introduction of telegraph machines. The latest price figures were delivered by runners who brought the tape from the market floor to the traders’ offices. With this system, the brokerage houses closest to the trading floor got the news first, a distinct advantage.
Most investors in stocks tend to think about their gains and losses only in terms of share price changes. But savvy investors also think about another very important part of the picture: dividends. Knowing a stock’s total return indeed makes it possible for you to compare your investment with other stock investments, but it also makes it much easier for you to see how your stock measures up to other types of holdings, such as corporate bonds, treasuries, and mutual funds.
Sound business model. You want to single out a company that has a solid business plan and a good grasp of where it wants to be in the year ahead, and a plan to get there. A company with a clear focus has a better chance of reaching its goals and succeeding rather than a company that just rolls along without a concrete plan.
Buffett believes that if you buy stock in quality companies, you have no reason to sell your investments unless there is a serious underlying problem behind a price dip. Buffett believes that investors should understand a company and its industry before making any investment decisions.
Here’s how behavioral finance tends to work. People jump to buy a stock because it’s hot. That drives up the price, and more investors snap up shares. It makes no difference that the company has an unproven track record or is loaded with debt — all that matters in the heat of the trading moment is the excitement of owning this very popular stock.
If you find at any point after you’ve invested that you simply cannot handle the market’s mood swing, you may want to re-evaluate your strategy. Even though your investment plan is not set in stone, you should be fully aware of your reasons for changing your original strategy. Maintaining realistic expectations will keep beginning investors from growing frustrated, disappointed, and disillusioned. It’s unrealistic to expect a 15% return on your investment if you aren’t willing to take any risks.
Carnegie expanded his holdings, and he built innovative new mills that would give him an enormous edge over his competitors. And by 1873, when the US economy slumped, Carnegie bought his competitors’ mills, modernized them, and continued to rake in profits.
One key secret to Carnegie’s vast financial success was an idea call vertical integration. He bought majority shares in the iron mines necessary to steel manufacturing, as well as shares in the railroads needed to move his products. These stepping stones come together to form a full path, increasing overall efficiency and reducing costs for the core business.
From Graham, young Buffett learned about the principles of value investing, and he absorbed a key message: Every company has an innate value that’s separate from its prevailing share price. He came away with his signature strategy, buying shares in companies that were worth intrinsically more than their stock prices suggested, companies that were undervalued by the market.
Those unbelievable returns were a direct result of Soros’s underlying investing philosophy, termed “reflexivity.” The basic premise is this: Investors’ behavior has a direct impact on market fundamentals, and it’s their actions that create the booms and busts that Soros sees as opportunities.
His most famous, and most infamous, deal brought Soros a $1B gain in a single day, and nearly wiped out the BoE. It was September 1992, a time when the British pound was strong, and Soros decided to bet against it. He borrowed billions of pounds, which he proceeded to convert into German marks. When the British pound crumbled, Soros reconverted those German marks at the new much more favorable exchange rate, and was able to repay his debt based on that new lower value of the pound.
After that, Soros was feared by governments around the world, terrified that the ruthless speculator would fix on their currencies, and then bankrupt them.
According to Soros, “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”
While bankers and investors desperately tried to claw their way out of the gaping market bottom brought on by that great panic, Hetty Green quietly sat with her now-liquid fortune. When the dust settled, she bought up bargain stocks left and right. She now also required physical collateral (like land) for new loans she made. Though some painted her as a vulture, Hetty helped keep NYC solvent during that Panic, as their lender of last resort.
Thomas Price didn’t believe in jumping in an out of the stock market, following trends and cycles, and carefully timing stock purchases and sales. Instead, he looked for solid companies, corporations that he expected big things from in the future. Not surprisingly, with that aim in mind, Price was dubbed the “father of growth investing.”