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Greetings, Pro-fundity team members -
07-25-03

At the bottom of the Guidepost, a full listing of this weeks picks are shown, in addition to the Charts via the Pick-link.

As a benefit of membership, you have access to all Guideposts (including Archived GP's) and Picks. If you miss a week or two for whatever reason, you will be able to go into the Historical Guidepost link to catch up with both the weekly guidepost and the 30 picks made for the week.

Greetings, fellow Pro-fundity team members

We introduced this Beginning Investing course with a discussion of the basics, considering why we should invest in the stock market. Last week we looked at what risk means to us as market investors or traders. Risk management is one of the most misunderstood (and neglected) principles in the investing game. Re-read the second lesson carefully (view all past lessons in the Historical Guideposts) in this continuing saga of education, enlightenment and understanding. This third segment closes the introductory material (Unit 1) answering the question “What is a stock?” Additionally, at this time it is important to assess what’s been learned in this first unit. So take time to review the questions that follow. It is important for you to answer these questions to the best of your ability. If you don’t have the answers fresh in your mind, go back through the material. By paying strict attention to these questions, your understanding of following lessons will be more relevant. But, the act of writing out the answers is critical to the learning process. Don’t neglect this part of your education. We have some meaningful exercises following the questions.

What is a Stock?

1. Okay, we’ve determined “Investing is a better than even bet in our favor!”, what next? How do we start? Where do we start? What is stock, anyway? What is a good stock? Is it fairly priced? All questions we need to ask. Let’s start at the beginning; Stock is ownership, simple as that. When we buy a share of General Electric, by paying a broker (who executes the buy on the floor of a stock exchange), we then own a small portion of the industrial giant. That means our fate is tied to the fate of GE, in that small instance (needn’t be small to us, could be all of our life’s savings). Anyway, if we’ve tied our saddle to that star, we actually own a portion of GE, ownership in every sense! That means we get a bit of every factory, machine, desk, water cooler, etc., under the GE umbrella. And most importantly, a bit of every dollar of profit that comes through the door. The more shares we buy, the larger our stake becomes. The value of our stake rises and falls with everyone else’s as the company’s stock value on the stock market changes from day to day. Stock ownership gives us both upside and downside, but without a large percentage of the total company shares, there is virtually no control.

2. We are talking about publicly traded stocks. Not all companies have taken that route and remain private, with all control in the hands of the owners. Polaroid, Michael’s Foods, and Graybar Electric, are examples of privately held companies. Since they are privately held, these companies needn’t disclose any of their finances. Whereas, in a publicly traded company, control is vested in the shareholders and all finances are in the public record. As a shareholder of a small piece of GE, we will be asked to vote once or twice a year on a board of directors and/or certain financial matters.

3. Why does a company decide to go public? Money! A company going public does an IPO (initial public offering) where some number of shares of company stock are offered to the “market.” A target price is placed on these shares, but the auction mentality of the market takes over and the price may be bid much higher depending on what the market thinks the company is worth. All of the IPO money received becomes property of the new public company. Millions of dollars are raised in these efforts which is then used to improve company products, services, facilities, research, marketing…, all things that make the company worth more. This is the reason for IPO’s, this is where a company raises money to become bigger and better. It is also payback time for company executives who have struggled often for years building the private company for a day such as this. The downside is they lose a measure of control, which is also perhaps why other companies elect to remain private.

4. An important thing to understand is what happens to the shares sold at the IPO. Company management itself will usually hold a large percentage of shares off the auction block. This leaves a major portion of company ownership in management hands. The remainder, the number of common shares left for possible purchase, is termed the float. Now, once this float is in private hands (both individual investors and institutions), the purchase and sale of shares is no longer with the company. When we buy those shares of GE, the company does not see a cent of the money paid. The company already got their money at the IPO. Now, we are simply buying shares someone else owns. It is a personal transaction between two consenting parties, quite apart from the company. We still buy that small piece of ownership, but it is a piece of ownership some other investor had previously purchased.

5. The size of the float in a company has an impact on changes in share price. This punches up the importance in the marketplace of what is termed the law of supply and demand. This law determines the price of almost everything in our daily lives. As the supply of oil goes down with political turmoil, the price of gas at the local station goes up. When the cabbage crop is poor because of weather patterns, we pay more for it at the local supermarket. This is especially true in the market. The law of supply and demand is the most important factor in the variation in share price! If the perception of company value is high, that will increase the demand for its shares. Increased demand will move the price higher. On the other side, if the “market” perceives a low value (trouble in management, poor growth prospects, etc.) the price will likely move lower with reduced demand for shares. A company with smaller float may be subject to wider price swings since the supply is more limited. But remember, stock transactions have nothing do with the company (as far as the purchase and sale of common company stock is concerned). Where the company makes a dramatic impact is on the market’s perception of the company value. That is, good management, increased earnings and profits, new products, etc., etc.

   What do we look for in a good stock?

6. The answer to that question is one of the more difficult issues we will face. The basis of sound company selection includes the factors:
   • Quality - Brand recognition, smart management, low debt, growing earnings…
     
   • Value - Real value of company assets, financial direction, historical performance…
     
   • Price - Earnings growth rate, performance ratios, peer-comparisons…

7. To properly assess whether the company (stock) is “good,” the price of company shares must be considered relative to the particular measure of what we call “good.” There are many different measures used for this task. On the “investment” side of the fence, one bundle of companies are termed value, another growth, yet another income. On the “trader” side there are also many ways to assess “good,” for example momentum, but these relate more to trading techniques than to stock groups. At any rate, each has its own set of measures to determine if the company is overvalued, undervalued, or properly priced. We will cover the investment side issues heavily in Unit 2, trading measures later.

Unit 1 - Questions
1. Explain why investing is not another form of gambling:
   
   
   
   
   
   
   
   

2. What are the odds of drawing a red bead from a bowl containing 30% Blue, 20% Red, and 50% Green?
   
   
   
   

3. Which of the six trend lines shown on Fig. 2 (Beginning Investing I) represent the most attractive investing environment? Explain why.
   
   
   
   
   
   
   

4. Explain the relationship between Risk and Reward, and discuss how this relates to investing?
   
   
   
   
   
   
   

5. How would you respond to someone who says that investing is just too risky?
   
   
   
   
   
   
   
   
   
   

6. What is the difference between possibilities and probabilities?
   
   
   
   
   
   
   
   

7. xplain the differences between a “public” and a “private” company and the advantages/disadvantages of each.
   
   
   
   
   
   
   
   

Market Capitalization:

In the first lesson, we used the number of shares as a measure of company size. A better measure, called Market Capitalization, is the number of outstanding shares times the share price. For example, a company with 20 million outstanding shares and a stock price of $30 has a market cap of $600 million. This is the most popular way to identify company size. Many investors limit their considerations to particular market caps. A rough division of cap values is shown below:

Market Capitalization’s

Another more detailed classification looks like this:

The differences here are not important, only the fact that company size can play an important role in our investing strategy. As a Unit 1 activity, you will have an opportunity to find market cap for any company of your choice. Let’s go into a free web site to find market cap for General Electric. Click on the following link:

This is the Finance section on Yahoo, with General Electric selected. Scroll down to the block labeled “Statistics At A Glance,” then near the end of this block find “Share Related Items.” This shows you Market Capitalization, Shares Outstanding, and Float. Notice, the Shares Outstanding and Float are different by 1 million shares. That means 1 million shares are held privately by GE with the balance available for common investors (float).

To find the value of one share of GE stock, divide the market cap by shares outstanding. How close did you come to the “Recent Price” above in the “Statistics At A Glance” block”

Peruse the wealth of information on GE at this site. Don’t be overwhelmed, we’ll discuss many items in following lessons. Enjoy

Main Picks:
ATMI,AUDC,BDX,DSCM,ICST,IDR,INVN,MLS,ORCC,SDIX
Breakouts:
ASKJ,ASYT,BRKS,FARO,JOSB,MKSI,QUIK,SWIR,TFS,ZIGO
QuickPicks:
ADSK,ASX,CHL,CTLM,HMA,METHA,NET,POM,SIFY,STEL

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