Understanding Stocks

Stock is simply a portion of a company. By owning stock, you are a shareholder. Stocks are bought and sold on stock exchanges, such as the New York Stock Exchange, NASDAQ, and the American Stock Exchange. If a stock isn't sold on a big exchange, then it's sold "over-the-counter" and is considerably less secure and less scrutinized.

Usually stock is issued to raise money for a variety of reasons: expansion, developing new products, to pay off debt and acquiring other companies. When a company issues stock for the first time, it is called an initial public offering or IPO. An IPO is underwritten by an investment banker that decides what the stock is worth and when it is best to issue it.

Volatility is when a stock price goes up or down. Usually, stock prices rise and fall with supply and demand. Nonetheless, there are other reasons for stock prices to fluctuate. The price will rise when everyone wants the stock and is buying it, however mass sales will also drive a price in the negative direction. Prices will drop when a particular industry takes a fall, when the economy has a general downturn, when the company management is failing, or when there is too much debt. Professional analysts and investment bankers who issue buy/sell/hold ratings also affect the price.

Smart investors like you will faithfully research their possibilities. You will be investing for the long-term, therefore short-term price dips or panics will not affect your investing strategy. The old adage, "buy low, sell high", works beautifully in most cases for long-term investors. Just remember, the stock market has returned on average 11% over the last century and that includes the Great Depression and various wars.

Common and preferred stock nametags relate to the prospects the stock has. Common stock is ownership in a company that may or may not pay dividends, which are paid after the preferred stock dividends are paid, and has no performance guarantees. Preferred stock is ownership with a reduced risk since the stock itself costs more than common stock. Preferred stock has a set amount for dividends, which is not increased when the stock price increases, and increases in value much more slowly than common stock. The upside to preferred stock is that you stand a greater chance of getting your money back if a bankruptcy occurs.

Stock is also classified by its forecasted performance: growth and value. Growth stock yields higher profits for higher prices, generally does not pay dividends, and is severely affected by short-term market fluctuations. Growth companies do not pay dividends since they are establishments looking towards expansion and usually re-invest profits. The stock is risky since it is highly reactive to market fluctuations and world news. Value stock is less expensive since it anticipates a turnaround and higher prices in the future. The downside to value stock is that it may never reach its potential.

Once again, you playing the part of the smart investor will diversify your portfolio with a mix of both stocks in your portfolio. Mom's old saying, "variety is the spice of life", sure comes true with investing as it has in almost all of life's nooks and crannies!

So, how does one pick companies to invest in? First, you should identify companies you know about, businesses you patronize, and companies related to your own interests. Then you should watch them for awhile. Check out Standard & Poor's Personal Wealth website (www.personalwealth.com), the ValueLine on-line newsletter (www.valueline.com), and stock analysis reports such as 10Qs, an annual report that companies are required to file (www.freeedgar.com). Definitely, compare your chosen company with at least two of its competitors.

Then go deeper and study their annual earnings versus their sales. Look at their P/E (price-to-earnings) ratio, their P/B (price-to-book value) ratio, their price-to-growth flow ratio and last but not least their PEG ratio. The P/E ratio tells how much an investor is willing to pay for $1 of earnings. A low number is good for the P/B ratio since it relates the company's assets minus their liabilities. The price-to-growth flow ratio helps to measure fast-growing industries, such as the technological industry today. The PEG ratio looks at the expected earnings growth; below a 1.5 is good.

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