Stocks in One Lesson

TABLE OF CONTENTS

Dedication
Foreword
Prefatory Note
Introduction

Part One. The Lesson

Chapter 1. Lesson
Chapter 2. Stock Ownership
Chapter 3. Stock Prices
Chapter 4. Price and Value
Chapter 5. Trading and Investing
Chapter 6. Investment Preferences
Chapter 7. Stock Market Dynamics

Part Two. The Lesson in Past Markets

Chapter 8. Twenties
Chapter 9. Thirties
Chapter 10. Forties
Chapter 11. Fifties
Chapter 12. Sixties
Chapter 13. Seventies
Chapter 14. Eighties, Nineties and Beyond

Part Three. The Lesson Applied

Chapter 15. Profi t Principles
Chapter 16. Returns
Chapter 17. Selection
Chapter 18. Buying
Chapter 19. Selling
Chapter 20. Financial Statements
Chapter 21. Earnings Fog
Chapter 22. Valuation
Chapter 23. Money
Chapter 24. Growth
Chapter 25. Investment Theory
Chapter 26. Financial Planning

Appendix 1. Information Sources
Appendix 2. Dividend Valuation
Appendix 3. Basic Questions
Definitions and Abbreviations
Bibliography
Author Note
Topic Index





INTRODUCTION
This book is about price and value in stocks. Specifically, how to profi t from the rising investment value of quality stocks in a market characterized by turbulent prices.

A stock’s investment value is derived from the related company’s earnings, dividends, cash flow, and other supporting fundamentals. In sharp contrast, a stock’s market price is driven by the vagaries of investor opinion concerning the firm’s anticipated future performance. Market price and investment value often deviate. The market price of a stock is never a reliable indicator of investment value.

The outward motion of the stock market is a frustrating panorama for most observers most of the time. Prices are completely erratic when viewed over the short run. They appear like an endless series of meaningless numbers: a tiresome display of changing digits. Yet, beneath this constant flux, the financial fundamentals that create value in stocks and influence market prices are largely understandable and open to objective examination. In other words, behind the superficial chaos of stock prices, there is a simple and perceptible logic to the value of stocks.

In this context, the mark of successful stock investing is an understanding of how value is created in stocks, why stock prices change, and, most vital, the confidence to buy upward bound value at modest prices.

No person or theory can predict the timing or the magnitude of price movements in the marketplace, but one can know in general why stock prices move up and down and how investment profits are made and lost. Further, while it’s impossible to determine the precise value of any given stock, you can estimate a safe and sensible purchase price using conventional valuation techniques combined with a long-term investment approach. This simple insight is a practical starting point for stock investing.

Eight decades have elapsed since the stock market crash of 1929. During this time, the stock market has undergone significant alteration. Early developments include the establishment of the U.S. Securities and Exchange Commission and legal reforms in banking and brokerage practices. Notable changes in recent decades include the deregulation of brokerage commissions, the growth of institutional investing, increased global investing, the expanding derivatives market, program trading, Internet trading, and the proliferation of deep-discount brokerage services. An avalanche of new financial “products” has also emerged, including index funds and exchange-traded funds.

Collectively, these developments have had a major impact on the size, complexity, and trading velocity of the overall stock market. Clearly, today’s financial markets offer far more scope for trading, investing, and managing risk than the financial markets of the past. But a closer look reveals that the ultimate source of long-run investment profit is still the same: expanding earnings and dividends from growing businesses supported by a growing economy.

When it comes to buying stocks, low commissions and fast trading will not make you a good investor. Careful selection and buying at a modest price will help you much more.

Over the long run, the stock market is up or even about 75% of the time. The economy and business enterprise spend more time growing than coasting or shrinking. Economic growth resumes following each period of recession. The advanced economies of the world have a record of compound growth stretching back over two hundred years. This general trend is not going to stop. Regardless of market conditions at any single point in time, the immediate investment picture – good or bad – is always subject to change. For this reason, your investment outlook should be open-minded and long range.

Over periods of five, ten, or fifteen years, established and well managed firms usually prosper in the soil of a gradually growing economy, yielding the normal profits of expanding enterprise. This thought should be the anchor of your outlook on stocks.

The long-run compound average rate of return for large company stocks is about 10-12% per year. The strongest companies will sometimes deliver average annual returns near 20%, depending upon the investor’s holding period and the purchase price. At an average annual return of 12%, an investment will almost double in six years. In this respect, mature growth companies are a stock investor’s best friend. These are large, proven companies with tangible growth prospects. They can serve as a stable force at the centre of your stock portfolio.

While small firms as a group offer better overall returns, they generally feature higher price volatility, little or no dividend, greater business risk, and a lower rate of survivorship. In addition, small firms are not as well covered by analysts and you must own more of them to be adequately diversified. It’s dangerous territory for a new stock investor. If you want sheer excitement and like to trade, then go ahead. Buy little companies. Otherwise, why take the gamble? Avoid small stocks until you understand the mechanics of stock value.

This book presents a conservative view of stock investing. The focus is on safety and long-run returns. The purpose is to explain the objective elements of price and value in stocks. This is valuable knowledge, whether you plan to invest over the long run or speculate over the short run.

Part One offers an investment point of view by contrasting market price and investment value. Part Two is a cursory history of the U.S. stock market going back to the economic boom of the twenties. The purpose is to emphasize price trends alongside changing business and economic conditions. Part Three is the applied section of the book. Here you will find practical guidelines for choosing stocks, plus other useful information to help in establishing your own stock investment plan.

While the conservative views expressed here are not for all stock investors, every beginning stock investor should, at a minimum, try to understand how individual stocks create value for shareholders.