Understanding Wall Street Fourth Edition Jeffrey B. Little and Lucien Rhodes McGraw-Hill New York Chicago San Francisco Lisbon London Madrid Mexico City Milan
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Helen T. Walbran Years Ahead of Her Time For more information about this title, click here Understanding Wall Street – 4th Edition Table of Contents What is a Share of Stock? 1 . . . how a company is organized . . . the meaning of profits and dividends . . . how stock prices are determined. Wall Street – How it Works 13 . . . a pictorial and narrative description of Wall Street’s colorful history . . . the role of the investment banker . . . an explanation of listed and over-thecounter trading. Analyzing Your Company 35 . . . how to identify the best companies and interpret their financial statements . . . using the reinvestment rate . . . calculating financial ratios . . . other highlights of security analysis. Reading the Financial Pages 53 . . . the history and calculations of the Dow Jones Averages . . . how to read the stock tables, earnings reports, stock split announcements, and other
important news items. Investing and Trading 73 . . . finding a stockbroker or investment advisor . . . opening a brokerage account . . . setting investment objectives . . . understanding the margin account . . . how to make money in a bear market . . . investment clubs . . . selecting mutual funds. Growth Stocks 103 . . . the meaning of “the growth stock theory” of investing . . . how companies grow . . . identifying growth companies . . . a guide on how much to pay for growth stocks. Manias, Fads, and Panics 125 . . . recognizing investment bubbles . . . examples and the pitfalls of emotional investing. . . the stock market crashes of 1929 and 1987 . . . the recent dot-com bubble. Bonds, Preferred Stocks and the Money Market 147 . . . an explanation of bonds and the bond tables . . . calculating “yield to maturity”. . . investing in convertible bonds . . . tax advantages of municipal bonds . . . understanding the Federal Reserve . . . the use of T-bills and other money
market instruments. The Internet 173 . . . the background of this new fast-growing medium . . . how today’s investors are using the World Wide Web. Worldwide Investing 183 . . . the emerging global market . . . the Japanese stock market . . . the new Germany . . . stocks in London and elsewhere . . . ADRs . . . participating through mutual funds. Gold & Silver 199 . . . learning from the past . . . gold and silver as a store of value . . . supply and demand, production, and stockpiles . . . the investment opportunities and risks . . . a few equities. The Principles of Technical Analysis 213 . . . methods for improving market timing . . . constructing bar charts and point & figure charts . . . how to read charts . . . the WST ratio and other reliable technical indicators. Stock Options 241
. . . how to use “put” and “call” options . . . the two dimensions of a premium . . . valuing option premiums . . . index options . . . simple explanations of various option strategies. Sources 273 . . . a dictionary of Wall Street . . . useful business publications . . . investment services. Appendix 289 . . . historical annual statistics for the DJIA and Consumer Price Index (CPI). Index 295 Preface With the substantial presence of mutual funds, banks and other large institutional Over the years, the public has been investors, it is widely believed today that encouraged to “Own a Share of America.” the so-called “small investor” is at a Yet, how many individuals have been disadvantage in the marketplace. To the prepared to invest wisely? contrary, many smaller investors have
found it possible to prosper handsomely in The stock market is rarely taught in high this challenging environment, whether the school, and even on the college level, market is going up or down. Armed with an investment courses are typically selected equal degree of common sense, vast only by students with specialized business quantities of information from companies interests. Moreover, investors have found it as well as the internet, and great portfolio difficult to educate themselves, even with flexibility, the average investor actually has the flood of literature available to date. Free the upper hand. After all, the basics and pamphlets and superficial guides have not the psychology of investing, which are provided substance, encyclopedic texts explained in this work, never change. have been too intimidating, and the “getrich-quick� books have deluded investors New Video with false hopes of easy gains. The author is pleased to offer a new,
Understanding Wall Street provides a good, inexpensive color video (available in VHS, practical education by combining CD, or DVD formats) based on the major investment fundamentals and many useful elements of this text. analytical techniques. It was written for two readers: first, the individual who knows little The Understanding Wall Street Video was or nothing about the stock market but has developed with the help of the New York always wanted to understand it; and and American Stock Exchanges and second, the “experienced” investor who features extensive, lively graphics recognizes that there is much more to throughout. Details can be found on the learn. This book offers more than just a last page of this book. colorful history of Wall Street or how to read the stock tables. It also describes, for example, the reinvestment rate, and the computation of current equity in a short seller’s margin account. In addition, new
investments such as ETFs are included. Copyright Š 2004, 1991, 1987, 1980, 1978 by The McGraw-Hill Companies, Inc. Click here for terms of use. This page intentionally left blank.
1 What is a share of stock? Copyright Š 2004, 1991, 1987, 1980, 1978 by The McGraw-Hill Companies, Inc. Click here for terms of use. This page intentionally left blank. 3 Introduction Every business day millions of shares of stock are bought and sold. How did these shares originate and how are the prices determined? For shares to be traded from one person to another, a
company must be created. How does it begin? Where does the money come from? In this chapter, the New-Design Chair Company is born and its officers confront the problems all successful corporations must solve. Directors are elected, shares are issued, profits are reinvested into the business, and dividends are declared. In the process, the reader will see capitalism at work and will gain an appreciation for a system that has produced the most advanced economy in the world.
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The New-Design Chair Company _______________________________________ Charlie, a young inventor, has just built a new light weight, folding chair having a – One Chair – superior design. Encouraged by family and _______________________________________ friends, he decides to turn his hobby of building chairs into a full-time business Selling Price $35.00 rather than sell his patents to a large Less Cost of Manufacturing, furniture company. Materials, Salaries, Labor, Other Direct Costs $20.00 Although Charlie has savings that could be ______ put into the venture, the amount is far short “Gross Profit”
$15.00 of the total capital necessary. He estimates Less Advertising Expenses, the total cost of the factory, machinery, and Sales Commissions, initial money needed for product inventory Other Expenses $10.00 to be approximately $2 million. ______ Profit Before Taxes $ 5.00 These “assets� (the factory, machinery, _______________________________________ inventory, and remaining capital) would be used to produce the chairs and maintain Charlie believes his new enterprise would the new business. The more chairs Charlie be beneficial in several ways. Thousands can produce using these assets, the more would enjoy using the new chairs, many profitable the business would be. people in his community would be earning
a living by making and selling the chairs Charlie has calculated that if he could and the business would also contribute to make and sell at least 100,000 chairs the welfare of his community, state, and annually, it would cost about $20 to country through the payment of taxes. If manufacture each chair. In addition, he Charlie could, indeed, manufacture and sell estimates the sales and marketing 100,000 chairs, this activity would no expenses for each chair to be roughly $10. longer be a hobby; it would be a sizable Since each new chair would be sold to his business. customers at the competitive price of $35, his profit (before paying federal, state, and Now Charlie faces a major problem. Where local taxes) would be $5 per chair. will he get almost $2 million for the factory, machinery, and working capital? He is unable to borrow such a large amount without collateral.
_______________________________________ However, he is willing to do this to secure the help of others. – 100,000 Chairs – _______________________________________ After exploring the advantages and disadvantages of the various legal forms of Total Sales $3,500,000 businesses, he decides to establish a Less Cost of Manufacturing, “corporation.” The principal reason for Materials, Salaries, choosing a corporation rather than a Labor, Other Direct partnership or any other form was financial Costs
$2,000,000 liability. Charlie learned that no matter __________ which legal structure is used, creditors “Gross Profit� $1,500,000 always have first claim on the assets if the business fails. However, a corporation, as a Less Advertising Expenses, legal entity, limits the financial risk of the Sales Commissions, owners to the amount of capital invested. Other Expenses $1,000,000 In other words, stockholders of a __________ corporation are not liable for more than Profit Before Taxes $ 500,000 they invest. Less Federal, State, Local Charlie forms the corporation under the
Taxes $ 240,000 laws of the state, names it the “New__________ Design Chair Company,” and selects a few Net Profit or “Earnings” $ 260,000 individuals to act as the board of directors _______________________________________ until the first annual meeting of stockholders. At that time, a board of He decides to find others, frequently called directors will be formally elected by the “venture capitalists,” who might also see stockholders. The directors decide to the potential for his idea and be willing to “issue” 250,000 shares of stock of the risk some capital to get the venture started. 400,000 total possible shares authorized by To interest others, Charlie must divide his the company’s founding charter (when the new business into smaller pieces to give
