Stock Investing for Dummies (Paperback)

Chapter One

In This Chapter

* Knowing the essentials

* Doing your own research

* Recognizing winners

* Exploring investment strategies

Stock investing was the hot thing during the late 1990s - a trend just like the hula hoop and pet rocks. With the new millennium, however, a reversal of fortunes has occurred as the bear market of 2000-2002 rocked our world (a bear market is a prolonged period of falling prices - in this case, stock prices). This decade has been a wild roller coaster ride that saw the market hit new highs in 2007, although it''s down in ugly fashion in 2008. During this time, the public figured out that stock investing isn''t for wild-eyed amateurs or dart-throwers (or the worst ... wild-eyed amateur dart-throwers!).

I wrote much of this 3rd Edition with current events and market conditions on my radar screen. The year 2008 witnessed some ominous events that will make stock investing very interesting (to say the least) for the time being. Don''t let that scare you, though; informed investors have made money in all sorts of markets - good, bad, and even ugly. As I write this, the conditions are in place for an inflationary depression, but selecting stocks that can benefit from these challenging times could indeed make you much wealthier.

The purpose of this book is not only to tell you about the basics of stock investing but also to let you in on some solid strategies that can help you profit from the stock market. Before you invest your first dollar, you need to understand the basics of stock investing, which I introduce in this chapter.

Understanding the Basics

The basics are so basic that few people are doing them. Perhaps the most basic (and therefore most important) thing to grasp is the risk you face whenever you do anything (like putting your hard-earned money in an investment like a stock). When you lose track of the basics, you lose track of why you invested to begin with. Find out more about risk (and the different kinds of risk) in Chapter 4.

When the late comedian Henny Youngman was asked, "How is your wife?" he responded, "Compared to what?" This also applies to stocks. When you''re asked, "How is your stock?" you can very well respond that it''s doing well, especially when compared to an acceptable yardstick such as a stock index (like the S&P 500). Find out more about indexes in Chapter 5.

REMEMBER

The bottom line in stock investing is that you shouldn''t immediately send your money to a brokerage account or go to a Web site and click "buy stock." The first thing you should do is find out as much as you can about what stocks are and how to use them to achieve your wealth-building goals. Chapters 2 and 3 help you take stock of your current financial situation and help you understand common approaches to stock investing.

Before you continue, I want to get straight exactly what a stock is. Stock is a type of security that indicates ownership in a corporation and represents a claim on the part of that corporation''s assets and earnings. The two primary types of stocks are common and preferred. Common stock (what I cover throughout this book) entitles the owner to vote at shareholders'' meetings and receive any dividends that the company issues. Preferred stock doesn''t usually confer voting rights, but it does include some rights that exceed those of common stock. Preferred stockholders, for example, have priority in certain conditions, such as receiving dividends before common stockholders in the event that the corporation is going bankrupt.

Preparing to Buy Stocks

Gathering information is critical in your stock-investing pursuits. You should gather information on your stock picks two times: before you invest and after. Obviously, you should become more informed before you invest your first dollar, but you also need to stay informed about what''s happening to the company whose stock you buy, and also about the industry and the general economy. To find the best information sources, check out Chapter 6.

TIP

When you''re ready to invest, you need a brokerage account. How do you know which broker to use? Chapter 7 provides some answers and resources to help you choose a broker.

Knowing How to Pick Winners

When you get past the basics, you can get to the meat of stock picking. Successful stock picking isn''t mysterious, but it does take some time, effort, and analysis. And the effort is worthwhile because stocks are a convenient and important part of most investors'' portfolios. Read the following sections and be sure to leapfrog to the relevant chapters to get the inside scoop on hot stocks.

Recognizing stock value

Imagine that you like eggs and you''re buying them at the grocery store. In this example, the eggs are like companies, and the prices represent the prices that you would pay for the companies'' stock. The grocery store is the stock market. What if two brands of eggs are similar, but one costs 50 cents a carton and the other costs 75 cents? Which would you choose? Odds are that you''d look at both brands, judge their quality, and if they''re indeed similar, take the cheaper eggs. The eggs at 75 cents are overpriced. The same is true of stocks. What if you compare two companies that are similar in every respect but have different share prices? All things being equal, the cheaper price has greater value for the investor.

But the egg example has another side. What if the quality of the two brands of eggs is significantly different, but their prices are the same? If one brand of eggs is stale, of poor quality, and priced at 50 cents and the other brand is fresh, of superior quality, and also priced at 50 cents, which would you get? I''d take the good brand because they''re better eggs. Perhaps the lesser eggs are an acceptable purchase at 10 cents, but they''re definitely overpriced at 50 cents. The same example works with stocks. A poorly run company isn''t a good choice if you can buy a better company in the marketplace at the same - or a better - price.

REMEMBER

Comparing the value of eggs may seem overly simplistic, but doing so does cut to the heart of stock investing. Eggs and egg prices can be as varied as companies and stock prices. As an investor, you must make it your job to find the best value for your investment dollars. (Otherwise you get egg on your face. You saw that one coming, right?)

Understanding how market capitalization affects stock value

You can determine a company''s value (and thus the value of its stock) in many ways. The most basic way is to look at the company''s market value, also known as market capitalization (or market cap). Market capitalization is simply the value you get when you multiply all the outstanding shares of a stock by the price of a single share.

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Calculating the market cap is easy. If a company has 1 million shares outstanding and its share price is $10, the market cap is $10 million.

Small cap, mid cap, and large cap aren''t references to headgear; they''re references to how large a company is as measured by its market value. Here are the five basic stock categories of market capitalization: