Stock Investing For Dummies

John Wiley & Sons

Chapter One

In This Chapter

* Knowing the essentials

* Doing your own research

* Recognizing winners

* Exploring investment strategies

Stock investing became all the rage during the late 1990s. Even tennis stars and punk rockers got into the act. Investors watched their stock portfolios and stock mutual funds skyrocket as the stock market was reaching the mania stage at the tail-end of an 18-year upswing (or bull market) in stocks. (See Chapter 15 for more information on bull markets.) Investment activity in the United States is a great example of the popularity that stocks experienced during that time period. By 1999, over half of U.S. households became participants in the stock market. Yet millions lost money when the stock market fell big time (the bear market - see Chapter 15) during 2000-2002. People invested. Yet they really didn't know exactly what they were investing in. If they had a rudimentary understanding of what stock really is, perhaps they could have avoided some expensive mistakes. 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.

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 applies to stocks. When you are 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 (such as the S&P 500). Find out more about indexes in Chapter 5.

The bottom line is that the first thing you do in stock investing is not send your money to a brokerage account or go to a Web site to click "buy stock." The first thing you do is find out as much as you can about what stocks are and how to use them to achieve your wealth-building goals.

Getting Prepared before You Get Started

Gathering information is critical in your stock-investing pursuits. There are two times to gather information on your stock picks: before you invest ... and after. You obviously 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 are buying and also about the industry and the general economy. To find the best information sources, check out Chapter 6.

When you are ready to invest, you will 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

Once you get past the basics, you can get to the "meat" of stock picking. Successful stock picking is not mysterious, but it does take some time, effort, and analysis. It's worth it since stocks are a convenient and important part of most investors' portfolios. Read the following section and be sure to "leap frog" to the relevant chapters to get the inside scoop on "hot stocks."

Recognizing stock value

Imagine that you like eggs and you're willing to buy 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 very similar, but one costs 50 cents while the other costs 75 cents? Which would you choose? Odds are that you would look at both brands, judge their quality, and, if they were 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 badly run company isn't a good choice if you can buy a better company in the marketplace at the same - or a better - price.

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 the value of a company (and thus the value of its stock) in many ways. The most basic way to measure this value is to look at a 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.

Calculating the market cap is easy. It's the number of shares outstanding multiplied by the current share price. If the 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 the company is as measured by its market value. Here are the five basic stock categories of market capitalization: