Investment Psychology

  • Myopic Loss aversion afflicts most investors, making them focus on the short term. However, a lot of short term information is irrelevant in the long term. If you’ve bought solid companies, the best advice is often “don’t just do something, sit there.”

  • Irrational Market Behavior

    • Overconfidence

    • Biased judgments

    • Herd mentality

    • Loss aversion

What is a Stock?

  • Equities (or stocks)—are an ownership interest in a company.-The Investment Answer by Murray & Goldie.

Why does a company sell Stock?

  • They want you to buy stock so they can use your money to get new equipment, develop better products, and expand their operations. It’s a great way for companies to raise money. 

Why does a company sell Bonds?

  • Let's say I bought Garmin Bonds (also known as corporate bonds because I'm buying them from a corporation), I am lending money to Garmin and will be paid back with interest. 

  • Bonds are generally considered to be lower risk/lower expected return investments (especially high-quality, short-term bonds).-The Investment Answer by Murray & Goldie.

How do Stocks Trade?

  • When a stock is bought and sold, it’s called trading, i.e. Garmin is trading at $30.  That means if you wanted to buy Garmin stock, you’d pay $30 for one share.

  • The ticker symbol is usually in parenthesis and follows the exchange on which the stock is listed. i.e. Garmin = GRMN

  • A $1 move in stock price is called a point. When Garmin dropped from $33 to $30, you’d say it declined 3 points.

  • Capital Appreciation + Dividend = Total Return

Where are Stocks Traded?

  • New York Stock Exchange (NYSE): the oldest of America’s big three exchanges, caters to well-established companies.

  • American Stock Exchange (AMEX or ASE): Lists smaller companies

  • National Association of Securities Dealers Automated Quotation System (NASDAQ of OTC): Highly traded market these days that has become more prominent by trading cool high tech companies like Microsoft, Intuit, and Dell. 

What is an Index?

  • An Index is simply an attempt (created by a stock firm) to monitor the progress of a market.

  • The Total Return of Common Indexes:

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  • Looking at this record, I see that in the long term, the S&P midcap 400 is a great investment. But because it tracks 400 medium sized companies, its somewhat volatile (not a stable investment). 

  • The most common benchmark for U.S. stock market investors is the S&P 500 index, which most people refer to as the market.-The Investment Answer by Murray & Goldie.

How do you buy Stocks?

  • Brokerage Firm: A business license by the government to trade securities for investors. There are a few different types.

    • Retail brokers are commissioned agents compensated by their firm or a third party for selling you investment products. Traditionally known as stock brokers, today they call themselves Financial Advisors and Financial Consultants.-The Investment Answer by Murray & Goldie.

  • Discount Brokerage Firms: They simply handle your stock buy and sell orders and charge a low commission to do so, i.e. Charles Schwab and Fidelity.

  • An independent, fee-only advisor should use a third-party custodian (a firm like Charles Schwab or Fidelity) to serve as the safe-keeper of your investments. These firms are responsible for ensuring that your money is in a separate account under your name with your advisor only having the limited authority to manage the account on your behalf. You receive regular statements, trade confirmations, and other information about your account directly from your custodian.-The Investment Answer by Murray & Goldie.

How to Research Stocks?

  • If you need to jog your memory, take a look at your last few credit card statements or your checkbook. Where do you repeatedly spend money? Life’s necessities can turn up great companies. Take food, for example. You might not want to invest in your local grocery chain, but what about that restaurant chain you keep visiting? All your friends like it, the paper gave it a 4 star rating, its always packed, and the food is wonderful and reasonably priced. It’s worth checking into. 

Placing a Stock Trading Orders

  • The bid is the highest quoted price that buyers are willing to pay for a security at any specific moment.

  • The ask is the lowest quoted price that sellers are willing to accept for the security.

  • The bid is the price you get when you sell the stock, the ask is the price you pay when you buy the stock. The spread is the difference between the two numbers and is kept by a dealer who's called a market maker on the OTC and a specialist on one of the exchanges.

Market v. Limit Orders

  • Market Order: A market order is very easy to understand. It instructs your broker to buy a security at the current ask price. That’s it. Your buy price is whatever the thing is trading for when the order reaches the floor. 

  • Limit Order: A limit order instructs your broker to buy or sell a security at a price you specify or better. When you place a limit order, it is either a day order or a good-til-cancelled (GTC) order. A day order expires at the end of the current trading day regardless of whether or not its conditions were met. A GTC order remains open until its conditions are met, which might never happen.

  • Stop Order: A stop order becomes a market order when a price you specify is reached. Like limit orders, stop orders are either good for the day or good til cancelled. If you own a stock and instruct your broker to sell it at a price lower than it currently trades for, that’s called a stop loss because you’re stopping your potential loss and protecting the profit you’ve already gained. You can use a stop order in the other direction too. 

  • A Limit order trades the stock at the price you specify or better; a stop order trades the stock at its current price after it touches the price you specify. Thus, with a stop order, your trade might occur at a price better or worse than the stop price.

  • Stop Limit Orders: First, you specify the price at which you want the stop order to kick in. Then you specify the price at which you want the limit order to trade. 

  • EXAMPLE: Garmin is selling at $15.50 per share. You want to buy 100 shares if it starts moving upward considerably. You could place a stop order at $17. That means that if Garmin suddenly spikes up to $19, your stop order will become a market order to buy 100 shares. If the price is moving quickly, the order might not go through until Garmin asks $18. Perhaps that’s fine with you because you just want to pick up your shares when the stock breaks out. It's more important that you actually buy the 100 shares than it is to buy them at a specific price. On the other hand, it might annoy you to pay more for Garmin than you think its worth. You still want to buy 100 shares if it starts moving up. You could place a stop limit order with the stop at $17 and the limit is $17.50. If the stock hits $17, your stop order becomes a limit order to buy 100 shares at $17.50 or better. If your broker can only get $18, the order won't execute. Once you buy your 100 shares, let's think positive and say they rise to $30. You don’t want to lose the profits you’ve already gained, so you place a stop loss at $28. If Garmin hits the skids and plummets to $18, your order will kick in at $28 and sell at the next opportunity, which might be lower than $28. That really bugs you, so on further consideration you decide to cancel the stop order and replace it with a stop limit order with a stop at $28 and a limit at $28 as well. Now if Garmin plummets to $18, you might go with it. Why? Because your limit order to sell at $28 or better won't kick in if the price hits $28 and immediately falls lower without ever coming back up. Know what you want to do and place the right kind of order.

How do you Evaluate Stocks?

  • There are two types of investing, Growth and Value.

    • Growth investors look for companies that are sales and earnings machines (wal mart, Microsoft, Starbucks). A Growth companies potential might stem from a new product, a breakthrough patent, overseas expansion, or excellent management. Growth investors examine company earnings and recent stock price strength. Investors expect the price of the stock to rise, therefore they buy high, and sell higher.

    • Value Investors look for stocks on the cheap. They compare stock prices to different measures of a company’s business such as its earnings, assets, cash flow, and sales volume. The Value investor purchases shares at the bottom of an uphill climb. Investors want to buy companies with a bright future so they look for good companies that have taken a momentary decline or new startup companies they believe will succeed. They buy low and hope to sell high. 

    • Growth investing is a safe way to make a small amount of money. Value investing is a dangerous way to make large amounts of money.

Fundamental Analysis vs. Technical Analysis

  • Fundamental Analysis: examines the information about the company’s health and potential to succeed. It is gathering information to learn about a company. By looking at a company’s management, its rate of growth, how much it earns, and how much it pays to keep the lights on and the cash register ringing are easy things for you and me to understand.

  • Technical Analysis: The interpreting of stock charts. The main measurement used to gauge demand is trading volume. After that, they look at trend charts, volatility, and small price movements. 

  • You evaluate the company behind the stock with fundamental analysis, then you evaluate the price of the stock and its demand with technical analysis.

Investing Metrics

  • Beta

    • Numerical description of Systematic Risk

    • The Broad Market is assigned a beta of 1. If a stock has a Beta of 2, then on average, it swings twice as far as the market. If the Market goes up 10%, the stock with a beta of 2 tends to rise 20%. The higher the beta, the more aggressive and volatile the stock.

  • Cash Flow per Share

    • What price you are paying for a share of the companies cash flow.

    • A company’s cash flow divided by the number of shares outstanding.

    • What you want: Positive and increasing Cash Flow per Share each year.

  • Current Ratio

    • The Most popular gauge of a company’s ability to pay its short-term bills.

    • Measured by dividing current assets by current liabilities. i.e. A company with assets of $300,000 and current liabilities of $100,000 is 3 or 3:1. 

    • What you want: Current Ratio>2

  • Dividend Yield

    • How much a company pays its shareholders for owning a share of its stock.

    • Annual Cash Dividend divided by its current price. If Garmin price rises from $30 to $60, but it maintains a constant dividend of 60 cents, its dividend yield drops from 2% to 1%

    • What you want: High for large companies

  • Earnings Per Share (EPS)

    • If a company’s earnings per share increase quarter after quarter at a faster rate, it's called earnings momentum and is a popular way of identifying solid growth companies. 

    • Takes what a company earned and divide it by the number of stock shares outstanding.

    • What you want: Should be positive and increasing each year. Should insist on 85 or higher

  • Net Profit Margin

    • A high profit margin tells you that the company’s management is good at controlling costs and they are the hallmark of companies that dominate their industry.

    • Determined by dividing the money left over after paying expenses by the amount of money it had before paying expenses. If a company makes 1 million and pays $900,000 in expenses, its net profit margin is 10% ($100,000/$1,000,000).

    • What you want: Should be in the top 20% of its industry and bigger is better.

  • Price/Book Ratio

    • Let's say GRMN could get $5billion for liquidating its company (selling EVERYTHING), if there are currently 1 billion shares of stock in GRMN outstanding, each share would be entitled to $5. Thus, GRMN has a book value per share of $5.00. That’s the book part of price/book. Next divide the current price by the book value to get the price to book ratio. If GRMN is currently selling for $30 a share, its price/book is $30/$5.00= 6. 

    • Compares a stock's price to how much the stock is worth right now if somebody liquidated the company.

    • What you want: Price/Book Ratio <1.

  • P/E Ratio

    • Calculated by dividing the closing price of the stock by the company’s total earnings per share for the last 4 quarters. It’s the most common measure of whether a stock is a good deal. All else being equal, you’d prefer to buy a stock with a low P/E because it means you’re paying a relatively small amount to own a share in the earnings.

    • The price of a stock divided by its earnings per share (price/EPS). GRMN sells for $30 a share that earned $2 last year and is projected to earn $4 next year. Therefore, the trailing PE is 15, and the forward PE is 7.5

    • What you want: PE <20

  • P/S or PSR: Price/Sales Ratio

    • What is it? How much you’re paying for each dollar of a company’ sales. In the example above, I would be paying $2 for each dollar of GRMN sales. Look at a comparison from SmartMoney. In summer 1996, Microsoft had a market value of $73.5billion and sales of $8billion. Its PSR was around 9. IBM had a market value of $55billion and sales of $72billion. Its PSR was .76. These numbers revealed something very important to investors considering both stocks. People were paying $9 for each dollar of Microsoft’s sales, but only 76 cents for each dollar of IBM’s sales. Aha! By PSR Measure, IBM was a better bargain than Microsoft.

    • Take the company’s total market value and divide it by the most recent 4 quarters of sales revenue. Simply divide the price per share by the sales per share to get PSR. If there are 1million shares of GRMN outstanding and the current price is $30 per share, then GRMN has a total market value of $30million. If GRMN has sales of $15million in the past 4 quarters, its PSR is 2. 

    • What you want: Small PSR

  • Quick Ratio

    • The Quick Ratio evaluates a company’s short-term liquidity. It provides a more accurate look at a company’s ability to deal with short term needs by dividing only the company’s cash and equivalents by its current liabilities. It looks at how quickly a company can respond to a surprise bill or sudden opportunity.

    • It is calculated by dividing current assets by current liabilities. Say GRMN has $50million cash and current liabilities of $25million. Dividing 50/25 gives you a quick ratio of 2.

    • What you want: The higher the better. Look for at least .5

  • ROE: Return on Equity

    • ROE shows you the rate of return to shareholders. It shows what a company has earned with the money people have invested in it. 

    • Calculated by taking the Net income divided by Total Shareholders Equity.

    • What you want: Bigger is always better. A good ROE is anything above 20%.

  • Max and Min Comparison

    • A stock's projected maximum percentage gain compared to its projected minimum percentage gain.

    • What you want: If the projected minimum is a decline from the current price, don’t bother with the stock.

  • Relative Price Strength

    • Shows you how a stock's price has performed compared to the prices of all other stocks. Gives the relative price strength of all stocks from 1 to 99. Stocks that rank 90 have outperformed 90% of all other stocks.

  • YTD%: Chg

    • Shows the stock's percentage price change since January 1 or its IPO.

  • Yield

    • Shown as an annualized percentage return provided by the dividend.

  • Insider Ownership

    • What you want: High Insider Ownership.

  • Projected Stock Value

    • What you want: The Higher the better.

  • Stock Buyback

    • What you want: You want a company to be buying back its stock.

  • 5yr sales and earnings gain

    • What you want to see:

      • >10% for large companies

      • >15% for medium size companies

      • >20% for small companies. 

  • S&P STARS Fair Value

    • What you want: 4 or 5

Company Size

  • Company Size: AKA Market Cap. Market Cap is determined by multiplying the number of outstanding shares of stock by the current market price per share.

    • Micro: <$250million.

    • Small: $250million- $1billion.

    • Medium: $1-5billion.

    • Large: $5-25billion.

    • Giant: >$25billion.