Making Sense of Stocks.

You can't build serious wealth without owning shares in the market. Here's all you need to get started.

FORGET BONDS, MONEY MARKETS, OR CDS. THESE DAYS, WHEN people talk about investing, they mean stocks. Mind you, we'll spend much of this book telling you why it's good to balance a portfolio with those other items--bonds, money market funds, etc. All the same, there's no getting around the fact that over time, owning company shares has been the way to make money. Think of it this way: Today, owning stock is practically as important as drawing a salary.

You may be able to run from the stock market, but we're willing to bet that you'll find it quite hard to hide. To escape any news of the Standard & Poor's 500, you'd have to retreat to the deepest recesses of the Amazon jungle. There are a lot of hermits out there who could tell you when the Dow Jones industrial average hit 8,000, 9,000, or 10,000. Your neighbors are keen on stocks like Cisco Systems or Amgen. The manager at the grocery store down the street thinks he knows a couple of technology stocks ready to go into orbit. Whether you check the morning paper, turn on a 24-hour cable news station, or chat current affairs with co-workers at the office, you'll probably get a face full of the latest on the stock market. Almost anyone you cross on the street will have a sense of whether stocks in general are up or down. Little wonder, then, that over $13 trillion worth of stock changed hands daily on the New York and Nasdaq exchanges, according to 1998 average volume figures compiled by the Securities Industry Association.

It's no mystery why we're all captivated by the stock market. Stocks are simply one of the best investments around. Their total return on average far exceeds bonds'. And, perhaps most importantly, stocks have the financial power to trounce inflation, the sneaky rise of prices that can eat away at your savings over time. It's a snap to accomplish all that and more if you're generating average annual returns of 10% or greater.

For proof of the power of stocks, just witness what the equity market has done in recent years. To say that over the past two decades, the broad market has enjoyed a phenomenal run might be holding back. Looking back over the past 15 years, the S&P 500 index reaped a healthy 18.92% in average annual returns, almost twice the stock market's historical yearly gain of 10% or so. In raw numbers, if you had bought a $1,000 piece of the Standard & Poor's 500, say in a Vanguard fund tracking the index, back in 1984, you'd have an investment worth $15,998.47 today.

REALITY CHECK

Dr. Anita Davis-Townsend figures it's time to work her way into the stock market. Davis-Townsend, an OB-GYN who lives in Houston, got into investing two years ago, after contacting a financial planner, Cheryl Creuzot. Davis-Townsend had a lot of things to sort out. She was joining a multispecialty group practice and had to figure out a retirement program. Her husband, Talbert Townsend, was about to head back to school to finish up an engineering degree. And her son, Cameron, was on his way.

Creuzot steered Davis-Townsend into a few mutual funds as a base, taught her the basics of investing, and told her to hold off on buying individual stocks for a little bit. In the meantime, Davis-Townsend and her husband started reading up. They have friends who invested in technology companies like Qualcomm and Dell who've done quite well. Then, whenever she goes in to [the hospital] to perform surgery, the television in the doctors' lounge is tuned to CNBC, and Davis-Townsend gets a dose of financial news throughout the workday. Finally, her husband has taken to hunting through the papers for companies that might make good investments. "He reads the Houston Chronicle daily ... he looks for stock ideas, reads up on mergers, and sees how some companies are growing and changing," says Davis-Townsend.

"I'd say we'd like to buy a stock soon, just to get the experience," says Davis-Townsend. "And now that we've studied up and have a pretty good foundation, I feel good about it."

TWO WAYS STOCKS MAKE MONEY

Stocks offer investors two ways to grow the money they earmark for retirement or college tuition or the down payments for new homes. First, they rack up capital gains, the appreciation share prices make over time as determined by the stock market. Second, if a company shows that it can not only make a healthy profit but also increase the amount of money it makes year after year, investors will bid its share price ever upward. If you own that same company's shares, that means you'll likely see the stock go up in value. It also means you could well opt to sell your stock later at a profit, a capital gain.

Often, as a shareholder, you'll find that you're also in line to receive another bonus of sorts, too, called a dividend. Stock investors get dividends when companies opt to carve out a certain portion of profits to share with shareholders. It's a sum that tends to come regularly every quarter, and is preannounced.

Of course, stocks can disappoint investors as well. If Acme Gravel Corp. seems to be barely treading water or if its profits are falling, investors will often abandon its shares. Its stock price will fall, and shareholders will suffer losses if they sell their stakes in the company. And, when stocks fall, they can do so swiftly and with little warning.

Investors in Oxford Health Plans know just how fast that kind of reversal can happen. The company had reported several years of solid results to the investing public, and between January 1, 1993, and September 30, 1997, Oxford rose 960%. No sooner had reports of earnings problems hit the newsstand in 1997, than Oxford shares took a dive, falling 62% in one day alone. By the end of 1998, the company stock had shed almost 80% of its value. That's proof enough that stocks are riskier investments than bonds or savings accounts. They're great for long-term gains, but are volatile investments as well. They sometimes hit rough times.

Needless to say, it's of the utmost importance to choose stocks well. There's no getting around some old-fashioned homework, preparation you'll have to do to get a sense of what kind of company you're buying into. Don't forget, too, it's best to approach the stock market with long-term patience. The market offers some great opportunities, but only if you're willing to stick with your investments.

In all the talk about money and risk, it's easy to overlook one important feature of stocks: ownership of a piece of corporate America. Buy a stock, slip it into your investment portfolio, and you've just pocketed a portion of the economy, a piece of Big Business U.S.A. You're in line to benefit directly from the health of the nation's industries and share in the expansion of key sectors--technology, healthcare, consumer goods, to name a few. Think of it this way: In your armchair, reading the newspaper or staring at the evening news, you're just an observer. As a shareholder, you're a participant, and one whose expertise is bound to grow over time.

Once you become a shareholder, or partial owner of a company, you'll be asked to vote on a number of key issues, not day-to-day business activities, but weighty matters, nonetheless. One day, it might be just who get to sit on the company's board of directors. Another time you'll be asked to vote on a takeover offer a company has received from an outside firm.

Think of it. Your portfolio can also be seen as a way to cast your vote on a number of other issues. Should you decide to buy stock, you should purchase shares in companies that are not only profitable, but whose products and practices you know and believe in. Your backing is a form of popular approval, a thumbs-up to the chief executive that the new gadgets rolling off the assembly line look great or that the promotion of an African American to the company's highest ranks is an encouraging sign to you. Shareholding can be your means to stand up and be counted, to whisper in the ears of the bosses and clue them in to what's on your mind.

WHAT IT'S ALL BOUT

Welcome to your piece of the executive suite.

Don't choke. Buying stock, after all, makes you the partial owner of a publicly traded company, one of the nearly 9,000 corporations whose shares are exchanged on the New York Stock Exchange, the Nasdaq, or the American Stock Exchange.

Of course, from all outward appearances, owning stock is a most modest take on the average CEO's perks. There's no plush furniture to speak of; no reserved parking space for your Mercedes-Benz, nor a chauffeur to whisk you to and from the helipad. You won't get a secretary to clean up your correspondence. And by the way, forget about playing on the office intercom, too.

Despite the lack of flash, you'll be glad to know that you're in line for some very worthwhile benefits. First of all, you join a host of other shareholders as owners of a vital corporation, one that manufactures goods or provides key services, one that hires workers, buys equipment, and fans out across the globe in search of new markets; and hopefully one that knows how to turn a profit. And, there on the list of shareholders, you're likely to be in good company, pardon the pun. You'll join pension funds, money managers, mutual fund gurus, movie stars, and athletes, a host of groups and individuals who are looking to tap into a company's growth while saving for the future.

There's more, starting with a slice of your company's profits, or earnings, as Wall Street likes to look at it. Shareholders get to benefit from a well-run company and its flow of profits in a number of ways. First off, companies with a history of strong earnings are likely to turn around and share a chunk of their intake with investors in the form of dividends. Quarterly, management will designate a set amount of profits to be distributed to shareholders, a reward for owning a stock. Stocks that pay dividends are a little like bank accounts: You get a predetermined rate of return for your investment.

Profits also help your stock investment to increase in value over time. Many stock market investors gauge the worth of a stock by the value of its parent company's earnings. It's only logical: Companies that bring in more money and retain a larger share of their sales have more funds for expansion. They can conquer new markets. They can hire more workers. They can increase dividends. They can take over other corporations and increase earnings as well. They can grow.

Most of the time when there's an increase in the profits that a company pulls in, you'll see its stock price climb. That increase, called capital appreciation, is the second--and arguably the most beneficial way--in which a stock makes money for shareholders.

There's a potential downside, too. Don't be fooled--stocks don't always have to appreciate in value. Sometimes they slump. On occasion, individual companies fall behind the times. They lose ground to the competition or their products fall out of favor with consumers. Whatever the reason, that kind of sea change is bound to affect their profits, and soon enough the company's share price as well. Read the financial pages of your local paper, or leaf through a publication like The Wall Street Journal or Barron's and you'll see accounts of companies that slip and see their shares slide.

How do you fight that? There are a couple of ways. For one, we recommend that you thoroughly look up and down any stock you're about to buy. Read up on the company that has caught your interest. Request a prospectus, and see what management believes in. Compare key statistics with the broad market and with the company's rivals in the same industry as well.

Another tactic: When you buy a stock, prepare to hold it for the long term, say a period of five years or more. Even great companies, outfits with the savviest of managements and the most innovative of products, are bound to see results hiccup at some time or another. A good number of them figure a way to bounce back. Should you sell a firm's stock on a whim, on one bad turn in fortune, you lose out on the chance to realize any gain during a rebound.

Or, finally, you can leave stock picking to a professional money manager and invest in a mutual fund that has a stake in company shares. If that's your choice, we suggest you read on; even as a mutual fund investor you'll want to know the nuances of the stock market so you can better appreciate what's happening to your mutual fund investment.

Remember, the trick of investing in stocks is essentially this: look to take advantage of a company's great track record, but at the same time, try to contain risks as much as possible. Painstaking research will help. And so will patience.

What exactly is the stock market? What are the exchanges? Is there any difference between the New York Stock Exchange and the Nasdaq? Should you care?

Whether you're into investing or a casual observer of the ups and downs of the economy, you hear a lot about this mysterious thing called a market. The fact is, there is no one market. There are exchanges, where stocks are traded in much the same way old works of art are traded at an auction. There are people who come to the market ready to buy. There are those who are participating because they want to sell a commodity--in this case shares.

The market is simply a large clearinghouse where shares trade hands. An exchange is just another take on that same meeting place for buyers and sellers, a spot where orders for shares are sorted out and filled. The largest is the New York Stock Exchange (NYSE), often called the Big Board, if only because of the fact that the companies it lists are often large corporate movers and shakers. The other well-known exchange is the American Stock Exchange, or Amex. There are regional exchanges as well in cities such as Chicago, Philadelphia, Boston, and Cincinnati. Overseas, there are exchanges in most nations, including France (located in Paris), the United Kingdom (London), and Germany (Frankfurt).

You might have heard of the Nasdaq or the term "over-the-counter" or OTC. The Nasdaq is no different from the NYSE, except for the fact that it is a computer network run by the National Association of Securities Dealers where brokers can match orders to buy shares with those to sell.

What does it all mean to you? Well, in all honesty, not particularly much. When you trade in shares you'll very likely rely on a broker to arrange your order and buy or sell your shares. That's the same whether you go through a discount outfit such as Jack White or a full-service brokerage such as SalomonSmithBarney. Your broker will deal with dealers who work at the exchanges or field large orders and match buyers with sellers.

And, for you, the individual investor, there's really not going to be much difference between the NYSE, Amex, and Nasdaq, either. Your focus should be on the company you choose to invest in, after all, which will determine how much you make on your money.

PAYING THE MIDDLEMAN 

You should also know--and keep in the back of your mind--that there are other folks benefiting from your choice to become a shareholder, too. Unless you buy--or sell--shares directly from a company itself, you'll have to pay an intermediary, a middleman, to take your money and purchase shares on the stock market. This dealer you'll know as your broker. The price you pay is called a commission.

While the task at hand is essentially the same, transaction after transaction, be aware that the commission or the cut you pay a broker varies from firm to firm. For discount outfits on the Internet, like E-Trade or Ameritrade, you can pay between $10 and $15 for a purchase or sale of shares--sometimes less. If you use a firm such as Charles Schwab & Co., you might pay $29.95 for the same deal. And, at a full-service broker, that same order to buy or sell shares will cost more--possible as much as $60 all told.

For now, however, we'll make a couple of suggestions. First, always figure a broker's commission into your initial investment and your sale of shares. After all, it's money coming out of your gains and off on its way to line the pockets of others. Another bee for your bonnet: The fact that you have to pay any commissions should serve up plenty of motivation not only to keep from trading over and over (which would run up your commission bill) but also to wait until you have a sizable chunk of cash. One rule of thumb: Buy enough stock to keep your commission to 1% or less of the total sale. Put into a real-life scenario, that means that for a planned purchase of $2,500, you shouldn't pay more than $25 for the transaction. If your broker charges more--we'll say $40--then you should wait until you can buy $4,000 worth of the shares of whatever company has caught your fancy.

THE INVISIBLE CERTIFICATE

Once you purchase shares, don't expect your stock certificate to come in the mail. Don't start looking for a cozy place around the house to hide proof of purchase once you've bought stock.

Sure, we've all remembered seeing stock certificates--most probably in old movies. Widows would clutch them tightly when a villain came over to foreclose the mortgage. Or, once they had dynamited the bank safe, robbers would snatch them out of safe deposit boxes.

Certificates have quite a history, and in the past, they were beautifully done. They've also headed the way of the dinosaur. In this era, stock ownership, stock purchases, and sales are recorded electronically and monitored in accounts you might set up with your brokerage, or in some cases with the company whose shares you own.

If you're nostalgic, get ready to pay the price for your piece of the past. Some brokerage firms charge a fee to issue you a certificate. But who knows ... these days the value of the old-time certificates has risen and they have become collectors' items.

Sign Language - Symbols

The stock market has its own special way of identifying companies, a tag, usually three or four letters long that analysts, brokers, and other professionals use to refer to a company. That abbreviation or nickname for a stock is called a ticker, ticker symbol or sometimes just a symbol. Tickers were thought up back in the days when brokers and institutional investors followed a ticker tape spewing from a machine. At the time, there needed to be an easy way to identify long company names without spelling them out. After all, there's only a little bit of room on ticker tape and a lot of companies to identify. Tickers have since stuck and you'll find that they often come in handy when you're talking to a broker or looking a stock up online.

Symbols vary in length, according to the exchange where a stock trades. New York Stock Exchange companies have one-, two-, or three-letter symbols (C is Citigroup, F is Ford, PEP is Pepsi, GE is General Electric, SWY is Safeway). American Stock Exchange firms have either two- or three-letter symbols. On the Nasdaq, stocks carry four- and sometimes five-letter symbols (INTC stands for Intel, etc).

Bull Market, Bear Market, Crash or Correction?

You hear a good number of phrases describing the market and the overall mood of investors. Some, like "bull market" or "bear market," are used so often they're widely understood. A bull market, most of us know, is a time when stocks are rising in value. Bulls are investors, market players who feel the market--or a particular stock--is going to keep climbing.

A bear market, meanwhile, is a period when stock prices slide. A bear feels the market is headed downward. How far do share prices have to drop to constitute a bear market? There's no standard decrease, but, by and large, a 15% fall, as measured by the Dow Jones industrial average or the S&P 500, identifies a bear market. Bear markets tend to show up every five years or so.

Bears in the wild come in several species, some with claws that are sharper than others'. Bear markets, too, come in a few varieties, some more ferocious than others. The scariest bear market around is a crash. During a crash, share prices drop drastically during a day, maybe two, of trading. The last crash the stock market suffered was in October of 1987, when share prices fell 22%. The only other crash occurred in October of 1929, and started the Great Depression.

Another less ornery sort of bear is a correction. A correction knocks the wind out of stocks, usually a good 10% of their share price at least. The nice thing about a correction? Well, even though a correction tends to hit the market every two years, its impact on stocks is less than a crash or bear market.

From The Black Enterprise Guide to Investing by James Anderson. Copyright [C] 2000 by James Anderson. Published by arrangement with John Wiley & Sons Publishers. All rights reserved.