How to Buy Stocks

July – August 2006 Issue Young Money Classroom: Learning Activity How to Buy Stocks Summary There are many different approaches to choosing stocks. Each comes with advantages and disadvantages, so you should try to find the approach best suited to your own financial situation and goals. Over time, you’ll develop your own set of criteria to pick stocks. Stick with the investing style that works best for you. Mixing up approaches may dilute the effectiveness of your chosen strategy: • Technical analysis This is an attempt to use price charts and other mathematical indicators to predict future price movements of a stock. Fundamental analysis Factors such as a company’s growth rate, balance sheet and quality of management are used to determine the true value of a security. Value and growth investing Value investors fit within the wide spectrum of fundamental analysis. They look at how much a company is worth based on its assets, and how well the company uses its assets to grow its business. Long-term investing Many long-term investors combine aspects of growth and value investing in their personal strategy, looking to identify undervalued stocks that have the potential to grow in the years ahead. • • • Discussion Topics (Answer the following; is there another good question you think would be good here?) 1. The price of a stock reflects the company’s current and expected value. To what extent do you think stock investing is a visceral/emotional/psychological activity? To what extent do you think stock investing can be boiled down to mathematical terms? 2. Which of the four strategies presented here is the best approach for you? Is there another approach that is better than these? 3. How do you conduct “adequate research” on your investments? How do you assign proper weights to “snapshots” looks versus long-term patterns? How do you differentiate between “talking heads” and people who have actually succeeded in their investments? 4. Why do you build an investment portfolio? How do you build that portfolio? Project Ideas (Sometimes we have to ask a number of related questions to get a full picture. • Do some research on the Dow Theory and see if is applicable today. • • • Do some research on three investors in the new today—George Soros, Warren Buffet, and Kirk Kerkorian—and see what investment strategy each developed. How does the volatility of the financial markets affect your investment portfolio? What can you do to handle/deal with sudden swings in value? How do you calculate how well your portfolio is doing? How do you measure total return on your investment? Additional Challenges (Sometimes it takes some time and good research to get hold of a topic, just because the answers can really tell us a lot.) • Take a major stock—say Microsoft—and see if any of the four approaches (Technical analysis, Fundamental analysis, Value and growth investing, Long-term investing) would have provided you larger profit. Invite a representative of a stock brokerage to visit your class, to explain how a brokerage conducts its business and advises its client. Assign members of the class to four groups, each one representing one of the investment strategies above. Over the course of three months, have each group invest according to its investment strategy and see how much each group profits at the end of the period. • • Glossary Balance Sheet —A quantitative summary of a company’s financial condition at a given point in time, including assets, liabilities, and net worth Growth Rate —The compounded annualized rate of growth of a company’s revenues/earnings/dividends Leverage —The degree to which an investor or business is utilizing borrowed money. Companies that are highly leveraged may be at risk of bankruptcy if they are unable to make payments on their debt; they may also be unable to find new lenders in the future. Limited Liability —The type of investment in which a partner or investor cannot lose more than the amount he or she invested (that is, the value of his share purchase). Thus, the investor is not personally responsible for the debts and obligations of the company in the event that these are not fulfilled. Stock —Stocks are ownership shares in a corporation. Your amount of ownership is a function of the percentage of your holdings to the entire number of shares issued. If 100,000 shares have been issues and you own 10,000 shares, then you own 10% of the corporation. You can realize income from dividends on your shares or appreciation in the value of the shares you hold.