Stock ownership is one way of being an owner of a share of a company. An owner is distinct from a lender which is what bondholders become when lending money to companies at
a fixed rate of return for a specific period of time. Owners are investors and direct beneficiaries of company management's success or failure (accounting for market trends) in making
sound business decisions for the company.
The Benefits of Investing in Stocks
Traditionally, stocks have offered the greatest opportunity for long-term growth and can provide an income flow through dividends. Also, stocks can have advantages tax-wise.
When a stock has been owned outside of a retirement plan or IRA for more than 12 months, any sale profit is taxed on the federal level as long-term capital gains (with a tax rate
ranging from 10 to 20%) rather than the higher federal ordinary income tax rate (which ranges from 15 to 39.6%).
These numbers are based on the federal income tax rules as of January 1, 2002 and may be subject to exceptions. State and local taxes may also be due. Income tax rules for retirement
plans and IRAs are different.
Starting January 1, 2001, even lower rates will apply to sales of assets held for more than five years. Depending on your tax bracket, the rate will be 8 to 18%. Consult the tax
laws yourself or consult with your accountant or tax professional for details. Or, better yet, consult a diversified investment advisor, like Shoreline Wealth & Investment Management.
Since tax laws can (and certainly will) change, always check with your tax advisor before making major decisions regarding your investments and your retirement accounts.
Keeping Track of Stock Prices and Indexes
It's important to monitor how your investments are doing. And between wired and wireless communication options, you can keep tabs on your stocks from anywhere at any time. But, it'd
be nice to sleep, get your work done and have a life, too.
So find a balance between your short-term need to know how your stocks are doing and your psychological well-being. If you're investing for the long-term, it might be best to avoid
checking prices as often as you might be doing now.
When you do take a look, however, keep in mind that, along with monitoring your individual portfolio, you should be watching the market as a whole. Keep your eye out for trends.
For this, you need to look into stock market indexes.
Indexes tell you how stocks in a defined group have done since the previous day, the last December 31st and over the last 12 months. By surveying a broad range of indexes you can
become familiar with their behavior.
But you might not have the time or the energy to study all the indexes. Among the more important ones are:
The Wilshire 5000 is the broadest index, and
includes most stocks headquartered in the US and traded
on US stock markets
The Russell 2000 indicates the performance of 2000 smaller company stocks
The Standard & Poor's 500 Index includes 500 large companies traded on the
US stock markets
The NYSE Composite Index tracks all of the stocks traded on the New York Stock
The NASDAQ Composite index covers a wider range of stocks including many in
the technology sector
The Dow Jones Industrial Average (DJIA) tracks the prices of 30 of the largest
Classes of stock
Most stock is common stock. With this type, you have the greatest potential for
reward and the highest risk for your investment. Your investment rises and falls
with the fortunes of the company in which you own shares. You may receive dividends
as an owner of common stock, but there are no guarantees.
Usually, preferred stock doesn't offer the same potential for growth as common
stock. Instead, this more limited opportunity for growth has another component-fixed
dividends. As opposed to common stocks, where the dividends can go up, down,
or might not be paid at all, preferred stocks have guaranteed, set dividends.
And if a company goes out of business, shareholders of preferred shares have
priority over holders of common shares to receive any remaining assets after
creditors have been paid.
Or you may be better off buying a company's bond, rather than its preferred shares.
Bonds are generally more secure, and have the benefit of a fixed date when they'll
mature, or be paid off. Bonds also offer greater security if a company becomes
Stock Splits and Reverse Splits
Sometimes a stock's price becomes so high that it's difficult for new or existing
investors to purchase very many shares. To solve that problem, corporations have
the ability to split shares in order to lower the price.
A stock split does not make a company more valuable. It is simply taking the
same pie and dividing it up into more pieces.
For example, a company may do a three-for-one split, where you receive two extra
shares for each one you own. If it was trading at $300 before the split, then
right after the split each share would probably trade for $100. A company doesn't
become more valuable just by issuing more shares. The value of the company before
and after the split should be the same.
Corporations can also do a reverse split, where shareholders end up with fewer
shares at a higher price, but the total value remains the same. Reverse splits
are less frequent.
Valuations of Stock
One of the easiest ways to value a stock is to determine it's premium or discount
relative to the market, it's peers and it's history. There are several common
ratios which help to determine the crucial "when to buy" or "when to sell" questions.
Three important ones are listed below for your review.
Price Earnings (P/E) Ratio
This ratio is the one most quoted and offers a quick "ballpark" analysis. Basically,
the formula takes the price of the stock and divides this number by the earnings
per share. The greater the earnings relative to price, the lower the P/E ratio
or premium in the stock. Conversely, the lower the earnings relative to price,
the higher the P/E ratio or premium in the stock. For example, a company priced
at $20 per share with $1 in earnings per share would have a P/E ratio of 20
Price Earnings Relative to Growth (PEG) Ratio
This is a really nice ratio tool for calculating price relative to growth. This
takes the P/E ratio described above and divides it by the growth ratio. A number
less than 1 indicates it is selling at a discount relative to it's growth rate.
For example if a company has a P/E ratio of 20 and it is growing at 20% per year,
the PEG ratio would be one.
Return on Equity (ROE) Ratio
This ratio is one used by Warren Buffet to value how well management is allocating
the shareholder's capital. Basically, this ratio divides the net earnings by
the shareholder's equity (this is the company's net worth calculated by subtracting
liabilities from assets). The bigger the number the better. And the more it increases
over time, the better since it shows positive momentum. For example, if a company
has net earnings of $50 million and a net worth of $250 million, the return on
equity would be 20%.
For more information:
If you'd like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.
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Charles M. Bloom, Registered Principal offers securities
and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.
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