Prosper Newsletter: November 2007 > Stock
You understand that the following information is educational in nature and is not intended to be legal, accounting, or tax advice. You are responsible for your own financial decisions and should consult your own legal, accounting, and tax advisors before making your financial decisions.
I would like to get started in stocks. What is the first thing I should know?
For starters, find out what you don't know. When you begin researching stocks on your own, you'll run into a lot of jargon—investment talk and terms that you may not be familiar with. So, the first step is to learn the definitions. That way, you can begin to evaluate the buzz.
And then, don't let the buzz scare you. Reports about the market range from positive euphoria to absolute depression. It depends on the day. Many people end up being far too reactionary in the market. See the buzz for what it is...buzz, noise. Sift through the intelligent reports and use them as a market pulse—not as a step-by-step plan of how to react as the market moves up or down.
Then prepare your position. Will you be picking just a few stocks and holding on to them for a long time? Or, will you be regularly trading a few that you focus on? This is the root of your personal investment strategy.
Once you have the market definitions down and are pretty confident that you can stick to your own plan, there are some straightforward ways to conduct your own investment analysis. Essentially, each stock should reflect the prevailing opinion about the company associated with the stock. You're looking for the health of the business—how it stands up to competition in the marketplace. As you compile your portfolio, check how each prospective stock stands up to these questions:
How does the company generate cash?
In this current credit situation, many businesses have borrowed money. So, their source of cash in their reporting might actually be borrowed capital. This may or may not bode well. It depends on the business. If the loans were for legitimate expansion and company revenues from sales are trending upwards, then this could be a great thing. Watch out for inflated sales figures based on heavy holiday shopping however. Whatever you do, don't make assumptions about the company's revenues from a cursory glance of the report summary. Dig deep.
How much cash does the business generate and when?
Is this a seasonal business with a consistently strong first quarter, tepid second, slow third, and terrible fourth? Is the opposite true, with all income generated around the holidays, then fighting to stay afloat the rest of the year? Does everyone else in the market time mass trades with this stock accordingly? Can you use this position to your advantage?
How sustainable is the cash flow?
There are instances where today's blue chips are tomorrow's stinkers. Be aware of industry conditions that could render a great blue chip obsolete. Will plasma and LCD technology completely edge out bulky projection televisions? Who makes the hot-selling products this time of year? Know the answer or pay the consequences.
How much capital does the business require to operate, to turn a profit?
You've heard the adage, "you have to spend money to make money." For some businesses this is definitely the case. Consequently, it costs more for them to make a dollar than a company with little overhead. The less capital a business needs to conduct operations, the more appealing it is to potential owners—and stock purchasers as well.
Is the price too good to pass up?
Ultimately, you have to look at price to gauge your return. A business generating $10 per share in profit every year is a great buy if the price is $20 per share. The earnings yield is 50%. However, if the same business sells at $200 per share, it is only boasting an earnings yield of 5%—perhaps a good deal, but maybe not the one you want.
Once you've mastered the definitions, your own strategy for buying and selling, and your own investment analysis, you'll really want to test your mettle in a safe environment. It may be tempting to jump right in and see what you can do, but spend some time in a virtual market setting that follows the market in real time. Try stocktrak.com. It's a great way to practice and not lose your shirt. Once you've put your skills to the test, get out there and make some money!
I always knew at some point it was going to actually cost me money to go to work instead of staying at home watching my stocks, I just wasn't expecting that it would be today. Even though I missed the really big drops, I'm still up over $1000 on the day. I'm waiting on a limit order on a BZH contract with over 200% return so the remaining two positions will be pure profit. This is just too much fun...
-B-
The stock market is a volatile place. We have seen another correction in the last couple of weeks. This recent volatility has increased option prices dramatically. It is a great time to place covered calls or credit spread trades, if you have the experience. With high option prices come high option premiums; thus, a higher return. Make sure to do your homework before making these trades and check the fundamentals to make sure you are investing in a fundamentally strong company. You will also want to do a technical analysis and make sure the stock is moving in a favorable direction.
During this time, be sure to check the option Greeks before making any option trade. Remember, it's not a good thing to buy an option when the volatility is at or near its 52-week high. (Most stocks will have a high volatility level after this recent volatility.) If you were to get in when the volatility is near the high and it comes down, your option will decrease in value. In some cases, it can decrease in value even if the stock moves in your direction. Make your trades cautiously, and be sure to pay attention to what the Dow and the S&P are doing because most stocks will follow their lead.
Some good sectors to watch are the tech and shipping sectors because both have been, and are, on the move. Stocks like Apple (AAPL) and Google (GOOG) have recently reported good earnings and have gone to all time highs as a result. With the earnings season underway, it's a good time to practice (or make) straddle or strangle trades on companies that will be reporting earnings. Make sure that the company you choose has a track record of being volatile after an earnings announcement. (You do this by looking at the one year chart and seeing if they tend to gap up or down after an earnings announcement.)
It's a great time to be in the market. Happy trading and happy holidays!
Prosper welcomes your feedback. Do you have a suggestion for a topic you would like us to address in the next edition of the monthly newsletter, or an idea for a great elective class webinar? Send us an email at newsletter@prosperlearning.com
