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Market Order – a market order does not have a set price and is therefore executed immediately at the current ‘market’ price. Markets, especially OTC markets, can be highly volatile and therefore the price of execution may differ dramatically from the price at time of order entry. Those who use market orders are more concerned about the speed of the execution as opposed to the price.
Uncovering The Securities Firm
December 31 2011| Filed Under » Brokers, Careers, Investing Basics, Portfolio Management
As individual investors, many of us trust our money to large securities firms or investment dealers. Typically employing tens of thousands of employees, the most recognized firms give investors confidence that their investment funds are managed by a seasoned team of professionals. However, we usually interact with these large businesses only by means of a single intermediary, such as our investment advisor or broker. So how does a large securities house really work? In this article, we will look at a typical securities firm, including its different departments and the roles of various employees. (To learn more about financial planners read Financial Planners: Practice What You Preach.)
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Departments and Divisions
Typically, a large firm has the following departments: sales, underwriting and financing, trading, research and portfolio, and administration. There are many small boutique firms that may serve only a single department of a business (i.e. retail sales), but even in this limited operation, their activities might resemble those of the respective department of a larger firm.
Sales
Sales is likely the department employing the largest number of people in the firm and it is the area that individual retail investors interact with the most. Within the retail sales force, investment advisors may focus on servicing a specific area of the investment industry, or they may provide a one-stop-shop for all retail investment needs. For example, an investment advisor may perform only those services that are associated with a stock broker, or offer other services as well, such as stock and mutual fund transactions, bond trading, life insurance sales and so forth. In a small firm, the activities of the investment advisor are likely to be more diverse.
A second division within the sales department is institutional sales. It is primarily involved in selling new securities issues to traders working at institutional client firms, such as pension funds and mutual funds. If a hot new securities issue generates so much interest that it quickly becomes oversubscribed, the job of institutional sales is as simple as allocating shares to the best clients (as a reward for their ongoing business).
Due to the large dollar volume of transactions and the commissions from both new issues and existing accounts, the institutional sales department often generates a significant portion of the firms profits (making institutional salespeople some of the best-paid personnel in the entire firm). The institutional sales department works closely with the firms trading department (discussed below) to maintain accounts in good standing.
Underwriting / Financing
The firms institutional sales division also works closely with the underwriting or financing department, which coordinates new securities issues and/or follow-up securities issues on the secondary market. The underwriting or finance department negotiates with the companies or governments issuing the securities, establishing their type of security, its price, an interest rate (if applicable) and other special features and protective provisions.
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The firms underwriting or financing department may be split into two divisions: the first relating to matters of corporate finance and the second to those of government finance. In a fully-integrated firm, these departments would be quite distinct, as the needs of corporations and governments vary widely. For example, the corporate finance department would require familiarity with stocks, bonds, and other securities, while the government department might be more geared toward bond and Treasury bill issues.
Trading
The firms trading department also has separate divisions, most likely according to the type of securities being traded: bonds, stocks and various other specialized financial instruments. Traders in the bond division may have sub-specializations, such as government or corporate money market instruments or bonds, or even such instruments as debentures.
The stock-trading department executes orders from retail and institutional sales staff. Stock traders maintain close links with traders on the floor of stock exchanges; although, with the rise of electronic trading, the interaction may be with a trading computer instead of a human being.
The firms trading department may also include a division geared toward various other specialized instruments, perhaps mutual funds or exchange-traded options, or commodity and financial futures contracts.
Research and Portfolio
The research department supports all other departments. Its securities analysts provide vital analysis and data to aid traders, salespeople and underwriters. This data is necessary for the selling and pricing of existing securities trades and new issues. The firms research department may consist of economists, technical analysts, and research analysts who specialize in specific types of securities or specific industries (within the equities specialization).
The research department may be further divided into retail and institutional divisions, although if the firm has only one research department, research reports geared to institutional clients may also be made available to retail investors. If the firm hosts a single institutional research department, it would be geared toward analyzing potential new issues, takeovers, and mergers, in addition to providing ongoing coverage of securities held by institutional clients. Together with the retail department, analysts may be further involved in structuring portfolios for individual and small-business accounts.
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Administration
The administration department is a vital component of the firms organization. It not only maintains proper paperwork and accounting for all trades and transactions, but also ensures compliance with securities legislation and oversees internal human resources matters. All trades made by the firm must be accounted for, and all incoming and outgoing funds and securities must be continually balanced. Securities must be checked for registration, and delivery requirements and dividend payments must be credited to accounts as received.
In the credit and compliance division, client accounts are constantly monitored for industry and firm compliance, ensuring that payments and securities are received by their due dates and that margin accounts fulfill applicable margin requirements. The financial division oversees accounting matters such as payroll, budgeting, and financial reports and statements. Minimum capital levels are maintained according to industry requirements, ensuring that the various departments within the firm hold sufficient funds to accommodate changes in the firms business.
The Bottom Line
Despite their importance to the investment industry and the economy at large, securities firms are still somewhat of a mystery to the average investor. Securities firms tend to maintain a rather secretive culture of inner-circle participants, due largely to the players specialized roles and occupations. Many retail investors interact with only their personal financial advisor or broker, and therefore lack insight into the larger set of roles within the firm. It benefits every investor to know whos who behind that set of magnificent oak doors, as each of the employees in a securities firm affects the real returns of ones investment portfolio.
In addition, price movements can be volatile and rise above resistance briefly.
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Investors must decide whether price (Limit Order) or timing/immediacy (Market Order) is more important to them.
5 Ways To Invest In Travel And Tourism
Most consumers are familiar with the travel and tourism industry from using its services for some needed rest and relaxation during family and related vacations. However, these same activities can be invested in, with many publicly-traded firms offering travel activities for the end benefit of growing the capital of their underlyingshareholders. Listed below are five areas of the travel and tourism market that could prove lucrative from an investing standpoint. It could also help committed travelers better understand the landscape and hunt down some travel deals.
Online Travel Providers
As with many industries, revenue continues to shift to the internet when it comes to providing travel and tourism services. Stock brokers have been replaced in large part with online trading platforms, while traditional travel agents have had to compete with online websites that allow consumers to shop for low prices and convenient schedules.
Leading online travel providers include publicly-traded players such as Orbitz, Priceline and Expedia. In particular, Priceline has been highly successful in driving traffic to its website to book flights and bid for cheap, last minute travel deals. Over the past five years, it has seen sales and profits grow around 20% annually. This growth has fully shown through in its stock price, which is up around 1,000% in the past five years.
Cruising
The cruise line industry has been in existence for more than a century, but still is not that widespread as a travel choice for many consumers. Carnival, the largest cruise line operator in the world, has estimated that only 3.4% of the population in North America has ever been on a cruise. The percentages are even lower in the rest of the world.
Capacity is also growing nicely; Carnival estimates the entire industry has seen average annual capacity growth of roughly 5.6 to 6.9% over the past five years.
Hotels
The hotel industry is dominated by a couple of leading international players. This includes publicly-traded firms Marriott and Starwood Hotels, as well as privately owned Hilton. These companies have largely blanketed their home United States market and are now growing internationally. In Starwoods case, 84% of its new hotel pipeline was international. These chains have also pursued the managing of properties for hotel owners, as well as timeshares where they sell the rights for consumers to use their properties for a week, or more, during each calendar year. (For additional reading, see Timeshares: Dream Vacation Or Money Pit?)
Maga-resorts
Large resort operators combine the development of hotels with other entertainment and related amenities. Publicly-traded operators in this space include Gaylord Entertainment, which owns the Opryland resort in Nashville and other properties in Texas, Florida and Maryland. It specializes in massive resorts that allow big travel groups to host conventions and other giant gatherings.
Vail Resorts owns some of the best-known ski resorts in Colorado and surrounding areas. This includes Vail Mountain, Breckenridge and Beaver Creek Resort. Of course, Walt Disney specializes in kid-friendly theme parks, hotels and entertainment complexes, such as Disney World in Florida and Disneyland in California.
Casinos
Las Vegas-style gambling is growing rapidly across Asia. Macao has grown into the largest gambling market in the world and has seen the building of massive casino resorts from Las Vegas-based firms such as Wynn Resorts and Las Vegas Sands. Both are publicly traded companies. This growth is expanding to other parts of Asia, including Singapore, and potentially Vietnam and Japan.
The Bottom Line
These are just some of the many opportunities to invest in the travel and tourism industries across the world. Overseas growth, especially in emerging market economies, should continue to outpace that in more developed markets in North America and Europe. However, as with the online travel space, there will always be pockets that are picking up market share in every part of the world. (To learn more, read An Evaluation Of Emerging Markets.)
In between the trading ranges are smaller uptrends within the larger uptrend. The uptrend is renewed when the stock breaks above the trading range.
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Companies that are unwilling or unable to meet OTC Markets' Guidelines for Providing Adequate Current Information but have submitted some but not all of current information required are rated as having limited information. These are often companies with financial reporting problems, economic distress, or in bankruptcy.
The flow of information has become faster with the Internet, and surprises are factored in instantly.
An Introduction To Securities Markets
The global securities market has been constantly evolving over the years to serve the needs of traders. Traders require markets that are liquid, with minimal transaction and delay costs, in addition to transparency and assured completion of the transaction. Based on these core requirements, a handful of securities market structures have become the dominant trade execution structures in the world. In this article, well take a look at some of the most popular market structures currently in use.
Quote-Driven Markets
Also called dealer markets, quote-driven markets are those in which the buyers and sellers engage in transactions with market makers, or dealers. The market makers post the bid and ask quotes for an inventory of stocks that they are willing to buy from, and sell to traders. Only certain dealers are allowed to perform the market making function and in return, they receive privileges, such as the right to post quotes, the ability to get information on the order flow and book, and generally lower or no fees paid to the exchanges.
Quote-driven markets are common in over-the-counter (OTC) markets such as bond markets, the forex market and some equity markets. The Nasdaq and London SEAQ are two examples of equity markets that have their roots as a quote-driven market. It should be noted that the Nasdaq structure also contains aspects of an order driven market.
The advantages of a quote driven market are typically best seen in illiquid markets. In securities that are thinly traded (low volume), dealers can step in to improve liquidity for traders, by maintaining an inventory of the security. In exchange for providing this liquidity, dealers make money from the spread between the bid and ask quotes. To generate profits, dealers will attempt to buy low (at the bid) and sell high (at the ask) and have high turnover.
Order Driven Markets
Another major dominant market structure type is an order driven market. In this type of market, the exchange matches buyers and sellers with each other and there is no middle man, like there is with quote driven markets. Price discovery is determined by the limit order of traders in the particular security. Most order-driven markets are based on an auction process, where buyers are looking for the lowest prices and sellers are looking for the highest prices. A match between these two parties results in a trade execution.
The biggest benefit of an order driven market in liquid markets, is the large number of traders willing to buy and sell the security. Generally, the larger the number of traders in a market, the more competitive the prices become; this theoretically translates into better prices for traders. The downside to this type of market is that in securities with few traders, the liquidity can be poor. An example of an order-driven market is the Toronto Stock Exchange (TSX), in Canada.
In addition, there are two main types of order driven markets, a call auction and a continuous auction market. In a call auction market, orders are collected during the day and at specified times an auction takes place, to determine the price. On the other hand, a continuous market, as the name suggests, operates continuously during trading hours and trades are executed whenever a buy and sell order match up. (For additional reading, check out: What Is The Difference Between A Quote Driven Market And An Order Driven One?)
Hybrid Markets
A third popular market structure, a category in which the New York Stock Exchange (NYSE) falls in, is the hybrid market, also known as a mixed market structure. The hybrid market combines features from both a quote-driven market and an order driven market. Although dominantly an order driven market that matches buyers and sellers, the NYSE also utilizes dealers to provide liquidity, in the event of low liquidity periods. In addition to being a hybrid market, the NYSE is also a continuous auction market.
Brokered Markets
The last market structure well look at in this article is the brokered market. In this market, brokers are the middle men who find counterparties for trades. When a client asks their broker to fill an order, the broker will search their network for a suitable trading partner. Often, brokered markets are only used for securities that have no public market, these are generally unique or illiquid securities, or both. Common uses of the brokered markets are for large block trades in bonds or illiquid stocks. (To know more about broker, read: What Is The Difference Between A Broker And A Market Maker?)
The direct real estate market is also a good example of a brokered market. This market contains assets that are relatively unique and illiquid. Clients generally require the assistance of real estate brokers to find buyers for their home. In these types of markets, a dealer wouldnt be able to hold an inventory of the asset, like in a quote-driven market, and the illiquidity and low frequency of transactions in the market would make an order-driven market infeasible, as well.
The Bottom Line
There are different types of market structures simply because traders have different needs. The type of market structure can be very important in determining overall transaction costs of a large trade and can affect the profitability of a trade. In addition, if you are developing trading strategies, sometimes the strategy may not work well across all market structures. Knowledge of these different market structures can help you determine the best market for your trades.
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How Dividends Work For Investors
During the dotcom boom of the late 1990s, the notion of dividend investing was laughable. Back then, everything was going up in double-digit percentages, and nobody wanted to fool around with the meager 2-3% gain from dividends. After all, we were in the new economy: the rules had changed and companies that paid dividends were too old economy.
As Bob Dylan once sang, The times, they are a-changin. After the bull market of the 90s ended, the fickle mob once again found dividends attractive. For many investors, dividend-paying stocks have come to make a lot of sense. In this article, well explain what dividends are and how you can make them work for you. (For background reading, see The Power Of Dividend Growth.)
Background on Dividends
A dividend is a cash payment from a companys earnings; it is announced by a companys board of directors and distributed among stockholders. In other words, dividends are an investors share of a companys profits, given to him or her as a part-owner of the company. Aside fromoption strategies, dividends are the only way for investors to profit from ownership of stock without eliminating their stake in the company.
When a company earns profits from operations, management can do one of two things with the profits. It can choose to retain them - essentially reinvesting them into the company with the hope of creating more profits and thus further stock appreciation. The other alternative is to distribute a portion of the profits to shareholders in the form of dividends. (Management can also opt to repurchase some of its own shares - a move that would also benefit shareholders. Read more about it in The Lowdown on Stock Buybacks.)
A company must keep growing at an above-average pace to justify reinvesting in itself rather than paying a dividend. Generally speaking, when a companys growth slows, its stock wont climb as much, and dividends will be necessary to keep shareholders around. This growth slowdown happens to virtually all companies after they attain a large market capitalization. A company will simply reach a size at which it no longer has the potential to grow at annual rates of 30-40% like a small cap, regardless of how much money is plowed back into it. At a certain point, the law of large numbers makes a mega-cap company and growth rates that outperform the market an impossible combination.
The changes witnessed in Microsoft (Nasdaq:MSFT) in 2003 are a perfect illustration of what can happen when a firms growth levels off. In January 2003, the company finally announced that it would pay a dividend: Microsoft had so much cash in the bank that it simply couldnt find enough worthwhile projects to spend it on - you cant be a high-flying growth stock forever!
The fact that Microsoft started to pay dividends did not signal the companys demise; it simply indicated that Microsoft had become a huge company and had entered a new stage in its life cycle, which meant it probably would not be able to double and triple at the pace it once did.
Dividends Wont Mislead You
By choosing to pay dividends, management is essentially conceding that profits from operations are better off being distributed to the shareholders than being put back into the company. In other words, management feels that reinvesting profits to achieve further growth will not offer the shareholder as high a return as a distribution in the form of dividends.
There is another motivation for a company to pay dividends: a steadily increasing dividend payout is viewed as a strong indication of a companys continuing success. The great thing about dividends is that they cant be faked. They are either paid or not paid, increased or not increased.
This isnt the case with earnings, which are basically an accountants best guess of a companys profitability. All too often, companies must restate their past reported earnings because of aggressive accounting practices, and this can cause considerable trouble for investors, who may have already based future stock price predictions on these (unreliable) historical earnings. (To learn more about evaluating earnings, read Earnings: Quality Means Everything.)
Expected growth rates are also unreliable. A company can talk a big game about wonderful growth opportunities that will pay off several years down the road, but there are no guarantees that it will make the most of its reinvested earnings. When a companys robust plans for the future (which impact its share price today) fail to materialize, your portfolio will very likely take a hit.
However, you can rest assured that no accountant can restate dividends and take back your dividend check. Moreover, dividends cant be squandered away by the company on business expansions that dont pan out. The dividends you receive from your stocks are 100% yours. You can use them to do anything you like: pay down your mortgage, spend it as discretionary income or buy the stock of a company you think has better growth prospects.
Who Determines Dividend Policy?
The companys board of directors decides what percentage of earnings will be paid out to shareholders, and then puts the remaining profits back into the company. Although dividends are usually dispersed quarterly, it is important to remember that the company is not obligated to pay a dividend every single quarter. In fact, the company can stop paying a dividend at any time, but this is rare, especially for a firm with a long history of dividend payments. (To learn more about this problem, read Is Your Dividend At Risk?)
If people were used to getting their quarterly dividends from a mature company, a sudden stop in payments to investors would be akin to corporate financial suicide. Unless the decision to discontinue dividend payments was backed by some kind of strategy shift, say investing all retained earnings into robust expansion projects, it would indicate that something was fundamentally wrong with the company. For this reason, the board of directors will usually go to great lengths to keep paying at least the same dividend amount.
How Stocks That Pay Dividends Resemble Bonds
When assessing the pros and cons of dividend-paying stocks, you will also want to consider their volatility and share price performance as compared to those of outright growth stocks that pay no dividends.
Because public companies generally face adverse reactions from the marketplace if they discontinue or reduce their dividend payments, investors can be reasonably certain they will receive dividend income on a regular basis for as long as they hold their shares. Therefore, investors tend to rely on dividends in much the same way that they rely on interest payments from corporate bonds and debentures.
Since they can be regarded as quasi-bonds, dividend-paying stocks tend to exhibit pricing characteristics that are moderately different from those of growth stocks. This is because they provide regular income, similar to a bond, but still provide investors with the potential to benefit from share price appreciation if the company does well.
Investors looking for exposure to the growth potential of the equity market, combined with the safety of the (moderately) fixed income provided by dividends, should consider adding stocks with high dividend yields to their portfolio. A portfolio with dividend-paying stocks is likely to see less price volatility than a growth stock portfolio. (This is why dividends are often considered to be a good recessionary investment. Read Dividend Yield For The Downturn to learn more.)
Conclusion
A company cant keep growing forever. When it reaches a certain size and exhausts its growth potential, distributing dividends is perhaps the best way for management to ensure that shareholders receive a return from the companys earnings. A dividend announcement may be a sign that a companys growth has slowed, but it is also evidence of a sustainable capacity to make money. This sustainable income will likely produce some price stability when paid out regularly as dividends. Best of all, the cash in your hand is proof that the earnings are really there, and you can reinvest or spend them as you see fit.
1 Overview of Financial Analysis -
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Choosing A Compatible Broker
Did you hear about Chanko Wireless?
Yeah, I got in at $25.10.
Well I got in at $25.05!
How did you get a better price than I did?
For those of you who dont remember this dialog, it is a snippet from an old Ameritrade (a brokerage) commercial. In the ad, two men bicker because one got into a wireless company for a nickel less than the other. Do you care about a nickel? If you are like the majority of investors, you probably dont. Still, this commercial raises a good point: one of the most important investment decisions you have to make has nothing to do with choosing stocks , bonds or mutual funds. Its about choosing the right broker for your individual needs. Here we look at what to consider.
How Does Choosing a Broker Relate to the Nickel?
First off, we should make it clear that we are not making any comment about Ameritrade. The nickel is important to many investors (primarily traders), but it amounts to only a few dollars if you are buying less than 100 shares. If you arent an active trader, a nickel wont even show up on the chart over the long term. So, worrying about the nickel when choosing a broker matters only for particular types of investors.
Its easy to see, then, that although there may be many good brokerages out there, not all of them are geared to the way you invest. Different investor personalities affect broker selection. The task of making your selection may seem overwhelming at first, but with a little study and some basic guidelines, youll be able to make an informed decision suited to your investing personality and end up with a broker that is right for you.
The Importance of Your Investing Personality
Your investing style is one of the biggest factors to consider when selecting an online broker. To determine your style, you must define your needs. Here are some questions to help you do this:
• Do you need personal advice, or can you do your own homework with research reports?
• How long do you typically hold an investment?
• What is the size of trades you typically make?
• How important is it to have direct access to a real person?
• Is fast and efficient order execution absolutely necessary?
There are four main types of investor personalities. Try to determine what personality you resemble most and ask yourself if your broker is providing the services that match your personality.
Individual Investors
Those classified under this category are also known as retail investors. They dont require any special assistance or advisory services. Individual investors empower themselves by doing their own research, selecting their own stocks and knowing how to place online orders efficiently. The main priorities for the independent investor are fast, consistent trade executions and low commission levels.
The fruit of such priorities and labor is the opportunity to take advantage of the lowest commission rates around. Several brokers like E*Trade and Ameritrade - known as discount brokers - have chosen to target independent investors because this clientele makes up such a large and diverse market.
Reliant Investors
These investors need some hand holding and assistance when selecting a prospective investment. Typically, they require a broker capable of offering individualized advice and assistance. This is especially true for new investors, who may need all the help they can get when starting out.
As you can imagine, extra services equal higher commissions, and as more and more investors become self-sufficient, brokers serving this market segment become fewer and fewer. The ones that do stay around are generally larger companies, such as Charles Schwab and Fidelity. Known as full-service brokers, they provide many of the services necessary for successful investing: that is, not only picking stock, but also tax planning, asset allocation and long-term planning . Additionally, if you are a new investor with a fairly large amount of money, but you arent comfortable investing on your own, you may consider a wrap account. This type of account charges one flat fee, usually quarterly, which covers all administrative, commission and management expenses. The drawback is that wrap accounts usually require minimum investments of between $50,000 and $100,000. (For more on the wrap, see Wrap It Up: The Vocabulary and Benefits of Managed Money.)
Short-Term Investors (Traders)
Short-term traders are not the same as day traders. Depending on the type of security, a short-term position can range from an hour to a few months. For the most part, short-term trading is a practice used primarily by the top financial players. These are the professionals who have devoted time to understanding all aspects of trading and investment and are often trading what are called momentum stocks or momo plays. Traders require access to superior research information, excellent execution skills and most likely the ability to trade in other types of securities, such as derivatives.
With such experience and knowledge, short-term traders require next to no assistance from a broker. Because these investors are attempting to profit from the relatively short-term movements in a securitys price, they are more concerned about getting the best possible fill price than a longer-term investor, but not as concerned as a day trader, as we explain below. Discount online brokers supply the fast order execution, the low commissions and the trading tools that are the biggest concerns of the short-term investor.
Day Traders
These are experienced stock traders who hold positions for a very short time (from minutes to hours) and make numerous trades each day - most trades are entered and closed out intraday.
As a result, day traders value order fulfillment speed and trade execution. So, for them, selecting the right broker is crucial. Day traders are probably the only investors who should worry about whether their broker will help them secure the nickel. Because day traders are self-sufficient and place many trades daily, they can demand exceptionally low commissions - usually no more than a couple of bucks a trade - and top-notch order fulfillment. Because the day trader needs to monitor stock prices constantly, live price quotations are essential to his or her success. The fancy tools for this come at a price, however, as commissions at brokerages with loads of tools will be higher than those at brokerages offering fewer tools. Like short-term investors/traders, day traders basically use online discount brokers to facilitate their trading. Again, speed of order execution, low cost and good tools are important to these types of investors not requiring advice from their broker.
Every successful investor needs to have the right tools for the trade. This begins with choosing the right broker. No broker is perfect for everybody, and a firm that doesnt meet your style isnt necessarily a low-quality company; it may just offer services that dont fit your investment personality. Whether youre concerned about that nickel or your retirement plan, there is a broker out there that is right for you.
The resistance level of the trading range was well marked by three reaction peaks at 47.5. The support level was not as clearly marked, but appeared to be between 40 and 41.
Do not sign the new account agreement unless you thoroughly understand it and agree with the terms and conditions it imposes on you. Do not rely on statements about your account that are not in this agreement.
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Everything Investors Need To Know About Earnings
You cant get far in the stock market without understanding earnings. Everybody from CEOs to research analysts is infatuated with this often-quoted number. But what exactly do earnings represent? Why do they attract so much attention? Well answer these questions and more in this primer on earnings.
What Are Earnings?
A companys earnings are, quite simply, its profits. Take a companys revenue from selling something, subtract all the costs to produce that product, and, voila, you have earnings! Of course, the details of accounting get a lot more complicated, but underneath all the financial jargon what is really being measured is how much money a company makes.
Part of the confusion associated with earnings is caused by its many synonyms. The terms profit, net income, bottom line and earnings all refer to the same thing.
Earnings Per Share
To compare the earnings of different companies, investors and analysts often use the ratio earnings per share (EPS). To calculate EPS you take the earnings left over for shareholders and divide by the number of shares outstanding. You can think of EPS as a per-capita way of describing earnings. Because every company has a different number of shares owned by the public, comparing only companies earnings figures does not indicate how much money each company made for each of its shares, so we need EPS to make valid comparisons.
For example, take two companies: ABC Corp. and XYZ Corp. They both have earnings of $1 million but ABC Corp has 1 million shares outstanding while XYZ Corp. only has 100,000 shares outstanding. ABC Corp. has EPS of $1 per share ($1 million/1 million shares) while XYZ Corp. has EPS of $10 per share ($1 million/100,000 shares).
Earnings Season
Earnings season is Wall Streets equivalent to a school report card. It happens four times per year; publicly traded companies in the U.S. are required by law to report their financial results on a quarterly basis. Most companies follow the calendar year for reporting, but they do have the option of reporting based on their own fiscal calendars.
Although it is important to remember that investors look at all financial results, you might have guessed that earnings (or EPS) is the most important number released during earnings season, attracting the most attention and media coverage. Before earnings reports come out, stock analysts issue earnings estimates - what they think earnings will come in at. These forecasts are then compiled by research firms into the consensus earnings estimate.
When a company beats this estimate its called an earnings surprise, and the stock usually moves higher. If a company releases earnings below these estimates it is said to disappoint, and the price typically moves lower. All this makes it hard to try to guess how a stock will move during earnings season: its really all about expectations. (For more on this phenonmenon, see Surprising Earnings Results.)
Why Do Investors Care About Earnings?
Investors care about earnings because they ultimately drive stock prices . Strong earnings generally result in the stock price moving up (and vice versa). Sometimes a company with a rocketing stock price might not be making much money, but the rising price means that investors are hoping that the company will be profitable in the future - of course, there are no guarantees that the company will fulfill investors current expectations.
The dotcom boom and bust is a perfect example of company earnings coming in significantly short of the numbers investors imagined. When the boom started, everybody got excited about the prospects for any company involved in the internet, and stock prices soared. Over time, it became clear that the dotcoms werent going to make nearly as much money as many had predicted. It simply wasnt possible for the market to support these companies high valuations without any earnings; as a result, the stock prices of these companies collapsed.
When a company is making money it has two options. First, it can improve its products and develop new ones. Second, it can pass the money onto shareholders in the form of a dividend or a share buyback (see The Lowdown on Stock Buybacks). It really is this simple!
In the first case, you trust the management to re-invest profits in the hope of making more profits. In the second case, you get your money right away. Typically, smaller companies attempt to create shareholder value by reinvesting profits, while more mature companies pay out dividends. Neither method is necessarily better, but both rely on the same idea: in the long run, earnings provide a return on shareholders investments .
Summary
Earnings means profit; its the money a company makes. It is often evaluated in terms of earnings per share (EPS) - this is the most important indicator of a companys financial health. Earnings reports are released four times per year and are followed very closely by Wall Street. In the end, growing earnings are a good indication that a company is on the right path to providing a solid return for investors.
Even though there is a long black candlestick indicating an open at 59, the stock fell so fast that it was impossible to exit above 44.
Complaints regarding companies should be directed to the SEC, while complaints regarding broker-dealers or other investment professionals should be directed to FINRA. More information about specific OTC regulations is covered in Part 3 – Regulation.
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5 Ways To Double Your Investment
Theres something about the idea of doubling ones money on an investment that intrigues most investors. Its a badge of honor dragged out at cocktail parties, a promise made by over-zealous advisors, and a headline that frequents the cover of some of the most popular personal finance magazines. Where this fixation comes from is anyones guess.
Perhaps it comes from deep in our investor psychology - that risk-taking part of us that loves the quick buck. Or maybe its simply the aesthetic side of us that prefers round numbers - saying youre up 97% doesnt quite roll off the tongue like I doubled my money. Fortunately, doubling your money is both a realistic goal that investors should always be moving toward, as well as something that can lure many people into impulsive investing mistakes. Here we look at the right and wrong way to invest for big returns.
The Classic Way - Earn It Slowly
Investors who have been around for a while will remember the classic Smith Barney commercial from the 1980s, where British actor John Houseman informs viewers in his unmistakable accent that they make money the old fashioned way - they earn it. When it comes to the most traditional way of doubling your money, that commercials not too far from reality.
Perhaps the most tested way to double your money over a reasonable amount of time is too invest in a solid, non-speculative portfolio thats diversified between blue-chip stocks and investment grade bonds. While that portfolio wont double in a year, it almost surely will eventually, thanks to the old rule of 72.
The rule of 72 is a famous shortcut for calculating how long it will take for an investment to double if its growth compounds on itself. According to the rule of 72, you divide your expected annual rate of return into 72, and that tells you how many years it takes you to double your money.
Considering that large, blue-chip stocks have returned roughly 10% over the last 100 years and investment grade bonds have returned roughly 6%, a portfolio that is divided evenly between the two should return about 8%. Dividing that expected return (8%) into 72 gives a portfolio that should double every nine years. Thats not too shabby when you consider that it will quadruple after 18 years.
The Contrarian Way - Blood in the Streets
Even straight-laced, even-keeled investors know that there comes a time when you must buy - not because everyone is getting in on a good thing, but because everyone is getting out. Just like great athletes go through slumps when many fans turn their backs, the stock prices of otherwise great companies occasionally go through slumps because fickle investors head for the hills.
As Baron Rothschild (and Sir John Templeton) once said, smart investors buy when there is blood in the streets, even if the blood is their own. Of course, these famous financiers werent arguing that you buy garbage. Rather, they are arguing that there are times when good investments become oversold, which presents a buying opportunity for brave investors who have done their homework.
Perhaps the most classic barometers used to gauge when a stock may be oversold is the price-to-earnings ratio and the book value for a company. Both of these measures have fairly well-established historical norms for both the broad markets and for specific industries. When companies slip well below these historical averages for superficial or systemic reasons, smart investors will smell an opportunity to double their money.
The Safe Way
Just like how the fast lane and the slow lane on the freeway eventually lead to the same place, there are both quick and slow ways to double your money. So for those investors who are afraid of wrapping their portfolio around a telephone pole, bonds may provide a significantly less precarious journey to the same destination.
But investors taking less risk by using bonds dont have to give up their dreams of one day proudly bragging about doubling their money. In fact, zero-coupon bonds (including classic U.S. savings bonds) can keep you in the double your money discussion.
For the uninitiated, zero-coupon bonds may sound intimidating. In reality, theyre surprisingly simple to understand. Instead of purchasing a bond that rewards you with a regular interest payment, you buy a bond at a discount to its eventual maturity amount. For example, instead of paying $1,000 for a $1,000 bond that pays 5% per year, an investor might buy that same $1,000 for $500. As it moves closer and closer to maturity, its value slowly climbs until the bondholder is eventually repaid the face amount.
One hidden benefit that many zero-coupon bondholders love is the absence of reinvestment risk. With standard coupon bonds, theres the ongoing challenge of reinvesting the interest payments when theyre received. With zero coupon bonds, which simply grow toward maturity, theres no hassle of trying to invest smaller interest rate payments or risk of falling interest rates.
The Speculative Way
While slow and steady might work for some investors, others may find themselves falling asleep at the wheel. They crave more excitement in their portfolios and are willing to take bigger risks to earn bigger payoffs. For these folks, the fastest ways to super-size the nest egg may be the use of options, margin or penny stocks.
Stock options, such as simple puts and calls, can be used to speculate on any companys stock. For many investors, especially those who have their finger on the pulse of a specific industry, options can turbo-charge their portfolios performance. Considering that each stock option potentially represents 100 shares of stock, a companys price might only need to increase a small percentage for an investor to hit one out of the park. Be careful and be sure to do your homework; options can take away wealth just as quickly as they create it.
For those who want dont want to learn the ins and outs of options but do want to leverage their faith (or doubt) about a certain stock, theres the option of buying on margin or selling a stock short. Both of these methods allow investors to essentially borrow money from a brokerage house to buy or sell more shares than they actually have, which in turn can raise their potential profits substantially. This method is not for the faint-hearted because margin calls can back your available cash into a corner, and short-selling can theoretically generate infinite losses.
Lastly, extreme bargain hunting can quickly turn your pennies into dollars. Whether you decide to roll the dice on the numerous former blue-chip companies that are now selling for less than a dollar, or you sink a few thousand dollars into the next big thing, penny stocks can double your money in a single trading day. Just remember, whether a company is selling for a dollar or a few pennies, its price reflects the fact that other investors dont see any value in paying more.
The Best Way to Double Your Money
While its not nearly as fun as watching your favorite stock on the evening news, the undisputed heavyweight champ of doubling your money is that matching contribution you receive in your employers retirement plan . Its not sexy and it wont wow the neighbors at your next block party, but getting an automatic 50 cents for every dollar you deposit is tough to beat.
Making it even better is the fact that the money going into your 401(k) or other employer-sponsored retirement plan comes right off the top of what your employer reports to the IRS. For most Americans, that means that each dollar invested really only costs them 65 to 75 cents out of their pockets. In other words, for every 75 cents, most Americans are willing to forgo out of their paychecks, theyll have $1.50 or more added to their retirement nest egg.
Before you start complaining about how your employer doesnt have a 401(k) or how your company has cut their contribution because of the economy, dont forget that the government also matches some portion of the retirement contributions of taxpayers earning less than a certain amount. The Credit for Qualified Retirement Savings Contribution reduces your tax bill by 10 to 50% of what ever you contribute to a variety of retirement accounts (from 401(k)s to Roth IRAs).
If Its Too Good to Be True …
Theres an old saying that if something is too good to be true, then it probably is. Thats sage advice when it comes to doubling your money, considering that there are probably far more investment scams out there than sure things. While there certainly are other ways to approach doubling your money than the ones mentioned so far, always be suspicious when youre promised results. Whether its your broker, your brother-in-law or a late-night infomercial, take the time to make sure that someone is not using you to double their money.
In a cash account, an investor must pay for the purchase of a security before selling it. If an investor buys and sells a security before paying for it, the investor is “freeriding”, which is not permitted under the Federal Reserve Board’s Regulation T and may require the investor’s broker to “freeze” the investor’s cash account for 90 days.
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7 Lessons To Learn From A Market Downturn
You can never really understand investing until you weather a market downturn. The valuable lessons learned can help you through the bad times and can be applied to your portfolio when the economy recovers. Listed below are some common investor experiences during tough economic times and the lessons each investor can come away with after surviving the events.
Lesson #1: Evaluate Your Egg Baskets
Youre pulling your hair out because everything you invest in goes down. The lesson: Always keep a diversified portfolio, regardless of current market conditions.
If everything you own is moving in the same direction, at the same rate, your portfolio is probably not well diversified, and you could stand to reconsider your asset-allocation choices. The specific assets in your portfolio will depend on your objectives and risk-tolerance level, but you should always include multiple types of investments. (Read Personalizing Risk Tolerance to find out how much uncertainty you can stand.)
Taking a more conservative stance to preserve capital should mean changing the percentages of holdings from aggressive, risky stocks to more conservative holdings, not moving everything to a single investment type. For example, increasing bonds and decreasing small-cap growth holdings maintains diversification, whereas liquidating everything to money market securities does not. Under normal market conditions, a diversified portfolio reduces big swings in performance over time. (For more information, read Diversification: Its All About (Asset) Class.)
Lesson #2: No Such Thing as a Sure Thing
That stock you thought was a sure thing just tanked. The lesson: Sometimes the unpredictable happens. It happens to the best analysts, the best fund managers, the best advisors, and, it can happen to you.
The perfect chart interpretation, fundamental analysis, or tarot card reading wont predict every possible incident that can impact your investment.
• Use due diligence to mitigate risk as much as possible.
• Review quarterly and annual reports for clues on risks to the companys business as well as their responses to the risks.
• You can also glean industry weaknesses from current events and industry associations.
More often, an investment is impacted by a combination of events. Dont kick yourself over unpredictable or extraordinary events like supply-chain failures, mergers, lawsuits, product failures, etc. (Learn how to find companies that manage risk well in The Evolution Of Enterprise Risk Management.)
Lesson #3: Proper Risk Management
You thought an investment was risk-free, but it wasnt. The lesson: Every investment has some type of risk.
You can attempt to measure the risk and try to offset it, but you must acknowledge that risk is inherent in each trade. Evaluate your willingness to take each risk. (See Measuring And Managing Investment Risk for information on keeping necessary risk under control.)
Lesson #4: Liquidity Matters
You always stay fully invested, so you miss out on opportunities requiring accessible cash. The lesson: Having cash in a certificate of deposit (CD) or money market account enables you to take advantage of high-quality investments at fire sale prices. It also decreases overall portfolio risk.
Penny stocks are the secret to 2000% profits!
Plan ahead to replenish cash accounts. For example, use the proceeds from a called bond to invest in the money market instead of purchasing a new bond.Sometimes cash can be obtained by reorganizing debt or trimming discretionary spending. Set a specific percentage of your overall portfolio to hold in cash. (Learn how to take advantage of the safety of the money market in our Money Market tutorial.)
Lesson #5: Patience
Your account balance is lower than it was last quarter, so you overhaul your investment strategy before taking advantage of your current investments. The lesson: Sometimes it takes the market an extended period of time to bounce back.
Your overall portfolio balance on a given date is not as important as the direction it is trending and expected returns for the future. The key is preparedness for the impending market upturn based on an estimated lag time behind market indicators. Evaluate your strategy, but remember that sometimes patience is the solution. (Doing nothing can mean good returns. Find out more in Patience Is A Traders Virtue.)
Lesson #6: Be Your Own Advisor
The market news gets bleaker every day - now youre paralyzed with fear! The lesson: Market news has to be interpreted relative to your situation.
Sometimes investors overreact, particularly with large or popular stocks, because bad news is replayed continuously via every news outlet. Here are some steps you can follow to help you keep your head in the face of bad news:
• Pay attention and understand the news, then analyze the financials yourself. (Read What You Need To Know About Financial Statements for help.)
• Determine if the information represents a significant downward financial trend, a major negative shift in a companys business, or just a temporary blip.
• Listen for cues the company may be downgrading its own expected returns. Find out if the downgrade is for one quarter, one year or if it is so abstract you cant tell.
• Conduct an industry analysis of the companys competitors.
After a thorough evaluation, you can decide if your portfolio needs a change. (For more information, read Do You Need a Financial Advisor?)
Lesson #7: When to Sell and When to Hold
The market indicators dont seem to have a silver lining. The lesson: Know when to sell existing positions and when to hold on.
Dont be afraid to cut your losses. If the current value of your portfolio is lower than your cost basis and showing signs of dropping further, consider taking some losses now. Remember, those losses can be carried forward to offset capital gains for up to seven years. (For more information, read Selling Losing Securities For A Tax Advantage.)
Selective selling can produce cash needed to buy investments with better earnings potential. On the other hand, maintain investments with solid financials that are experiencing price corrections based on expected price-earnings ratios. Make decisions on each investment, but dont forget to evaluate your overall asset allocation. (Read more in Asset Allocation: One Decision To Rule Them All.)
Conclusion
Downward stock market swings are inevitable. The better-prepared you are to deal with them, the better your portfolio will endure them. You may have already learned some of these lessons the hard way, but if not, take the time to learn from others mistakes before they become yours.
General Steps to Fundamental Evaluation
Even though there is no one clear-cut method, a breakdown is presented below in the order an investor might proceed. This method employs a top-down approach that starts with the overall economy and then works down from industry groups to specific companies.
A good starting point for research is the OTC market tier structure – which quickly indicates the level and timeliness of information available for OTC companies.
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5 Ways To Protect Your Portfolio From Volatility
Is it possible to gauge the level of anxiety in the investment markets? Certainly, and The Chicago Board of Exchange Volatility Index (VIX) measures it. The VIX reacts in real time - just as a stock does - and measures the level of volatility in the U.S. markets over the next 30 days. When the VIX is at 30, in the next 30 days the market could move as much as 2.5% in either direction, (30% divided by 12 months equals 2.5%). The VIX has hovered around 30 for the latter part of 2011, indicating that the market is still highly volatile.
Although short-term traders may call periods of high volatility great times to make money, the truth is that traders of all skill levels will face challenges in this market. What can you do to protect your portfolio against the wild stock market swings? Though it may not sound exciting to the average active trader, the best defense is to stick with conservative, boring strategies.
Hedge
Think of hedging as an insurance policy. Lets assume that you own Bank of America stock and it is now in a market decline. One way to hedge would be to purchase a put option, with a strike price below where you purchased the stock. You wont lose money on any move below your strike price. Other hedging options include short selling a stock and purchasing put options on index funds, like popular exchange traded fund SPDR S
OTC Markets organizes and disseminates price and company information making the marketplace more transparent, efficient and investor friendly. We have created the OTC market tiers to motivate OTC companies to provide more information to investors and we offer companies products and services to help them get their information out on our network for all investors to find.
There were still two more opportunities (days) to get in on the action. On the third day after the breakout, the stock gapped up and moved above 56.
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The Christmas Saints Of Wall Street
There is something about twinkling lights, garlands and gifts that causes a change in people - not the same change as a good eggnog with double the rum does, but its not far off. At Christmas time, people are merrier and more generous than usual. The Red Cross and UNICEF see moredonations in December than they do in all the other 11 months combined. People that usually sprint toward the office with their collars up and their eyes straight may be more likely to drop change into an outstretched hand or donation pot. Strangers exchange greetings instead of suspicious glares - this is the Christmas spirit.
This Christmas season, we will look at some people whose Christmas spirit doesnt leave when the pine needles drop. They may not be in the same league as ol Saint Nick, but they arent far off.
The Old Guard
Philanthropy on Wall Street is not a recent event. It has, however, been in need of a pick-up since the recession pinched, squeezed and finally stemmed the flow of big money into charity. The original saints of Wall Street can still be felt by tracing your finger down a list of libraries, hospitals, foundations, research centers, womens shelters and other projects aimed at helping the less fortunate. If you do this, youll find that some names occur more often than others.
Steel, Oil and Cars
The old guard, consisting of Andrew Carnegie, John D. Rockefeller, Andrew W. Mellon and Henry Ford, all made their fortunes in oil, steel or a combination of the two - cars, ships, etc. Charity came to these men late in life, and it is sometimes said that much of their philanthropy was giving back the money they made from crushing unions and creating unfair monopolies. While there is truth to these claims, it is also true that most of what we call unsavory business practices in hindsight were commonplace in their time. Carnegie, Rockefeller, Mellon and Fords devotion to education, medical care and the fight against poverty made them stand out at a time when the worlds richest people hoarded their money within their families. These men, and the foundations they left behind, have given billions of dollars to improve life in America.
The Next Generation
Whereas the philanthropists of the past were based in heavy industry, the next generation is largely made of tech street barons and stock gurus. Here are few of the members of the new generation of philanthropists:
Gordon and Betty Moore (Intel)
Gordon Moore was one of the co-founders of Intel Corporation. With his wife Betty, he has made donations in the hundreds of millions of dollars to two main causes: environmental conservation (with a focus on marine life) and medicine. The latter grew out of Betty Moores bad experiences with hospitals. Betty and her husband have funded training programs for nurses in the hope of preventing common medical mistakes. The Moores also have given generously to improving secondary education, culminating in a $600-million gift to the California Institute of Technology in 2001.
Michael and Susan Dell
Michael Dell, founder of Dell Computers, and his wife Susan have been increasing their involvement in philanthropy every year since Michael stepped down as the CEO in July 2004, leaving behind a profitable company through which he amassed a large personal fortune. Having four young children of their own, the Dells have used their wealth to advance childrens causes (heath, education and medicine). The Michael
The difference in detail can be seen with the daily and weekly chart comparison above.
The FINRA OTCBB system, on the other hand, is a quotation only system, as it lacks the electronic messaging capabilities of OTC Link. Furthermore, only companies that are SEC-reporting (or bank/insurance reporting) are eligible for quotation on the FINRA OTCBB. Since these securities may also be quoted on OTC Link, many BB eligible securities are ‘Dually-Quoted’ on both inter-dealer quotation systems. Currently, 99% of OTCBB eligible securities are quoted on OTC Link.
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Buy-And-Hold Investing Vs. Market Timing
If you were to ask 10 people what long-term investing meant to them, you might get 10 different answers. Some may say 10 to 20 years, while others may consider five years to be a long-term investment . Individuals might have a shorter concept of long term, while institutions may perceive long term to mean a time far out in the future. This variation in interpretations can lead to variable investment styles.
For investors in the stock market , it is a general rule to assume that long-term assets should not be needed in the three- to five-year range. This provides a cushion of time to allow for markets to carry through their normal cycles.
However, whats even more important than how you define long term is how you design the strategy you use to make long-term investments . This means deciding between passive and active management. Read on to learn more.
Long-Term Strategies
Investors have different styles of investing, but they can basically be divided into two camps: active management and passive management. Buy-and-hold strategies - in which the investor may use an active strategy to select securities or funds but then lock them in to hold them long term - are generally considered to be passive in nature. Figure 1 shows the potential benefits of holding positions for longer periods of time. According to research conducted by Charles Schwab Company in 2012, between 1926 and 2011, a 20-year holding period never produced a negative result.
Source: Schwab Center for Financial Research
Figure 1: Range of S
Semi-log scales are useful when the price has moved significantly, be it over a short or extended time frame.
All OTC securities are assigned a market tier based on their reporting method (SEC Reporting, Alternative Reporting Standard) and disclosure category – Current, Limited or No Information. Securities on OTCQX, the highest tier of the OTC market, are required to have Current disclosure and meet minimum financial qualifications. Securities in OTCQB tier must be SEC, Bank or Insurance reporting and must be Current in their disclosure.
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Taking The Bite Out Of A Bear Market
A bear market is defined as a decline of 20% in the following three major stock market indexes :
• Dow Jones Industrial Average (DJIA)
• Standard
Technical analysts believe that the current price fully reflects all information. Because all information is already reflected in the price, it represents the fair value, and should form the basis for analysis.
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The OTC market does not have this limitation. They may agree on an unusual quantity, for example. In OTC market contracts are bilateral (i.e. contract between only two parties), each party could have credit risk concerns with respect to the other party. OTC derivative market is significant in some asset classes: interest rate, foreign exchange, equities, and commodities.
How To Invest In Private Companies
The internet has revolutionized the world of retail stock investing by making vast amounts of financial information quickly and easily available to individual investors. And though still in the early stages, the advent of digital information exchange is also making it easier for more individuals to invest in privately-held companies. Just as eBay has put buyers in contact with sellers of collectibles that used to collect dust on attic shelves, today private companies are much more able to seek out buyers of their securities to allow them to raise capital. TUTORIAL: Advanced Financial Statement Analysis
The drawback to vast amounts of information is the difficultly in knowing what to focus on. Below is a comparison of private companies to public ones, overview of private company types and varieties, investment options currently available for interested investors, and a survey of other considerations to make when investing in private companies.
Private Companies versus Public Companies
Overall, it is much easier to invest in a publicly-traded firm. Public companies, especially larger ones, can easily be bought and sold on the stock market and therefore have superior liquidity and a quote market value. Conversely, it can be years before a private firm can again be sold and prices must be negotiated between the seller and buyer.
In addition, public companies must file financial statements with the Securities and Exchange Commission (SEC), making it easy to track how they are doing on a quarterly and annual basis. Private companies are not required to provide any information to the public, so it can be extremely difficult to determine their financial soundness, historical sales and profit trends.
Investing in a public company may seem far superior to investing in a private one, but there are a handful of benefits to not being public. A major criticism of many public firms is that they are overly focused on quarterly results and meeting Wall Street analyst short-term expectations. This can cause them to miss out on long-term value creating opportunities, such as investing in a product that may take years to develop, hurting profits in the near term. Private firms can be better managed for the long term as they are out of Wall Streets reach. An annual report by the World Economic Forum has detailed that productivity increases when a public firm is taken private. They can also create more jobs when run more efficiently and profitably.
Being an owner of a private firm also means sharing more directly in the underlying firms profits. Earnings may grow at a public, firm but they are retained unless paid out as dividends or used to buy back stock. Private firm earnings can be paid directly to the owners. Private owners can also have a larger role in the decision-making process at the firm, especially those with large ownership stakes.
Types of Private Companies
From an investment standpoint, a private company is defined by its stage in development. For instance, when an entrepreneur is first starting a business he or she usually receives funding from a friend or family member on very favorable terms. This stage is referred to as angel investing, while the private company is known as an angel firm. Past the start-up phase is venture capital: investing where a group of more savvy investors comes along and offers growth capital and managerial know-how and other operational assistance. At this stage a firm is seen to have at least some long-term potential.
Past this stage can be mezzanine investing, which consists of equity and debt, the last of which will convert to equity if the private company cant meet its interest payment obligations. Later-stage private investing is simply referred to as private equity and is currently a multi-billion dollar business with many large players.
For investors, the stage of development a private company is in can help define how risky it is as an investment. For instance, approximately 40% of angel investments fail and the risk falls the more developed and profitable a private company becomes. And although the goal of many private firms is to eventually go public and provide liquidity for company founders or other investors, other private business may prefer to stay private given the benefits given above. Family businesses may also prefer privacy and the handing of ownership across generations. These are important matters to become aware of when deciding to invest in a private company. (To learn more, see What Is Private Equity?)
How to Invest in Private Companies
Early-stage private investing offers the most investment opportunities but is also the most risky. As a result, joining an angel investor organization or investment group may be a good idea to make the process easier and potentially spread the investment risks across a wide group of firms. Venture funds also exist and solicit outside partners for investing capital.
As noted above, the internet has quickly become a central source to find these types of organizations, while other websites have sprung up to fill a void and put buyers and sellers of many types of private companies together. Online sources also have made it easier to at least locate basic information on a private firm. This can be done by visiting the companys websites, and reading online blogs and articles that discuss the firm and its industry.
Other resources that can be used include small or private business brokers that specialize in buying and selling these firms. Private equity is also an option, and ironically a number of the largest private equity firms are publicly traded so can be purchased by any investor. A number of mutual funds can also offer at least some exposure to private companies.
Other Considerations
Overall, it is important to reiterate that private companies are illiquid and require very long investing time frames. Most investors will also need an eventual liquidity event to cash out. This includes when the company goes public, buys out private shareholders, or is bought out by a rival or another private equity firm. And just like with any security, private companies need to be valued to determine if they are fairly valued, overvalued or undervalued.
It is also important to note that investing directly in private firms is usually reserved only for wealthy individuals. The motivation is that they can handle the additional illiquidity and risk that goes with private investing. The SEC definition calls these wealthy individuals accredited investor or qualified institutional buyer (QIB) when considering institutions.
The Bottom Line
It is now easier than ever to invest in private companies, but an investor still has to do his or her homework. Investing directly is still not going to be a viable option for most investors, but there are still ways to gain exposure to private firms through more diversified investment vehicles. Overall, an investor definitely has to work harder an overcome more obstacles when investing in a private firm as compared to a public one, but they work can be worth it as there are a number of advantages to be gained by investing in private companies.
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