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Demo Accounts A Good (But Imperfect) Indicator Of Investing Skills
Demo accounts are advertised all over the internet, and people who surf financial sites are often exposed to many ads inducing them to open a demo account. Demo account trading is the new form of paper trading. The old-fashioned paper trade involved writing down entries and exits to see how a methodology played out in the market. Demo accounts allow the trader to do this on a computerized simulator. The simulated trading environment does provide a trader with the opportunity to get used to the software they will be using with their broker to trade the markets, but when a person moves to live trading after the demo account, there are several shocks they need to prepare for.
Why the Shock?
Many traders trade profitably in a demo account, but when they move to live trading with their own money, a succession of losses may occur one after the other. Why does this happen?
1. Demo accounts provide better execution than live trading .
Demo accounts will normally fill a market order at the price showing on the screen. When an order is placed in the live market, it is subject to slippage, and therefore it is quite common for market orders to not be filled at the price expected, or in the case of large orders, for at least a portion of the position to be acquired at a different price than is expected.
Demo accounts will also generally give early fills when bidding or offering. Bids and offers in the live market are also subject to a queue. Bidding at the current bid price does not guarantee a fill, as only a few shares or contracts may be filled at that price. In a demo account, it is hard to know which orders would actually have been executed in the live market. This is true of entries and exits, and thus results attained from a demo account are highly subjective at best, and completely inaccurate at worst.
2. Demo accounts often provide more capital than what the trader will actually be using for live trading.
Demo software generally allows the trader to choose the amount of capital he or she would like to simulate trading with. The amounts vary, but are often very large and beyond the actual capital the trader has for trading his own account.
Simulated trading with more capital than will actually be traded provides an unrealistic safety net. More capital allows for small losses to be more easily recouped, while a loss on a smaller account is harder to recoup.
It is also important to note that even share lots (100 shares) in more expensive instruments, which were easy to afford in the high-capital demo account, may be beyond the capacity of the trader in a live account. The instruments and volume traded in the simulator may not be able to be replicated with real capital. A trader may be able to trade several lots of Google at $500/share, but unless he or she has similar capital for live trading, he or she may be unable to trade those higher priced instruments at all.
3.
A demo account cannot simulate the emotions of fear and hope (also called greed) that the trader will experience with real money.
This is one of the most jarring differences between simulated and live trading. A fear of losing ones own capital can wreak havoc on a proven trading system and prevent the trader from implementing it properly. Greed (or hoping a losing position will come back to profitability) can have the same effect, keeping the trader in a trade long after it should have been exited.
When real money is on the line, money that can have a potential material impact (or is perceived to have a potential impact), it is far different from trading a demo account where success or failure has no material impact on the persons life.
Can Demo Trading Be Made More Realistic?
Demo trading does have some benefits, as it gives new traders a general idea of how the market and a companys software works. So, can you trade a demo account in a certain way to make it more realistic? While a demo account can never offer the same results that would be realized in live trading, there are several things you can do when testing out systems on a demo platform to make the results as realistic as possible.
1. Make Realistic Assumptions
If a bid or offer is placed, and you can see that the bid or offer was within one tick or one cent of the low or high of that move, assume that your order was not filled. The demo may show this order was filled, but in the actual market, this may not happen. Remove the profits or losses from these trades from the net profit/loss shown on the simulator – as if the trade never existed. Only assume bids or offers are filled if price trades through the bid or offer by at least a cent more. For thinly traded stocks or low-volume stocks this buffer should be expanded.
2. Account for Slippage
On market orders assume at least a one-cent slippage on high volume stocks, and assume larger slippage in lower volume or more volatile stocks.
3. Trade With Modest Capital
If possible, trade the same amount of capital in the demo account as will be traded in the live market. If the demo does not allow this, trade only a fraction of the demo account capital. Dont access any funds from the demo capital which would be in excess of live trading funds.
4. Get Personal
Pretend the money is real as much as possible. Monitor emotions and how trades are affecting you psychologically while those emotions are felt. Since demo capital provides no real loss or profits, the sense of loss or profit needs to be added in by the trader. One method of doing this is to withhold something you enjoy if you fail to follow your trading plan, or give yourself a small reward when the trading plan is followed (regardless of profit or loss).
Summary
Demo accounts can provide some benefit to new traders, as they allow the trader to become familiar with trading software and get a sense of how the market works. The problem is that simulated results rarely correlate to actual trading results. Therefore, the trader must be aware that execution, capital and emotions can be different when trading real money as opposed to fake money. Traders can, however, make demos more realistic by excluding profits/losses on orders that are unlikely to have been filled in the real market, factoring in slippage, keeping the demo account capital in line with what will actually be traded and making demo losses and profits (and thus emotions) real by incorporating external stimulus.
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Getting Started In Stocks
So youve decided to invest in the stock market. Congratulations! In his 2005 book The Future for Investors, Jeremy Siegel showed that, in the long run, investing in stocks has handily outperformed investing in bonds, Treasury bills, gold or cash. In the short term, one or another asset may outperform stocks, but overall stocks have historically been the winning path.
Tutorial: Stock Basics
But there are so many ways to invest in stocks. Individual stocks, mutual funds, index funds, ETFs, domestic, foreign - how can you decide what is right for you? This article will address several issues that you, as a new (or not-so-new) investor, might want to consider so that you can rest more easily while letting your money grow.
Risk Taker, Risk Averse or in the Middle?
You may be eager to get started so that you, too, can make those fabulous returns you hear so much about, but slow down and take a moment to contemplate some simple questions. The time spent now to consider the following will save you money down the road.
What kind of person are you? Are you a risk taker, willing to throw money at a chance to make a lot of money, or would you prefer a more sure thing? What would be your likely response to a 10% drop in a single stock in one day or a 35% drop over the course of a few weeks? Would you sell it all in a panic?
The answers to these and similar questions will lead you to consider different types of equity investments, such as mutual or index funds versus individual stocks. If you are naturally not someone who takes risks, and feel uncomfortable doing so but still want to invest in stocks, the best bet for you might be mutual funds or index funds. This is because they are well diversified and contain many different stocks. This reduces risk - and doesnt require individual stock research. (For more insight, read Personalizing Risk Tolerance, Mutual Fund Basics and The Lowdown On Index Funds.)
Have much time and interest do you have for investing?
Should you invest in funds, stocks or both? The answer depends on how much time you wish to devote to this endeavor. Careful selection of mutual or index funds would let you invest your money, leaving the hard work of picking stocks to the fund manager. Index funds are even simpler in that they move up or down according to the type of company, industry or market they are designed to track.
Individual stock investing is the most time consuming as it requires you to make judgments about management, earnings and future prospects. As an investor, you are attempting to distinguish between a money-making stock and financial disaster. You need to know what they do, how they make their money, the risks, the future prospects and much more.
Therefore, ask yourself how much time you have to devote to this enterprise. Are you willing to spend a couple of hours a week, or more, reading about different companies, or is your life just too busy to carve out that time? Investing in individual stocks is a skill, which, like any other, takes time to develop. (For more on this research, read Introduction To Fundamental Analysis.)
Eggs in One Basket
It is best that you not be exposed to only one type of asset. For instance, dont put all of your money in small biotech companies. Yes, the potential gain can be quite high, but what will happen to your investment if the Food and Drug Administration starts rejecting a higher percentage of new drugs? Your entire portfolio would be negatively impacted. (For related reading, see The Ups And Downs Of Biotechnology.)
It is better to be diversified across several different sectors such as real estate (a real estate investment trust is one possibility), consumer goods, commodities, insurance, etc., rather than focusing on one or two or three, as above. Consider diversifying across asset classes, as well, by keeping some money in bonds and cash, rather than being 100% invested in stocks. How much to have in these different sectors and classes is up to you, but being invested more broadly lessens the risk of losing it all at any one time. (For more insight, check out Introduction To Diversification.)
A Portfolio for Beginners
If you are just starting out, think seriously about investing most of your money in a couple of index funds, such as one tracking the broad market (e.g. the S
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6 Misconceptions About Investing Young
Investing is seen by many as an arduous task - one that is complicated, risky and best left to other people. It is often easier to avoid investing altogether, than confront it head on. A natural human reaction is to create excuses that rationalize why one has chosen to avoid an activity. Investing at a young age is no exception: a variety of misconceptions about investing young perpetuates the idea that investing is best left to older people and experts. This article will examine several of these misconceptions that are often used as an excuse to delay or avoid investment activity.
SEE: Young Investors: What Are You Waiting For?
I dont have enough money.
While it is true that young adults are usually inundated with debt - from student loans, car payments and mortgages - many can find at least a small amount of money to invest on a monthly or yearly basis. Contributing to employer-sponsored plans, such as 401(k)s, can allow a small investment to grow over time, particularly when matched by the employer. The power of compounding creates a golden opportunity for young investors, even those on a tight budget. It is important to keep in mind that investing does not have to involve huge positions; it is possible to invest in a very small number of stock shares.
I dont know anything about investing.
Ignorance is not an excuse to avoid investing. Young investors have many years to study, research and develop proficiency in investing techniques and strategies. A wealth of information is available to tech-savvy young adults, from financial and education websites, to social media pages, webinars and the many advanced trading platforms that are available for free or for a limited monthly fee.
Investing is too risky.
Many young adults are keenly aware of the economic crisis and the resulting chaos that ensued. While investing can be risky, it can be managed in a way that keeps it from being too risky, however that is defined for each individual. Young investors with a low risk tolerance can select more conservative portfolios, like blue-chip stocks and bonds. Investors with a higher tolerance for risk can enter more aggressive positions with higher reward potential.
Investing can wait till Im older.
Young investors have to contribute less to make more money over time than older investors. This is due to the power of compounding. A person who starts at age 20 and invests $100 per month until age 65 (a total contribution of $54,000) will have more than $200,000 when he or she reaches age 65, assuming a 5% return. If the person delays investing until age 40, he or she will have to contribute $334 each month (a total contribution of $100,200) to arrive at the same $200,000 by age 65.
Investing is for old people and Wall Street types.
While the media do portray many investors either as wizened old men or young, power-hungry Wall Street types, most investors are ordinary people, both young and old, wealthy and not. Even though we often hear You are never too old to start investing (or saving for retirement), the opposite is true as well: people are never too young to start investing.
My 401(k) should be all I need.
Depending on social security and 401(k)s can be risky. It is difficult to predict where social security will be in future years, and many investors learned the hard way in the last decade that employee-sponsored retirement plans dont always work out. Starting young and diversifying through a variety of investment vehicles is the best way to secure ones financial future.
The Bottom Line
Young adults often have so many distractions that it is difficult to set aside the time to think about investing. In addition to being busy with friends, work and hobbies, this age group is often burdened by a significant amount of debt, making investing seem like something that will have to wait. Despite these common misconceptions about investing young, those who do start studying, researching and investing young, have many advantages over those who wait, including the power of compounding and the ability to weather a certain degree of risk.
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The Alphabet Soup Of Stocks
If youve ever watched financial TV or read financial papers, you may have heard of classifications like cyclical, growth and income stocks . As if the difference between preferred and common stocks wasnt enough, there are now more categories to add to the confusion! In this article, well try to replace the confusion with some clarity and logic.
Stocks and the Business Cycle
Many stocks can be broken into categories that denote the way in which different stocks perform during various times of the year or periods of the business cycle:
• Seasonal - These companies are characterized by the different levels of demand they face throughout the year. A snow shovel manufacturer, for example, is probably not very busy in the summer. Another seasonal effect is the increase in retail sales during the holidays. Butinvesting in seasonal stocks doesnt mean that you can automatically gain a healthy profit simply by purchasing a retail stock in the fall and selling it just after Christmas - not all seasonal stocks are guaranteed to do well, even during their peak seasons. When you analyzefinancial statements for a seasonal stock , you need to compare results to the same season of the previous year. (For related reading, see Analyzing Retail Stocks.)
• Non-Seasonal - These stocks are not affected by the change of seasons. Certain companies produce or sell goods that have what we call an inelastic demand curve. A good example is a peanut butter manufacturer - the demand for peanut butter is generally not affected by the weather or holidays.
• Cyclical - These companies, whose business activities intensely follow the business cycles of the economy, are always the first stocks to reflect a recession or an expansion. These companies dont necessarily intend to follow the business cycle, it just so happens that their products share this relationship with the economy. A good example of a company with cyclical stock would be a car manufacturer or an airline company. Luxury is one of the factors in the relationship between these stocks and the business cycle. Take Porsche, for example: when the economy is doing well, the sales of these fine automobiles rise. Conversely, when the economy goes into a slump, sales slow down.
• Non-Cyclical - This is the opposite of a cyclical stock. Profits of a non-cyclical stock do not change readily with the business cycle. These are companies that provide us with essentials, such as healthcare and food. Also referred to as defensive stocks, these stocks dont rely on the economic environment for increased sales. A perfect example is the diaper industry: regardless of whether the economy is busting or booming, parents have to buy diapers for their babies.
• Stocks and Dividends
Adding to the confusion, stocks are also classified according to their type of dividend payout schemes. Now remember, this is separate from what we have already discussed. Dividend payouts have little to do with the seasonal demands a company faces; instead, they are determined by each companys individual policies and objectives.
• Growth
- Growth stocks are known for their lack of dividends and rapidly increasing market prices. Defined by their tendency to grow faster than the market, these companies generally reinvest all earnings into infrastructure in order to maintain rapid growth, rather than directly paying out their earnings to investors. Young technology companies are often considered to be high growth, but the main characteristic of growth companies is that they believe that plowing earnings back into the research and development of new products benefits shareholders more than a dividend check every three months.
• Income - These stocks arent (usually) growth hungry, or theyve already reached their maximum growth potential. Income stocks prices do not tend to fluctuate a great deal. However, they do pay dividends that are higher than average. The value of an income stock depends on its reliability and track record in paying dividends. Generally, the longer a company has maintained dividend payments, the greater its value to investors. Historical examples of income stocks are real estate investment trusts (REITS) and utility stocks, many of which pay out annual dividends of 5% or more. (Learn how dividends benefit investors in The Power Of Dividend Growth.)Stock Slang Terms
Finally, the financial industry uses many slang terms to describe and categorize stocks. These terms arent always intuitive, but they do have their place in the financial world. Here are some of the many terms used to characterize stocks:
• Blue Chip – These are companies that are cream-of-the-crop, old-school and everlasting. Blue chips tend to be market mammoths, and have proven their ability to survive through both good times and bad. The term comes from poker, where blue chips are the ones with the highest value. These companies are generally expensive to purchase but can be safe bets. General Electric (NYSE:GE), Wal-Mart (NYSE:WMT) and IBM (NYSE:IBM) have all established themselves as blue chips.
• Penny Stock - The term penny stock is used to denote stocks that trade for less than a dollar, but can also refer to stocks that are considered very speculative. These stocks are generally new to the market, with no reputation or history to fall back on. Penny stocks present the possibility of large gains or losses. (For related reading, check out Spot Hotshot Penny Stocks.)
• Bo Derek – This is a term created by traders in the late 70s to describe the perfect stock. Back then, actress Bo Derek was considered the perfect 10. This slang term might be a little dated for a new generation of investors, as Bo Derek was famous in another era.
Conclusion
Now, how do these terms fit with one another you might ask? Well, next time you hear a cyclical income stock referred to as a real Bo Derek, youll know what it means. A stocks categorization can be varied and prone to change in different situations. Stocks that were once speculative may become blue chip, cyclical stocks can become non-cyclical due to some widespread economic changes and seasonal stocks may reduce their exposure to seasonal pressures by exporting goods. Changing times mean that dynamic companies will change their visions and goals. The important thing is to not only remember what category a stock falls under, but also how it compares to other stocks of the same group.
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The Value Line Investment Survey
Have you ever opened the statement that your mutual fund company sent to you, then looked at the returns and thought, I could do better than that?
Its an increasingly common feeling, as the returns generated by many equity mutual funds often leave investors frustrated. If you want to try your hand at picking stocks but dont know where to start, the Value Line Investment Survey can help.
The Survey
The Value Line Investment Survey consists of professional research and recommendations on approximately 1,700 stocks. According to Value Line, this represents … approximately 95% of the trading volume of all stocks traded in U.S. markets … The Survey also provides weekly updates on the financial markets, recommended portfolios, developments involving covered securities and special topical reports. For would-be stock pickers, Value Line provides an easy way to start your research.
How to Get Started
Bearing in mind that conducting your own stock research is a time-consuming task, the first step in getting familiar with the tools Value Line offers is to set aside a few hours of reading time. You will need to study the materials closely in order to understand how to use them before you will be ready to invest any cash.
Prior to delving into the literally thousands of pages of stock research at your fingertips, start by reviewing The Complete Guide to Using The Value Line Investment Survey. In roughly 40 pages, this slim volume explains Value Lines ranking system (stocks are rated from one to five in a variety of categories) provides line-by-line explanations for the information provided in each of the research reports. At the back of the booklet is a detailed glossary of investment terms that includes definitions for terms ranging from bond ratings to unit labor costs.
Next, youll want to read, A Quick Study Guide. This guide explains the information included in the two binders that serve as primary research tools for investors using the hard copy version of Value Line. (An online service is also available.) The first binder contains the Summary and Indexand Ratings and Reports. The second binder contains Selection and Opinion. The Quick Study Guide also explains how to use the research to choose stocks for your portfolio.
Binder 1: Summary and Index
Starting with the first binder, the Summary and Index provides an overview of the stock screens Value Line provides, including lists of stocks with the lowest price-to-earnings ratio, the highest dividend yields, the highest annual total revenues and a host of other choices. These screens help investors identify stocks that align well with theirpersonal investment goals. For example, investors seeking income may look for stocks that offer high dividend payments, while investors seeking growth may seek stocks that have the highest appreciation potential. If this is your first effort at picking stocks, this portion of the Survey could be of particular interest to you. In addition, the Summary and Index catalogs all of the covered stocks and provides the page number where the research reports can be found.
It also provides key statistics for the universe of covered stocks, including price-to-earnings ratio, dividend yields and appreciation potential. These statistics provide information about the universe and the direction it has been moving in, as well as providing a baseline for comparing an individual stock against the universe.
The Ratings and Reports section provides stock research on approximately 1,700 companies. The research includes an analysts report that provides a brief overview of the company, a review of its financial health and a recommendation regarding its attractiveness to investors. The data portion of the report provides a detailed statistical analysis, including a price target, transactions by company officials (buying/selling), transactions by institutions, chart of historical returns, sales figures, earnings data and much more. Perhaps the best thing about the research section, particularly if you are a novice, is its ranking system.
Every stock in the survey is ranked on a scale of one to five in three different areas: timeliness, safety and technical. A rank of one denotes stocks that are expected to outperform the rest of the Value Line universe. Timeliness refers to performance expectations for the next six to twelve months. Safety compares the securitys price stability against its peers, and the Technical ranking compares 10 price trends to provide price return potential for a three to six month period. An alphabetical listing of all covered stocks, including key statistics and the ranking numbers, is particularly convenient for investors seeking a specific rating in one or more categories.
Binder 2: Weekly Selection and Opinion
The second binder contains the Weekly Selection and Opinionsection, which includes an economic outlook, market commentary and research on selected topics. Additionally, it includes evaluations of four model portfolios, one targeting short-term growth, one for long-term growth, one for income and, lastly, one for both growth and income. The evaluations highlight both successful selections and failures, which serves as an important reminder.
While the Value Line Investment Survey is a convenient, easy-to-use tool that is particularly helpful to novice investors, investing is not an endeavor that comes with any guarantees. The information you read in the Survey is well researched and impressively packaged, but there is no guarantee that it is correct. Like any other stock research, the insight provided by Value Line does not mean that you cant lose money on an investment that you make using the research. As with all security purchases, let the buyer beware
Using the Data
Taken as a whole, the Value Line Investment survey provides all the tools an investor needs to develop a picture of the current economic landscape, learn about stock analysis and identify securities that are appropriate for a variety of investment objectives. By matching the results of the research with your personal investment needs, you should be able to put together enough information to choose a stock or build an entire portfolio.
How to Get It
The Value Line Investment Survey is available by subscription. A one-year subscription is just over $500 for the online version and just under $600 for the print version. For an additional fee, the firm also offers research on mutual funds, exchange traded funds, convertible securities and more. You can get them all for just under $1,000.
Interestingly, many large libraries receive the print version of the Value Line Investment Survey and provide it to patrons for free. This provides an opportunity to learn about, use and thoroughly evaluate the materials before plunking down the cash for a personal subscription conveniently delivered to your house.
Next Steps
The Value Line Investment Survey is not the only professional research that you can easily access. In fact, it is just the first in a long list of tools. After you have read, researched and mastered the Value Line tool set, you can expand your repertoire of investment tools by using the research reports provided through websites associated with online brokerage accounts. These sites provide access to research reports similar to those offered by Value Line. It is worth noting that reports from various research providers often contradict each other.
The Bottom Line
While these contradictions may be frustrating, think of research as data gathering. You can take in data from as many sources as possible and use that data to formulate your own opinion. Relying on any single source of data is unlikely to be a wise decision, as there are no guarantees that the researchers behind your data source will always make the right call. Of course, if reading these research reports is too time consuming, too scary or too frustrating, you can always buy a mutual fund or hire a professional financial advisor to provide investment recommendations.
If the order is not marketable, the broker-dealer may create or edit its existing quote on an Inter-dealer Quotation System (e.g. OTC Link) to reflect a new price or size. The quote lets all other broker-dealers know the price which they are willing to buy or sell. Broker-dealers are only required to update their quote if the price of the order is equal or superior to their existing quote.
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Conglomerates: Cash Cows Or Corporate Chaos?
Conglomerates are companies that either partially or fully own a number of other companies. Not long ago, sprawling conglomerates were a prominent feature of the corporate landscape. Vast empires, such as General Electric (NYSE:GE) and Berkshire Hathaway (NYSE:BRK.A), were built up over many years with interests ranging from jet engine technology to jewelry. Corporate hodgepodges like these pride themselves on their ability to avoid bumpy markets. In some cases, they have produced impressive long-term shareholder returns - but this doesnt mean that corporate conglomerates are always a good thing for investors. If youre interested in investing in these behemoths, there are a few things you should know. Here we explain what conglomerates are and give you an overview of the pros and cons of investing in them.
The Case for Conglomerates
The case for conglomerates can be summed up in one word: diversification. According to financial theory, because the business cycle affects industries in different ways, diversification results in a reduction of investment risk. A downturn suffered by one subsidiary, for instance, can be counterbalanced by stability, or even expansion, in another venture. In other words, if Berkshire Hathaways brick-making division has a bad year, the loss might be offset by a good year in its insurance business.
At the same time, a successful conglomerate can show consistent earnings growth by acquiring companies whose shares are more lowly rated than its own. In fact, GE and Berkshire Hathaway have both promised - and delivered - double-digit earnings growth by applying this investment growth strategy.
The Case Against Conglomerates
However, the prominent success of conglomerates such as GE and Berkshire Hathaway is hardly proof that conglomeration is always a good idea. There are plenty of reasons to think twice about investing in these stocks , particularly in 2009, when both GE and Berkshire suffered as a result of the economic downturn, proving that size does not make a company infallible.
Investment guru Peter Lynch uses the phrase diworsification to describe companies that diversify into areas beyond their core competencies. A conglomerate can often be an inefficient, jumbled affair. No matter how good the management team, its energies and resources will be split over numerous businesses, which may or may not be synergistic.
For investors, conglomerates can be awfully hard to understand, and it can be a challenge to pigeonhole these companies into one category or investment theme. This means that even managers often have a hard time explaining their investment philosophy to shareholders. Furthermore, a conglomerates accounting can leave a lot to be desired and can obscure the performance of the conglomerates separate divisions. Investors inability to understand a conglomerates philosophy, direction, goals and performance can eventually lead to share underperformance.
While the counter-cyclical argument holds, there is also the risk that management will keep hold of businesses with poor performance, hoping to ride the cycle. Ultimately, lower-valued businesses prevent the value of higher-valued businesses from being fully realized in the share price . (For further reading, see The Ups And Downs Of Investing In Cyclical Stocks.)
Whats more, conglomerates do not always offer investors an advantage in terms of diversification. If investors want to diversity risk, they can do so by themselves, by investing in a few focused companies rather than putting all of their money into a single conglomerate. Investors can do this far more cheaply and efficiently than even the most acquisitive conglomerate can.
The Conglomerate Discount
The case against conglomerates is a strong one. Consequently, the market usually applies a haircut to the piecewise, or sum-of-parts, value - that is, it frequently values conglomerates at a discount to more focused companies. This is known as the conglomerate discount. According to a 2001 article in CFO Magazine, academic studies have suggested in the past that this discount could be as much as 10-12%, but more recent academic inquiries have concluded that the discount is closer to 5%. Of course, there are some conglomerates that command a premium but, in general, the market ascribes a discount.
The conglomerate discount gives investors a good idea of how the market values the conglomerate as compared to the sum value of its various parts. A deep discount signals that shareholders would benefit if the company were dismantled and its divisions left to run as separate stocks.
Lets take a shot at calculating the conglomerate discount using a simple example. Well use a fictional conglomerate called DiversiCo, which consists of two unrelated businesses: a beverage division and a biotechnology division.
DiversiCo has a stock market valuation of $2 billion and total debt of $0.75 billion. Its beverage division has balance sheet assets of $1 billion, while its biotechnology division has $0.75 billion worth of assets. Focused companies in the beverage industry have median market-to-book values of 2.5, while pure play biotech firms have market-to-book values of 2. DiversiCos divisions are fairly typical companies in their industries. From this information, we can calculate the conglomerate discount:
Example - Calculating the Conglomerate Discount
Total Market Value DiversiCo:
= Equity Debt
= $2 billion $0.75 billion
= $2.75 billion
Estimated Value Sum of the Parts:
= Value of Biotech Division Value of Beverage Division
= ($0.75 billion X 2) ($1 billion X 2.5)
= $1.5 billion $2.5 billion
= $4.0 billion
So, the conglomerate discount amounts to:
= ($4.0 billion - $2.75 billion)/$4.0 billion
= 31.25%
Copyright ??2009 Investopedia.com
DiversiCos conglomerate discount of 31.25% seems unusually deep. Its share price does not reflect the true value of its separate divisions. It becomes clear that this multibusiness company could be worth significantly more if it were broken up into individual businesses. Consequently, investors may push for divesting or spinning off its beverage and biotech divisions to create more value. If that were to happen, Diversico might be worth closer examination as a buying opportunity.
What to Look For
The big question is whether investing in conglomerates makes sense. The conglomerate discount suggests it does not. But there may be a silver lining. If you invest in conglomerates that break up into individual pieces through divestitures and spinoffs, you could capture an increase in value as the conglomerate discount disappears. As a general rule, you stand to get greater returns when conglomerates break up than when they are built.
That said, some conglomerates do command a valuation premium - or at least a slim conglomerate discount. These are extremely well-run companies. They are managed aggressively, with clear targets set for divisions. Underperforming companies are quickly sold, or divested. More importantly, successful conglomerates have financial rather than strategic or operating objectives, adopting strict approaches to portfolio management .
If you choose to invest in conglomerates, look for ones with financial discipline, rigorous analysis and valuation, a refusal to overpay for acquisitions and a willingness to sell off existing businesses. As with any investment decision , think before you buy and dont assume that big companies always come with big returns.
In the OTC market, companies that qualify and are current in their financial disclosure may choose to apply their currently tradeable security(ies) for OTCQX. Companies may also choose to provide adequate disclosure either to regulators or OTC Markets Group in order to be classified in a ‘Current’ OTC Market Tier.
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Banking On Blue Chip Stocks
Blue chip stocks, named after the highest-valued chips in poker, are prized investment holdings representing ownership in some the most successful firms in the economy. If you want to invest in companies that have proven their ability to ride out economic downturns and maintain profitability even when times get tough, you should take a look at these stocks.
Basic Characteristics of Blue Chip Stocks
A blue chip stock is a share of ownership in a large, well-established and stable company that has a long history of consistent earnings growth and dividend payments. Blue chip companies have a large market capitalization, strong balance sheets and good cash flow. Blue chip stocks have low volatility overall, but strong changes in the overall market can also have strong effects on these stocks. The performance of an individual blue chip company will tend to correlate closely with the performance of the S
The OTC Bulletin Board (which is a facility of FINRA), and OTC Link LLC (which is owned by OTC Markets Group, Inc., formerly known as Pink OTC Markets Inc.), for example, operate within the OTC market, particularly with respect to OTC equity securities.
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Valuing Firms Using Present Value Of Free Cash Flows
Decisions to invest can be made based on simple analysis such as finding a company you like with a product you think will be in demand in the future. The decision might not be based on scouring the financial statements, but the underlying reason for picking this type of company over another is still sound. Your underlying prediction is that the company will continue to produce and sell high-demand products and thus will have cash flowing back to the business. The second, and very important, part of the equation is that the companys management knows where to spend this cash to continue operations. A third assumption is that all of these potential future cash flows are worth more today than the stocks current price.
To place numbers into this idea, we could look at these potential cash flows from the operations, and find what they are worth based on their present value. In order to determine the value of a firm, an investor must determine the present value of operating free cash flows. Of course, we need to find the cash flows before we can discount them to the present value.
Calculating Operating Free Cash Flow
Operating free cash flow (OFCF) is the cash generated by operations, which is attributed to all providers of capital in the firms capital structure. This includes debt providers as well as equity. Calculating the OFCF is done by taking earnings before interest and taxes and adjusting for the tax rate, then adding depreciation and taking away capital expenditure, minus change in working capital and minus changes in other assets. Here is the actual formula:
OFCF = EBIT(1-T) depreciation - CAPEX - ??working capital - ??any other assets
Where:
EBIT = earnings before interest and taxes
T= tax rate
CAPEX = capital expenditure
This is also referred to as the free cash flow to the firm, and is calculated in such as way to reflect the overall cash-generating capabilities of the firm before deducting debt related interest expenses and non-cash items. Once we have calculated this number, we can calculate the other metrics needed such as the growth rate. (These five qualitative measures allow investors to draw conclusions about a corporation that are not apparent on the balance sheet. check out Using Porters 5 Forces To Analyze Stocks.)
Calculating the Growth Rate
The growth rate can be difficult to predict and can have a drastic effect on the resulting value of the firm. One way to calculate it is to take the return on the invested capital (ROIC) multiplied by the retention rate. The retention is the percent of earnings that are held within the company and are not paid out as dividends. This is the basic formula:
g = RR x ROIC
Where:
RR= average retention rate, or (1- payout ratio)
ROIC= EBIT(1-tax)/total capital
Present Value of Operating Free Cash Flows
The valuation method is based on the operating cash flows coming in after deducting the capital expenditures, which are the costs of maintaining the asset base. This cash flow is taken before the interest payments to debt holders in order to value the total firm. Only factoring in equity, for example, would provide the growing value to equity holders. Discounting any stream of cash flows requires a discount rate, and in this case it is the cost of financing projects at the firm. The weighted average cost of capital (WACC) is used for this discount rate. The operating free cash flow is then discounted at this cost of capital rate using three potential growth scenarios; no growth, constant growth and changing growth rate.
No Growth
To find the value of the firm, discount the OFCF by the WACC. This discounts the cash flows that are expected to continue for as long as a reasonable forecasting model exists.
Firm Value = ? Operating Free Cash Flowst
(1 WACC)t
Where:
Operating Free Cash Flows = the operating free cash flows in period t
WACC = weighted average cost of capital
If you are looking to find an estimate for the value of the firms equity, subtract the market value of the firms debt.
Constant Growth
In a more mature company you might find it more appropriate to include a constant growth rate in the calculation. To calculate the value, take the OFCF of next period and discount it at WACC minus the long-term constant growth rate of the OFCF.
Value of the firm = ?OFCF1
k-g
Where:
OFCF1 = operating free cash flow
k = discount rate (in this case WACC)
g = expected growth rate in OFCF
Multiple Growth Periods
Assuming the firm is about to see more than one growth stage, the calculation is a combination of each of these stages. Using the supernormal dividend growth model for the calculation, the analyst needs to predict the higher-than-normal growth and the expected duration of such activity. After this high growth, the firm might be expected to go back into a normal steady growth into perpetuity. To see the resulting calculations, assume a firm has operating free cash flows of $200 million, which is expected to grow at 12% for four years. After four years, it will return to a normal growth rate of 5%. We will assume that the weighted average cost of capital is 10%. (Learn about the components of the statement of financial position and how they relate to each other. See Reading The Balance Sheet.)
Multi-Growth Periods of Operating Free Cash Flow (in Millions)
Period OFCF Calculation Amount Present Value
1 OFCF1 $200 x 1.121 $224.00 $203.64
2 OFCF 2 $200 x 1.122 $250.88 $207.34
3 OFCF 3 $200 x 1.123 $280.99 $211.11
4 OFCF 4 $200 x 1.124 $314.70 $214.95
5 OFCF 5 … $314.7 x 1.05 $330.44
$330.44 / (0.10 - 0.05) $6,608.78
$6,608.78 / 1.104 $4,513.89
NPV $5,350.92
Table 1: The two stages of the OFCF goes from a high growth rate (12%) for four years followed by a perpetual constant 5% growth from the fifth year on. It is discounted back to the present value and summed up to $5.35 billion dollars.
Both the two-stage dividend discount model (DDM) and FCFE model allow for two distinct phases of growth: an initial finite period where the growth is abnormal, followed by a stable growth period that is expected to last forever. In order to determine the long-term sustainable growth rate, one would usually assume that the rate of growth will equal the long-term forecasted GDP growth. In each case the cash flow is discounted to the present dollar amount and added together to get a net present value.
Comparing this to the companys current stock price can be a valid way of determining the companys intrinsic value. Recall that we need to subtract the total current value of the firms debt to get the value of the equity. Then, divide the equity value by common shares outstanding to get the value of equity per share. This value can then be compared to how much the stock is selling for in the market to see if it is over- or undervalued.
The Bottom Line
Calculations dealing with the value of a firm will always use unique methods based on the firm being examined. Growth companies might need a two-period method when there is higher growth for a couple years. In a larger, more mature company you can use a more stable growth technique. It always comes down to determining the value of the free cash flows and discounting them to today. (Calculate whether the market is paying too much for a particular stock.
Limit Orders allow investors to specify the exact price they are willing to accept for a buy or sell order. While Limit Orders are designed to offer more price protection for investors, a Limit Order may not be executed if the price of the security does not reach the price stated in the Limit Order.
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3 Questions To Find Your Trading Plan
You have put in the work creating a trading plan or possibly spent money on supposedly great strategies, but you still cannot seem to turn a trading profit. Or maybe you are starting out in trading and investing and want to be cautious before you start putting real money on the line. No matter what level you are at, before you trade - or if are already trading and struggling - you should have a trading plan. That plan needs to be tailored to you and your needs; a plan that is not will likely result in a drain on your trading account.
The following three questions can save you a lot of grief. Run through these questions during your planning stages to make sure your plan will serve you well. If it cannot pass this three question test, it should not be used.
SEE: Day Trading Strategies For Beginners
Why Ask These Questions?
Executing a plan is not just about the design itself, it is about the person executing that plan. Someone can search their whole life for a great trading system, not realizing it is themselves that need work, not the system. Therefore, these questions take the plan and the trader into account, making sure the two fit together. No matter how good a trading plan, it is useless if the trader cannot personally stick to it or implement it properly.
These three questions will help to clarify the traders objectives for the trading plan, take inventory of the consequences which may arise by executing the plan, and determine if they will be able to even stick with their plan, given their personality.
1. Does the Plan Allow Me to Achieve the Outcome I Want?
Sounds simple enough, but not so fast.
An outcome needs to be specific and measurable. Stipulating I want to be rich is not concise enough. What is the ultimate goal that you want your trading plan to bring you? Is the outcome feasible and reasonable? Can the plan you currently have actually produce that, or given the realities of the plan is it likely to fall short of the outcome you desire?
The plan and outcome must also balance short-term and long-term goals. While the long-term goal may be to be financially independent, continually trying to make as much money as possible in the short-term with high risk trades could jeopardize the long-term goal. Short-term goals must work in harmony with the long-term goals, not against them. Brainstorm what you want your trading plan to produce and make sure that the plan works to satisfy both the short and long-term desired outcomes.
2. What Are the Consequences and Risks of My Plan, and Can I Deal with Them?
In this step we strip away the fantasy and focus on reality. The fact is most traders lose money - even very smart ones - so how is your plan different? All plans have risk; what is the downside of the strategies you have employed? Go through the plan and write down all of the risks and pitfalls you see.
Now, also consider consequences outside of trading. Will realizing your plan mean you spend less time with family or friends? Will it mean cutting back on certain expenses? Will it create more stress (less stress) or cut into other work time?
Once all the potential risk and pitfalls of your strategy have been fully and honestly addressed, can you realistically handle all the potential consequences of trading this plan? If so, proceed. If not, rework the plan making sure the consequences of your plan are within your personal tolerance.
3. Does the Plan Account for Me Being Me?
This is the most important question, as ultimately you must be able to implement the plan. A plan means nothing if you cannot execute it.
If you cannot sit in front of a screen for more than 30 minutes, no matter how good your plan is you will likely not be a good day trader. Or, if you cannot sleep at night with an open position, your swing trading plan will likely do you no good. You will continually struggle to adhere to it.
We each have different traits and tendencies. If you have a gambling streak, account for this in your plan - maybe have a demo account off to the side (or have a play money poker game open) so you can satisfy your gambling craving without losing real money. Plan and account for everything.
Be brutally honest, and make sure your trading plan accounts for the market and yourself. Accept yourself for your tendencies, and make sure that the plan can actually be employed by you based on who you are. Do not sugar coat anything, as doing so could result in problems down the road.
If the plan is easy to implement for you and fits with who you are, use the plan. If you do not think you will be able to stick to it, come up with a plan you can follow.
The Bottom Line
A trading plan is only as good as the trader who implements it. The plan and trader must mesh, or the trader will be unable to implement the plan and it will be useless. To make sure the trading plan fits, the trader must pass the plan through three questions: Does the plan achieve the outcome I want? Can I handle the consequences of the plan? Does the plan account for me being me? If the plan can pass through all of these questions, the trader has a much better chance of being able to actually follow through with their investment strategy and is more likely to experience success in the markets
Once a broker-dealer receives an order, they often go through the following steps/decisions as part of the trading process.
Ostrich Approach To Investing A Bird-Brained Idea
Of the different investment strategies and behaviors that an investor or fund manager can adopt, some notable ones include active investing , passive investing and the ostrich effect.
• Active investing involves the constant buying and selling of securities in order to profit from short-term changes in the stock market. This strategy is often very beneficial when the market is doing particularly well.
• Passive investing is just the opposite of active investing: it employs a buy-and-hold strategy to profit from long-term trends in the stock market and is used by investors who want to avoid risks.
• Both active and passive investors may exhibit the ostrich effect, or a tendency to ignore bad news in the market.
While there are similarities between passive investing and the ostrich effect, such as the risk-averse nature of the investors who practice them, there are also major differences. These differences, and the dangers of ignoring market news, will be explored here.
What Is Passive Investing?
Passive investing is a long-term strategy that involves restricted buying and selling of securities. A passive investor buys securities in order to hold them for a long period of time, because he or she believes that stocks will go up in the long run.
An investor who invests passively does not seek to beat the market; he or she just wants to match the markets returns. In order to accomplish this, passive investors often invest in index funds and exchange-traded funds (ETF) that mirror market indexes. This is why passive investing is sometimes referred to as index investing. (Get to know the most important market indexes and the pros and cons of investing in them in Index Investing.)
Advantages of Passive Investing
Some advantages of passive investing include the following:
• Lower costs and higher profits: Investing in index funds usually incurs lower management fees, because a passively traded portfolio requires fewer resources and less time to manage than an actively traded portfolio. If an actively traded portfolio yields the same returns as a passively traded portfolio, the passive investor is going to receive a higher return, because when investors sell a security, the amount of profit they receive is equal to the sell price less the buy price, minus management fees and trading commissions. (Learn how you can save on fees and commissions in Settling Wrap Fees.)
• Automatic gains from market upswings: Since passive portfolios are constructed to closely follow the performance of market benchmarks like the S
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If the broker-dealer cannot, or chooses not to, execute the trade internally, they must attempt to execute the trade with another broker-dealer. This often means accessing the security on OTC Markets Group’s OTC Dealer application and ascertaining whether the order is marketable. Marketable orders are orders where the price specified can immediately be executed in the market. Market Orders are, by definition, marketable. Limit Orders are marketable if the limit price is better than or equal to the bid price (for sell orders) or ask 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.)
TUTORIAL: Investing 101 For Beginner Investors
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.
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Short selling is a trading strategy where an investor, believing that a security is over-valued, borrows (from a broker-dealer or institutional investor) and sells a security and then repurchases and returns (to the broker-dealer or institutional investor) the security at a lower price. The difference between the sale price and the purchase price is the investor’s profit.
How To Efficiently Read An Annual Report
A companys annual report is the single most important way for it to convey itself to potential investors. As such, it should come as no surprise that an annual report serves to present the company in best light possible without violating any Securities and Exchange Commission (SEC) regulations. Unfortunately, many investors read annual reports but fail to read them effectively. In other words, while annual reports are clearly prepared without any intent to deceive or reflect dishonesty about the business, investors should always read them with a sense of skepticism. In other words, learn how to read between the lines and decipher the actual condition of the company. Annual Report Vs. 10-K Filing
Typically, a company will file both an annual report and 10-K report to the SEC. An annual report is the shorter version that often comes with pictures, nice glossy color pages, a letter from the Chairman/CEO and an overview of the financials.
The 10-K is the black and white, no color pictures document that is submitted to the SEC. Very often, a business will simply file the 10-K as its annual report since that document is mandatory for every public company. So guess which one carries more significance to the investor - the longer and more boring 10-K filing. Think of the glossy annual report as informative marketing material. If a company does file both reports, use the annual report as a great first look at a business before tackling the 10-K filing. Very often, the annual report and 10-K are merged into one document, with the annual report at the beginning to provide an overview of the years results.
The Components of an Annual Filing
If you are interested in investing in a public company you can not avoid examining and reading the 10-K filing, which I will now refer to as the annual report.
The 10-Ks begin with a detailed description of the business, followed by risk factors, a rundown of any legal issues, and, finally, the numbers and financial notes in the back. Oftentimes, the most essential components of the annual filing are the following items:
• Item 1: Business - a description of the companys operation
• Item 1A: Risk Factors
• Item 3: Legal Proceedings
• Item 6: Selected Financial Data
• Item 7: Managements Discussion and Analysis of Financial Condition
How to Tackle
People read annual reports in different ways. Some investors even prefer to start at the back and work their way to the beginning. It makes no difference how you read them, as long you absorb the essential points of the business and its financial condition. However, there is a good way to tackle these reports that is both most efficient and most effective.
Without question, you should first read Item 1, which is the business description. You cant possibly go any further in your research without knowing what the company does! Also, by getting to know the business first, you can then determine if you need to go any further. That determination is simple. Just ask yourself if you understand what the company does, who its customers are, and the industry it operates in. If you answer no, youre done. Move on to the next business.
Next, you should jump to Items 6 and 7 and examine and analyze the financial data . How has the company performed over a period of years? Has the balance sheet gotten stronger or weaker over time? Look over the cash flow statement and see if the business has been a generator of cash or a user of cash. Its possible for businesses to report net income while at the same time remaining cash flow negative. Compare the income statement with the cash flow statement for any red flags. If you like what you see, move on and if not, move on to the next company.
Afterwards its time to determine if any hidden surprises may lurk beneath the surface. So you must now go back and read the risk factors section and the legal proceedings section, if any legal matters exist. Because this is a filing to the SEC, the risk factors will be very detailed and include risks like our industry is highly fragmented with lots of competitors or our stock price may experience periods of volatility. While these are important risks to consider, they should not significantly reduce the desirability of the business.
Instead, focus on any unusual risk factors, such as if the company generates a substantial portion of its revenues for one or two customers. In addition, the Legal Proceedings section will alert you if any significant lawsuits are in the works. Again, dont ignore any legal liabilities, but if youre looking at a billion dollar company and it has a pending lawsuit against it for damages of $10 million, thats not uncommon. Pfizer, one of the largest drug companies in the world, will also have patent lawsuits and drug liability claims that may exceed hundreds of millions of dollars. But thats part of the normal course of business for any major pharmaceutical company, and a drop in the bucket for Pfizer when you see that the company has over $50 billion in cash and short-term investments on the balance sheet.
Focus on What You Know
We all have different ways of deciphering and storing information. Feel free to read the annual report in a way that works for you. But learn to concentrate on the most important aspects of a companys 10-K filing. By doing so, you will avoid wasting unnecessary time on companies that do not meet your investment suitability. But always remember that just because you arent investing in that particular business that you have wasted your time. Investing is a discipline that rewards those who are continuously learning.
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This question must be answered by your broker-dealer. Broker-dealers hold customer orders in their proprietary order books and only they can tell you why your order has not been filled. Possible explanations include: the order may not yet be marketable (at or within the bid/ask spread) or if it is/was marketable, other customer orders at the same price may have been in the order book longer and received execution priority.
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The 3 Moral Types Managing Your Money
In the late 1970s, business academic Archie Carroll published some now classic work on corporate ethics and social responsibility. His work includes the well-known CSR Pyramid (Corporate Social Responsibility), which deals with stakeholders, economic responsibilities, philanthropy and many other related issues.
Of particular relevance to private investors, however, are the three moral types commonly encountered in the industry. Your financial fate is influenced very substantially by whether your broker and/or his/her firm is immoral, amoral or moral. Each type is clearly differentiated from one another and you only want to give your money to the moral ones; the immoral and the amoral are to be avoided like the plague. We will now take a look at the differences between the three methods and what this could mean for your savings.
The Immoral, the Amoral and the Moral
Immoral brokers , fund managers and firms do not care about you at all. They want to make money out of you and not for you. They are motivated only by self-interest and regard clients as factors of production to be exploited, manipulated and bled. There can be no doubt that even though such people are only fit to be shunned, they abound in the industry, which has led to many mis-selling and mismanagement scandals, not to mention major crises in recent and less recent years. Some are in jail, and many others should be.
Amoral sellers are arguably not as bad, but they are bad enough. While not blatantly dishonest, they look after themselves and just do not bother about ethics. They keep to the letter of the law, but the spirit of the law is ignored. Therefore, they fulfill their regulatory obligations, but they do not look after your interests. They are unlikely to fleece you outright, but they can lose you a lot of money through indifferent management and bad advice.
Moral people are the only ones who deserve your money. They will treat your fairly, do their best for you and sell you only what they truly believe is what you want and what is suitable for you. Fortunately, there are such people out there, but the two groups of baddies and mega-baddies are there as well, and they all want your money. Only the moral ones have a conscience, and can be trusted and relied upon.
Why Is it Like This?
Human nature has produced all three types of morality for at least 2000 years, particularly in the context of money and wealth, and that is not going to change. All professions have their black sheep, but because the financial services industry deals only with money, it has more of these than elsewhere. Furthermore, due to the nature of the industry, there is a lot of money to be made from selling excessively risky and other forms of lousy products to the unwary; and the unwary have been around since the year dot.
This precarious scenario is exacerbated by the complexity of the industry; there are a plethora of local and international products. Furthermore, it is horrendously easy to present products so that they sound far better than they really are. People are also genuinely tempted by greed and offers that are too good to be true. This is an environment in which amorality and immorality thrive.
In fact, in this day and age, dishonest people with some financial or selling skills can make a fortune with minimal risk. Why pick locks, blow up safes or ride your horse into town with guns blazing, when you can put on a snazzy suit and pretend to be a gentleman, selling the investment of a lifetime?
SEE: 8 Ethics Guidelines For Brokers
How Do You Find the Moral Ones?
As is always the case, you need to be as educated as you can on investment issues, shop around and double check. I would also emphasize that there are other ways to spot what type of seller you are dealing with.
My experience is that you can tell a lot by observing how the brokers you deal with personally handle you and your money. If they seem to really want you to understand what you are getting, that is good. If they offer you a wide range of products and do not push just one or two, that is better. If the range includes various alternative risk-return combinations, some of which really do not earn so much for the seller, such as trackers, and funds with low or no up-front fees, then you could be dealing with a moral person.
Body language is also important. Keep an eye open for some telltale and quite reliable signs of lying. These include blinking, speech errors and hesitation, self-touching and doing weird things with ones hands. Jittery feet are supposed to be a reliable sign that you are dealing with the wrong moral type. Given the importance of body language, it is often safer to ensure that you deal with sellers personally, rather than just by email or on the phone.
In general, be perceptive and have a healthy level of cynicism. In this industry, cynicism is a good investment.
SEE: Choosing A Compatible Broker
The Bottom Line
What we have here are the good, the bad and the ugly aspects of the investment industry. These types are here to stay, but you can avoid the immoral and the amoral by being careful and watching for warning signs. Watch out for pushy selling, products or policies that you do not understand, and for patterns of behavior that just dont seem right. Make sure your money stays your own and grows over time. It can also help to understand some of the ethical issues your broker faces.
The broker relies on this information to determine which investments to recommend to you. If a broker tries to sell you an investment before asking you these questions, that's a very bad sign. It signals that the broker has a greater interest in earning a commission than determining whether the investment is consistent with your investment goals and tolerance for risk.
NITE-LYNX $DTVI BarChart Technical Analysis
http://www.barchart.com/technicals/stocks/DTVI
Profiting In A Post-Recession Economy
People will always question what the future economy will look like after it suffers a recession. Though there are different implications with each recession - owing to its causes and the governmental and financial changes that are brought about - the economy will definitely shift and there will emerge new economic practices and trends for industries, consumers and investors.
Following the depths of the 2007-2009 recession theres a new world characterized by:
• Non-existent consumer discretionary spending
• Tighter credit and borrowing standards
• Reduced home ownership
• Increased consumer savings
The above effects will serve to:
• Hold down corporate profit growth
• Restrict employment growth
• Likely reduce future expected market returns
Despite the above, investors have options and opportunities as long as they keep their expectations in line with the expected future outcome. Some wonderful investment opportunities exist for investors in all stages of life.
Industries to Look For
When it comes to investing in the economy defined by the characteristics above, one question should dominate your investment consideration: Does this company make an essential or non-essential product?
When times are tough, people respond with their wallets. Unless folks are given great incentives, they wont buy unless they have to. In that kind of environment, I would favor food companies to retailers, healthcare providers to homebuilders, and defense contractors to automakers. Things like food, medicine and national security are musts in this world. An extra purse or a new car or bigger homes are not. And heres the best part: most of the companies that provide these necessary goods will continue to be around for a long time. (These type of companies are normally grouped in a sector called consumer staples – to learn more see A Guide To Consumer Staples.)
When economies are sour, the stock market tends to punish all companies regardless of what line of business they are in. In other words, a business like a Kraft or Johnson and Johnson that sell essential food and health products all over the world may likely see its shares suffer along with other discretionary businesses like retailers. And you can be comforted by the fact that even in tough times, people still need to buy food and Tylenol. Looking for these types of companies will likely earn you market-beating returns during the several years following a recession, despite an overall sluggish economy.
Despite the temptation, avoid retailers and other companies that make non-discretionary consumer goods. Such companies will likely experience reduced profit margins as they are forced to mark down their products to entice consumers.
Importance of Commodities
Commodities are the most fundamental of human essentials. Things like wheat, corn, oil, zinc, copper and coal. While you might not physically buy some of these commodities, you cant go through a normal day without them. Every time you turn on a light switch or power up your stove, the electricity used is provided by coal or natural gas. Grains are the basic building blocks for all the foods we eat. Oil, besides being refined into gasoline, goes in things like plastic, carpets, soaps and detergents.
Besides being essentials, commodities also have inflationary pricing power. If the government prints massive amounts of money to combat the recession, inflation will likely happen. It might not happen immediately afterwards, but it will rear its ugly head. Commodities, for those reasons are a good place to be.
Fertilizer companies are also great considerations. Fertilizer is the necessary ingredient to boost crop yield - that is, producing more food from the same amount of land. As the global population grows, so will the need to maximize food production. When looking at commodity plays, focus on the larger businesses with the quality assets such as the large integrated oil companies. We will always need oil and the biggest companies have the deepest pocket book to continue providing us with the black gold during various pricing environments. Otherwise look for those companies that are the low cost producers.
International Investment Exposure
To illustrate why investors should also consider diversifying internationally we can take a look at the 2007-2009 recession. Although this was a global economic recession, it didnt affect every country equally. According to J.D. Power Asia-Pacific, as of 2009, it was estimated that there were 820 cars for every 1,000 people in the US. In China, the figure was 34 cars per 1,000. Numbers like this illustrate the potential in countries like China, Brazil and India.
Major international commodity companies are now almost certain to have exposure to the growth in China. Such businesses enable investors to get the exposure without having to invest directly in China. The growth engines for companies like Johnson and Johnson is the fact that billions of people outside the U.S. will need its products.
Conclusion
As long as investors are aware of the likely economic shifts that lie before them in a post-recession environment, the opportunity to make excellent investments is there.
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How To Outperform The Market
All investors must reevaluate and refine their investing styles and strategies from time to time. As we gain investing experience and knowledge, our view of the market is likely to change and most likely broaden how we envision the extent of our investing capacity. Those who want to try to outperform the market - that is, realize returns greater than the market average - might consider an active trading strategy, even if only for a portion of their portfolio. Here we explain what active trading is, how active traders view the market, their tools and investment vehicles and finally, the risks associated with their style.
What Is Active Trading?
The best way to understand active trading is to differentiate it from buy-and-hold investing, which is based on the belief that a good investment will be profitable in the long term. This means ignoring day-to-day market fluctuations. Using a buy and hold strategy, this kind of investor is indifferent to the short-term for two reasons: first, because he or she believes any momentary effects of short-term movements really are minor compared to the long-term average, and second, because short-term movements are nearly impossible to exactly predict.
An active trader, on the other hand, isnt keen on exposing his or her investments to the effect of short-term losses or missing the opportunity of short-term gains. Its not surprising then, that active traders see an average long-term return not as an insurmountable standard but as a run-of-the-mill expectation. To exceed the standard, or outperform the market, the trader realizes that he or she must look for the profit potential in the markets temporary trends, which means trying to perceive a trend as it begins and predict where it will go in the near future.
Below is a chart that demonstrates the difference between the long and short-term movements of the market. Note that even though the security moves upward over time, it experiences many smaller trends in both directions along the way.
Performance and the Short Term
Traders are active because for them the importance of the markets short-term activity is magnified - these market movements offer opportunity for accelerated capital gains. A traders style determines the time frame within which he or she looks for trends. Some look for trends within a span of a few months, some within a few weeks, and some within a few hours. Because a shorter period will see more definitive market movements, a trader analyzing a shorter time frame will be more active, executing more trades.
A greater number of trades doesnt necessarily equal greater profits. Outperforming the market doesnt mean maximizing your activity, but maximizing your opportunities with a strategy. An active trader will strive to buy and sell (or vice versa in the case of shorting) at the two extremes of a trend within a given time frame. When buying a stock, a trader may try to buy it at the lowest point possible (or an upwards turning point, otherwise known as a bottom) and then sell it when there are signs that it has hit a high point. These signs are generally discerned by means of technical analysis tools, which we discuss below. The more the trader strives to buy and sell at the extremes, the more aggressive - and risky - is his or her strategy.
Maximizing returns or outperforming the market isnt just about reaping profits, its also about avoiding losses. In other words, the trader will keep an eye out for any signs that the security is about to take a surprising turn in an undesirable direction. When these signs occur, the trader knows that it is time to exit the investment and seek profits elsewhere. A long-term trader, on the other hand, stays invested in the security if he or she has confidence in its value, even though it may be experiencing a downward shift - the buy and hold investor must tolerate some losses that the trader believes are possible to avoid.
Technical Analysis
You need particular analytical techniques and tools to discern when a trend starts and when it will come to an end. Technical analysis specializes in interpreting price trends, identifying the best time to buy and sell a security with the use of charts. Unlike fundamental analysis, technical analysis sees price as an all-important factor that tells the direction a security will take in the short term. Here are three principles of technical analysis:
• For the most part, the current price of a stock already reflects the forces influencing it - such as political, economic and social changes - as well as peoples perception of these events.
• Prices tend to move in trends.
• History repeats itself.
From these three principles emerges a complicated discipline that designs special indicators to help the trader determine what will happen in the future. Indicators are ways in which price data is processed (usually by means of a calculation) in order to clarify price patterns, which become apparent when the results of the indicators calculation are plotted on a chart. Displayed together with plotted historical prices, these indicators can help the trader discern trend lines and analyze them, reading signals emitted by the indicator in order to choose entry into or exit from the trade. Some examples of the many different types of indicators are moving averages, relative strength and oscillators.
Fundamental analysis can be used to trade, but most traders are well trained and experienced in the techniques of charting and technical analysis. It is a blend of science and art that requires patience and dedication. Because timing is of the utmost importance in active trading, efficiency in technical analysis is a great determiner of success.
Leverage
The short term approach of investing offers opportunities to realize capital gains not only by means of trend analysis, but also through short-term investing devices that amplify potential gains given the amount invested. One of these techniques is leveraging, which is often implemented by something called margin.
Margin is simply the use of borrowed money to make a trade. Say you had $5,000 to invest: you could, instead of simply investing this amount, open a margin account and receive an additional, say, $5,000 to invest. This would give you a total of $10,000 with which to make a trade. So, if you invested in a stock that returned 25%, your $10,000 investment turns into $12,500. Now, when you pay back the original $5,000, youd be left with $7,500 (well assume interest charges are zero), giving you a $2,500 profit or a return of 50%. Had you invested only $5,000, your profit wouldve been only $1,250. In other words, margin doubled your return.
However, as the upside potential is exacerbated, so is the downside risk. If the above investment instead experienced a 25% decline, you would have suffered a loss of 50%, and if the investment experienced a 50% decline, you wouldve lost 100%. You may have already guessed that, with leverage, a trader can lose more than his or her initial investment! As such it is a trading tool that should be used only by experienced traders who are skilled at the art of timing entry into and exit from investments. Also, since margin is borrowed money, the less time you take to pay it back, the less interest you pay on it. If you take a long time to try to reap profits from a trade, the cost of margin can eat into your overall return.
The Risks
Active trading offers the enticing potential of above-average returns, but like almost anything else thats enticing, it cannot be achieved successfully without costs and risks.
The shorter time frame to which traders devote themselves offers a vast potential but, because the market can move fast, the trader must know how to read it and then react. Without skill in discerning signals and timing entries and exits, the trader may not only miss opportunities but also suffer the blow of rapid losses - especially if, as we explained above, the trader is riding on high leverage. Thus, learning to trade is both time consuming and expensive. Any person thinking of becoming an active trader should take this into account.
Also the higher frequency of transactions of active trading doesnt come for free: brokerage commissions are placed on every trade and, since these commissions are an expense, they eat into the traders return. Because every trade costs money, a trader must be confident in his or her decision: to achieve profits, the return of a trade must be well above the commission. If a trader is not sure of what he or she is doing and ends up trading more frequently because of blunders, the brokerage costs will add up on top of any losses.
Finally, because securities are being entered and exited so often, the active trader will have to pay taxes on any capital gains realized every year. This could differ from a more passive investor who holds investments for numerous years and does not pay capital gains tax on a yearly basis. Capital gains tax expense must also be factored in when an active trader is calculating overall return.
Conclusion
As you gain more education and experience as an investor, you may become curious about the different ways to reach returns. It is important to be willing to learn about different strategies and approaches, but it is equally important to know what suits your personality, skills and risk tolerance. You may have guessed that active trading is best suited to those who are committed to taking control over their portfolio and pursuing their goals quickly and aggressively. All of this requires a willingness to not only take risks, but also keep up skills and efficiency. If this sounds like you, it may be time to start learning more!
Behold the $XSNX BarChart Technical Analysis NITE-LYNX
http://www.barchart.com/technicals/stocks/XSNX
Liquidity follows transparency. Companies that provide current disclosure either through a regulator or directly to OTC Markets Group experience significantly greater levels of liquidity, improved price discovery, and more efficient trading.
NITE-LYNX $AMBS BarChart Technical Analysis
http://www.barchart.com/technicals/stocks/AMBS
Rational Ignorance And Your Money
Ignorance is regarded as rational when the cost of information and finding out exceeds the benefits. This is especially true in situations where it would be a waste of time to learn about the particular issue. A classic example of this would be in general elections, where one vote really does not count much. Clearly, however, if everyone thinks this way, there is a problem, but the fact remains that rather than poring over election promises and campaigns for hours, you would do better to invest the time learning more about and managing your portfolio of assets.
The Two Faces of Investor Ignorance
In the world of money, with its countless traps, endless alternatives, conflicts of interest and shady dealers, ignorance is probably less rational than in any other context. However, investors have to contend with two associated problems, which I would term inevitable ignorance and induced ignorance.
Inevitable Ignorance
Inevitable ignorance arises because it is just not possible to know everything about your investments. Clearly, the amount known varies very substantially between investors, due to huge disparities in experience, education, the amount of time people are able and willing to devote to their money, and so on.
However, everyone is ignorant about some aspects of their own investments and of the industry. For instance, nobody knows all there is to know about every company on the New York Stock Exchange, let alone those in France, China, Brazil and the rest of the world, developed, developing and in between. Not to mention, who could possibly know about the management and future prospects of all those thousands of funds out there, ranging from equities, to bonds, to futures and options, to alternative investments and CDs? (Consider yourself a beginner? Need to brush up on the basics? Start with Why You Should Understand The Stock Market.)
Induced Ignorance
Sadly, the wheeler and dealers of the industry are fully aware of this and therefore create ignorance quite deliberately in order to sell things that people would not buy if they were fully informed. It is well documented in the marketing literature that people take advantage of rational ignorance by increasing the complexity of a decision.
The rogues in the investment industry exploit both rational and irrational ignorance by ensuring that products are either so numerous and/or available in so many combinations and permutations that buyers are overwhelmed and find it too much trouble to make an informed decision; they just take their chances and, at worst, way too much risk.
To be fair, some of this complexity is inherent to the products and markets themselves; there are a lot of people selling a lot of things that are not particularly easy to understand. People often dont like having to think and worry about money, so they leave it to others who do not always behave ethically, and who themselves may be ignorant. In the case below, we have a combination of the above factors leading to continued ignorance. (For an additional on dishonesty in the market, check out The Rise Of The Rogue Trader.)
An Information Brochure for Certificates
Precisely because of widespread financial ignorance, advisors and brokers in Germany are obliged to provide a certain type of brochure with certificates and other investments. These are along the lines of what you get with medicine, and the documents are termed just that, Beipakzettel (package brochure). Similar to what you get with pills, information is to be provided on the risks and opportunities, as well as cost and taxation implications.
A study performed in Sept. 2011, however, revealed that this measure does not help much. For starters, there are no guidelines as to who is to provide the brochures, so it usually ends up being the seller.
For the study, a tabloid newspaper article, which is generally considered very understandable, was compared to the financial product brochures for bonus or caped-bonus certificates; they were found to be barely comprehensible. The long, unfamiliar words, complex sentences and clumsy grammar left readers totally perplexed. The literature for the major banks tested varied, but overall the results were extremely poor.
Part of the problem, explained one consultant, was that the providers found themselves in a quandary. On the one hand, they had to provide sufficient information in three pages to convey the relevant issues. On the other hand, they wanted to ensure they were covered legally. This resulted in legalese formulations designed to be legally watertight, but which severely reduced the readability and comprehensibility.
The moral of the story is that even well-intentioned efforts to reduce rational investment ignorance,¬ by making it easy and rational to be informed, can easily fail. So what does this say about bad-faith attempts to sell lousy investments through a smoke screen?
The Bottom Line
In this context, the regulators really do have an important role to play, but it needs to be done better than in the above case. Banks have to resolve the legally watertight vs. readability trade-off. Somehow, they need to get the message across clearly, but without opening themselves up to legal problems.
As always, investors must find out as much as they can, including who to trust, but they also need to understand and accept the limits of what they and others can and do know, and act accordingly. It is certainly advisable to buy only what you understand or trust, but as implied above, eliminating everything you dont understand fully, may mean burying your cash in the garden, which is not a great investment either.
FINRA applies short sale delivery requirements to those equity securities not otherwise covered by the delivery requirements of SEC Regulation SHO. Reg. SHO applies to all securities of all reporting issuers whether listed for trading on an exchange or quoted in the OTC market. New Rule 4320 expanded Reg.
For thou convenience $ADFS BarChart Technical Analysis NITE-LYNX
http://www.barchart.com/technicals/stocks/ADFS
The Basics Of Outstanding Shares And The Float
Financial lingo is very important for anybody interested or invested in products like stocks, bonds or mutual funds. Many of the financial ratios used in fundamental analysis include things like outstanding shares and the float. Lets go through these terms so that next time you come across them, you can know their significance.
Restricted and Float
When you look a little closer at the quotes for a company , you may see some obscure terms that youve never encountered before. For instance, restricted shares refer to a companys issued stock that cannot be bought or sold without special permission by the SEC. Often, this type of stock is given to insiders as part of their salaries or as additional benefits. Another term that you may encounter is float. This refers to a companys shares that are freely bought and sold without restrictions in the public. Denoting the greatest proportion of stocks trading on the exchanges, the float consists of regular shares that many of us will hear or read about in the news.
Authorized Shares
Authorized shares refer to the largest number of shares that a single corporation can issue. The number of authorized shares per company is assessed at the companys creation and can only be increased and decreased through a vote by the shareholders. If at the time of incorporation the documents state that 100 shares are authorized, then only 100 shares can be issued.
Now just because a company can issue a certain number of shares doesnt mean that it is going to issue all of these shares to the public. Typically, companies will, for many reasons, keep a portion of the shares in their own treasury. For example, CTC may decide to maintain a controlling interest within the treasury just to ward off any hostile takeover bids. On the other hand, the company may have shares handy just in case it wants to sell them for excess cash (rather than borrowing). This tendency of a company to reserve some of its authorized shares leads us to the next important and related term: outstanding shares.
Outstanding Shares
Not to be confused with authorized shares, outstanding shares refer to the number of stocks that a company actually has issued. This number represents all the shares that can be bought and sold by the public as well as all the restricted shares that require special permission before being transacted. As we already explained, shares that can be freely bought and sold by public investors are called the float, and this value changes depending on if the company wishes to repurchase shares from the market or sell out more of its authorized shares within its treasury.
Lets look back at our company CTC. From the previous example, we know that this company has 1000 authorized shares. If they offered 300 shares in an IPO, gave 150 to the executives and retained 550 in the treasury, then the number of shares outstanding would be 450 shares (300 float shares 150 restricted shares). If after a couple years CTC was doing extremely well and wanted to buy back 100 shares from the market, the number of outstanding shares would fall to 350, the number of treasury shares would increase to 650 and the float would fall to 200 shares since the buyback was done through the market (300 – 100).
Hold on a minute though - this is not the only way that the number of outstanding shares can fluctuate. In addition to the stocks it issues to investors and executives, many companies offer stock options and warrants. These stock options and warrants are instruments that give the holder a right to purchase more stock from the companys treasury. Every time one of these instruments is activated, the float and shares outstanding increase while the number of treasury stocks decrease. For example, suppose CTC issues 100 warrants. If all these warrants are activated, then Corys Tequila Corporation will have to sell 100 shares from its treasury to the holders of the warrants. Thus, by following the most recent example, where the number of outstanding shares is 350 and treasury shares is 650, the exercise of all the warrants would change the numbers to 450 and 550 respectively, and the float would increase to 300. This effect is known as dilution.
Why Is It Important?
Because the difference between the number of authorized and outstanding shares can be so large, its important that you realize what they are and which figures the company is using. Different ratios may use the basic number of outstanding shares while others may use the diluted version. This can affect the numbers significantly and possibly change your attitude towards a particular investment ; furthermore, by identifying the number of restricted shares versus the number of shares in the float, investors can gauge the level of ownership and autonomy that insiders have within the company. All these scenarios are important for investors to understand before they make a decision to buy or sell.
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