Equity Investments - Analyzing a Company - Types of Stock

1. Growth Company and Growth StockA growth company is a company that consistently grows by investing in projects that will generate growth. A growth stock, however, is a stock that earns a higher rate of return over stocks with a similar risk profile.
   
   Feasibly, a company could be a growth company, but its stock could be a value stock if it is trading below its peers of similar risk.

2. Defensive Company and Defensive StockA defensive company is a company whose earnings are relatively unaffected in a business cycle downturn. A defensive company is typically reflective of products that we "need" versus "want". A food company, such as Kellogg, is considered a defensive company. A defensive stock, however, will hold its value relatively well in a business cycle downturn.

3. Cyclical Company and Cyclical StockA cyclical company is a company whose earnings are affected relative to a business cycle. A cyclical company is typically reflects products we "want". A retail store, such as The Gap, is considered a cyclical company. A cyclical stock, however, will move with the market in relation to the business cycle.

4. Speculative Company and Speculative Stock.A speculative company is a company that invests in a business with an uncertain outcome. An oil exploration company is an example of a speculative company. A speculative stock, however, is a stock that has potential for a large return, as well as the potential for considerable losses. An example of speculative stocks can be found in the tech bubble, where investors put money into speculative stocks, but the investor could have been hurt financially or made large gains depending on the stock the investor invested in.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/equity-investments/analyzing-companies-stock-types.asp#ixzz1yf8SKSRC

Corporate Finance - Dividend Growth Rate and the Effect of Changing Dividend Policy

Signaling An Earning's Forecast Through Changes in Dividend PolicyMuch like a company can signal the state of its operations through its use of capital-financing projects, management can also signal its company's earnings forecast through changes in its dividend policy. 

Dividends are paid out when a company satisfies its internal needs for cash. If a company cuts its dividends, stockholders may become worried that the company is not generating enough earnings to satisfy its internal needs for cash as well as pay out its current dividend. A stock may decline in this instance. 

Suppose for example Newco decides to cuts its dividend to $0.25 per share from its initial value of $0.50 per share. How would this be perceived by investors?

Most likely the cut in dividend by Newco would be perceived negatively by investors. Investors would assume that the company is beginning to go through some tough times and the company is trying to preserve cash. This would indicate that the business may be slowing or earnings are not growing at the rate it once had. 

To learn more about dividends, please read: The Importance of Dividends

The Clientele Effect.A company's change in dividend policy may impact in the company's stock price given changes in the "clientele" interested in owning the company's stock. Depending on their personal tax situation, some stockholders may prefer capital gains over dividends and vice versa as capital gains are taxed at a lower rate than dividends. The clientele effect is simply different stockholders' preference on receiving dividends compared to capital gains.

For example, a stockholder in a high tax bracket may favor stocks with low dividend payouts compared to a stockholder in a low tax-bracket who may favor stocks with higher dividend payouts.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/dividend-growth-changing-dividend-policy-effects.asp#ixzz1yf633Zet

Corporate Finance - Earning Growth Rate and Dividend Growth Rate

 Calculating a Company's Implied Dividend Growth Rate

Recall that a company's ROE is equal to a company's earnings growth rate (g) divided by one minus a company's payout rate (p).

Example:Let's assume Newco's ROE is 10% and the company pays out roughly 20% of its earnings in the form of a dividend. What is Newco's expected growth rate in earnings?

Answer:g = ROE*(1 - p)
g = (10%)*(1 - 20%)
g = (10%)*(0.8)
g = 8%

Given an ROE of 10% and a dividend payout of 20%, Newco's expected growth rate in earnings is 8%.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/dividend-growth-changing-dividend-policy-effects.asp#ixzz1yf57n9sb

Corporate Finance - Dividend Theories

Dividend Irrelevance TheoryMuch like their work on the capital-structure irrelevance proposition, Modigliani and Miller also theorized that, with no taxes or bankruptcy costs, dividend policy is also irrelevant. This is known as the "dividend-irrelevance theory", indicating that there is no effect from dividends on a company's capital structure or stock price. 

MM's dividend-irrelevance theory says that investors can affect their return on a stock regardless of the stock's dividend. For example, suppose, from an investor's perspective, that a company's dividend is too big. That investor could then buy more stock with the dividend that is over the investor's expectations. Likewise, if, from an investor's perspective, a company's dividend is too small, an investor could sell some of the company's stock to replicate the cash flow he or she expected. As such, the dividend is irrelevant to investors, meaning investors care little about a company's dividend policy since they can simulate their own.

Bird-in-the-Hand TheoryThe bird-in-the-hand theory, however, states that dividends are relevant. Remember that total return (k) is equal to dividend yield plus capital gains. Myron Gordon and John Lintner (Gordon/Litner) took this equation and assumed that k would decrease as a company's payout increased. As such, as a company increases its payout ratio, investors become concerned that the company's future capital gains will dissipate since the retained earnings that the company reinvests into the business will be less. 

Gordon and Lintner argued that investors value dividends more than capital gains when making decisions related to stocks. The bird-in-the-hand may sound familiar as it is taken from an old saying: "a bird in the hand is worth two in the bush." In this theory "the bird in the hand' is referring to dividends and "the bush" is referring to capital gains.

Tax-Preference TheoryTaxes are important considerations for investors. Remember capital gains are taxed at a lower rate than dividends. As such, investors may prefer capital gains to dividends. This is known as the "tax Preference theory". 

Additionally, capital gains are not paid until an investment is actually sold. Investors can control when capital gains are realized, but, they can't control dividend payments, over which the related company has control. 

Capital gains are also not realized in an estate situation. For example, suppose an investor purchased a stock in a company 50 years ago. The investor held the stock until his or her death, when it is passed on to an heir. That heir does not have to pay taxes on that stock's appreciation. 

The Dividend-Irrelevance Theory and Company ValuationIn the determination of the value of a company, dividends are often used. However, MM's dividend-irrelevance theory indicates that there is no effect from dividends on a company's capital structure or stock price. 

MM's dividend-irrelevance theory says that investors can affect their return on a stock regardless of the stock's dividend. 

For example, suppose, from an investor's perspective, that a company's dividend is too big. That investor could then buy more stock with the dividend that is over his or her expectations. Likewise, if, from an investor's perspective, a company's dividend is too small, an investor could sell some of the company's stock to replicate the cash flow he or she expected. As such, the dividend is irrelevant to investors, meaning investors care little about a company's dividend policy since they can simulate their own. 

The Principal Conclusion for Dividend Policy

The dividend-irrelevance theory, recall, with no taxes or bankruptcy costs, assumes that a company's dividend policy is irrelevant. The dividend-irrelevance theory indicates that there is no effect from dividends on a company's capital structure or stock price. 

MM's dividend-irrelevance theory assumes that investors can affect their return on a stock regardless of the stock's dividend. As such, the dividend is irrelevant to an investor, meaning investors care little about a company's dividend policy when making their purchasing decision since they can simulate their own dividend policy.

How Any Shareholder Can Construct His or Her Own Dividend Policy.

Recall that the MM's dividend-irrelevance theory says that investors can affect their return on a stock regardless of the stock's dividend. As a result, a stockholder can construct his or her own dividend policy. 

• Suppose, from an investor's perspective, that a company's dividend is too big. That investor could then buy more stock with the dividend that is over the investor's expectations.
• Likewise, if, from an investor's perspective, a company's dividend is too small, an investor can sell some of the company's stock to replicate the cash flow the investor expected.

As such, the dividend is irrelevant to an investor, meaning investors care little about a company's dividend policy since they can simulate their own.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/dividend-theories.asp#ixzz1yf1Ugmp6

Corporate Finance - Effects of Debt on the Capital Structure

Using Greater Amounts of DebtRecall that the main benefit of increased debt is the increased benefit from the interest expense as it reduces taxable income. Wouldn't it thus make sense to maximize your debt load? The answer is no.

With an increased debt load the following occurs: 
Interest expense rises and cash flow needs to cover the interest expense also rise.
Debt issuers become nervous that the company will not be able to cover its financial responsibilities with respect to the debt they are issuing.

Stockholders become also nervous. First, if interest increases, EPS decreases, and a lower stock price is valued. Additionally, if a company, in the worst case, goes bankrupt, the stockholders are the last to be paid retribution, if at all. 

In our previous examples, EPS increased with every increase in our debt-to-equity ratio. However, in our prior discussions, an optimal capital structure is some combination of both equity and debt that maximizes not only earnings but also stock price. Recall that this is best implied by the capital structure that minimizes the company's WACC.

Example:The following is Newco's cost of debt at various capital structures. Newco has a tax rate of 40%. For this example, assume a risk-free rate of 4% and a market rate of 14%. For simplicity in determining stock prices, assume Newco pays out all of its earnings as dividends.

Figure 11.15: Newco's cost of debt at various capital structures

At each level of debt, calculate Newco's WACC, assuming the CAPM model is used to calculate the cost of equity.

Answer:At debt level 0%:
Cost of equity = 4% + 1.2(14% - 4%) = 16%
Cost of debt = 0% (1-40%) = 0%
WACC = 0%(0%) + 100%(16%) = 16%
Stock price = $18.00/0.16 = $112.50

At debt level 20%:
Cost of equity = 4% + 1.4(14% - 4%) = 18%
Cost of debt = 4%(1-40%) = 2.4%
WACC = 20%(2.4%) + 80%(18%) = 14.88%
Stock price = $22.20/0.1488 = $149.19

At debt level 40%:
Cost of equity = 4% + 1.6(14% - 4%) = 20%
Cost of debt = 6% (1-40%) = 3.6%
WACC = 40%(3.6%) + 60%(20%) = 13.44%
Stock price = $28.80/0.1344 = $214.29

Recall that the minimum WACC is the level where stock price is maximized. As such, our optimal capital structure is 40% debt and 60% equity. While there is a tax benefit from debt, the risk to the equity can far outweigh the benefits - as indicated in the example.

Company vs. Stock ValuationThe value of a company's stock is but one part of the company's total value. The value of a company comprises the total value of the company's capital structure, including debtholders, preferred-equity holders and common-equity holders. Since both debtholders and preferred-equity holders have first rights to a company's value, common-equity holders have last rights to a company value, also known as a "residual value".

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/debt-effects-capital-structure.asp#ixzz1yezxSCbw

Video on WACC
Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality
Read more: http://www.investopedia.com/video/play/what-is-wacc#ixzz1yfHGTd8N
http://www.investopedia.com/video/play/what-is-wacc#axzz1ybqROWiK

Differing amounts of debt financing cause changes in EPS and thus a company's stock price.

Effect of Changes in Sales or Earnings on EBIT 

Differing amounts of debt financing cause changes in EPS and thus a company's stock price. The calculations for EBIT and EPS are as follows:

Formula 11.16

EBIT = sales - variable costs - fixed costs EPS = [(EBIT - interest)*(1-tax rate)] / shares outstanding

This LOS is best explained by the use of an example. 

Example:The following is Newco's cost of debt at various capital structures. Newco has $1 million in total assets and a tax rate of 40%. Assume that, at a debt level of zero, Newco has 20,000 shares outstanding.

Figure 11.10: Newco's cost of debt at various capital structures

In addition, Newco has annual sales of $5 million, variable costs are 40% of sales and fixed costs are equal to $2.4 million. At each level of debt, determine Newco's EPS.

Answer:At debt level 0%:
Shares outstanding are 20,000 and interest costs are 0.
EPS = [($5,000,000 - 2,000,000 - 2,400,000-0)*(1-0.4)]/20,000
EPS = $18 per share

At debt level 20%:
Shares outstanding are 16,000 [20,000*(1-20%)] and interest costs are 8,000 (200,000*0.04).
EPS = [($5,000,000 - 2,000,000 - 2,400,000-8,000)*(1-0.4)]/16,000
EPS = $22.20 per share

At debt level 40%:
Shares outstanding are 12,000 [20,000*(1-40%)] and interest costs are 24,000 (400,000*0.06).
EPS = [($5,000,000 - 2,000,000 - 2,400,000-24,000)*(1-0.4)]/12,000
EPS = $28.80 per share

At debt level 60%:
Shares outstanding are 8,000 [20,000*(1-60%)] and interest costs are 48,000 (600,000*0.08).
EPS = [($5,000,000 - 2,000,000 - 2,400,000-48,000)* (1-0.4)]/8,000
EPS= $41.40 per share

At debt level 80%:
Shares outstanding are 4,000 [20,000*(1-80%)] and interest costs are 80,000 (800,000*0.10).
EPS = [($5,000,000 - 2,000,000 - 2,400,000-80,000)* (1-0.4)]/4,000
EPS = $78.00 per share

With each increase in debt level (accompanied with the decrease in shares outstanding), Newco's earnings per share increases.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/business-financial-risk.asp#ixzz1yey1qp1O

Corporate Finance - Business and Financial Risk

To further examine risk in the capital structure, two additional measures of risk found in capital budgeting:

1.Business risk
2.Financial risk

1.Business RiskA company's business risk is the risk of the firm's assets when no debt is used. Business risk is the risk inherent in the company's operations. As a result, there are many factors that can affect business risk: the more volatile these factors, the riskier the company. Some of those factors are as follows:

• Sales risk - Sales risk is affected by demand for the company's product as well as the price per unit of the product.
• Input-cost risk - Input-cost risk is the volatility of the inputs into a company's product as well as the company's ability to change pricing if input costs change.

As an example, let's compare a utility company with a retail apparel company. A utility company generally has more stability in earnings. The company has les risk in its business given its stable revenue stream. However, a retail apparel company has the potential for a bit more variability in its earnings. Since the sales of a retail apparel company are driven primarily by trends in the fashion industry, the business risk of a retail apparel company is much higher. Thus, a retail apparel company would have a lower optimal debt ratio so that investors feel comfortable with the company's ability to meet its responsibilities with the capital structure in both good times and bad.

2.Financial RiskA company's financial risk, however, takes into account a company's leverage. If a company has a high amount of leverage, the financial risk to stockholders is high - meaning if a company cannot cover its debt and enters bankruptcy, the risk to stockholders not getting satisfied monetarily is high.

Let's use the troubled airline industry as an example. The average leverage for the industry is quite high (for some airlines, over 100%) given the issues the industry has faced over the past few years. Given the high leverage of the industry, there is extreme financial risk that one or more of the airlines will face an imminent bankruptcy.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/business-financial-risk.asp#ixzz1yewzbr6X

Corporate Finance - Factors that Influence a Company's Capital-Structure Decision

The primary factors that influence a company's capital-structure decision are:

1.Business risk
2.Company's tax exposure
3.Financial flexibility
4. Management style
5.Growth rate
6.Market Conditions

1.Business RiskExcluding debt, business risk is the basic risk of the company's operations. The greater the business risk, the lower the optimal debt ratio.

As an example, let's compare a utility company with a retail apparel company. A utility company generally has more stability in earnings. The company has less risk in its business given its stable revenue stream. However, a retail apparel company has the potential for a bit more variability in its earnings. Since the sales of a retail apparel company are driven primarily by trends in the fashion industry, the business risk of a retail apparel company is much higher. Thus, a retail apparel company would have a lower optimal debt ratio so that investors feel comfortable with the company's ability to meet its responsibilities with the capital structure in both good times and bad.

2.Company's Tax ExposureDebt payments are tax deductible. As such, if a company's tax rate is high, using debt as a means of financing a project is attractive because the tax deductibility of the debt payments protects some income from taxes.

3.Financial FlexibilityThis is essentially the firm's ability to raise capital in bad times. It should come as no surprise that companies typically have no problem raising capital when sales are growing and earnings are strong. However, given a company's strong cash flow in the good times, raising capital is not as hard. Companies should make an effort to be prudent when raising capital in the good times, not stretching its capabilities too far. The lower a company's debt level, the more financial flexibility a company has.

The airline industry is a good example. In good times, the industry generates significant amounts of sales and thus cash flow. However, in bad times, that situation is reversed and the industry is in a position where it needs to borrow funds. If an airline becomes too debt ridden, it may have a decreased ability to raise debt capital during these bad times because investors may doubt the airline's ability to service its existing debt when it has new debt loaded on top.

4.Management Style Management styles range from aggressive to conservative. The more conservative a management's approach is, the less inclined it is to use debt to increase profits. An aggressive management may try to grow the firm quickly, using significant amounts of debt to ramp up the growth of the company's earnings per share (EPS).

5.Growth RateFirms that are in the growth stage of their cycle typically finance that growth through debt, borrowing money to grow faster. The conflict that arises with this method is that the revenues of growth firms are typically unstable and unproven. As such, a high debt load is usually not appropriate.

More stable and mature firms typically need less debt to finance growth as its revenues are stable and proven. These firms also generate cash flow, which can be used to finance projects when they arise.

6.Market ConditionsMarket conditions can have a significant impact on a company's capital-structure condition. Suppose a firm needs to borrow funds for a new plant. If the market is struggling, meaning investors are limiting companies' access to capital because of market concerns, the interest rate to borrow may be higher than a company would want to pay. In that situation, it may be prudent for a company to wait until market conditions return to a more normal state before the company tries to access funds for the plant.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/capital-structure-decision-factors.asp#ixzz1yevRPv00

Factors influencing Decisions: A Quest for the proper course of Decision-making in Share-investments

Factors influencing Decisions:

A Quest for the proper course of Decision-making in Share-investments

It has been seen for a long time that human being is not always rational and his decisions are not always objective. For instance, if one watches share market, technically the price of a stock should be reflection of its P/E, P/CF & P/BV values, but such is not the case most of times, because the prices of indices are also governed by various aspect and factors of human mindset- expectations, sentiments and excitement to name a few.

This unpredictability of human behavior has led to emergence of a new field in psychology termed as ‘Behavioral Finance’. Behavioral Finance is the study of roles of behavioral factors in the field of finance, especially investment

It is well-known fact that intelligence is one of the important factors, besides hard work and perseverance for achieving success in life. It is generally expected from an intelligent individual to perceive and understand situation properly, think rationally and reason out everything, before making any decision. Clarity of goal, a well-thought strategy to achieve the same, moderate level of motivation, a disciplined behavior with flexibility to reassess the strategies with new developments is certain other requirements to achieve success. This is applied everywhere, in all decisions and goals including individual’s investment decisions as well.

But since human beings do not live in isolation, therefore there are other factors as well which influence his interpersonal relations, and consequently his decisions. Rationality in a man’s decisions or behavior is not always seen as to be expected from them. For instance, people do make different decisions in the two similar situations or behave similarly in two different situations depending upon their emotive state of mind. Thus, emotion plays a vital role in influencing his behavior and decisions. This becomes more apparent in case of investment-related decisions when taken in relation to the share market.

But debate does not end just here. Human beings are not just born for investment; they have other things to do as well. There are numerous occasions when people make mistakes in investment-decisions mostly under the influence of emotions and stress. It is not possible for a person to be totally immune to his emotions, but once he is aware of the risks involved with emotional instability, one can limit the losses. In this context, fear and greed are the most well-known emotions. There is tendency in human-beings to make more money in short time and this tends him to invest in share-market, even when it is at boom. So when market is bearish, the emotion of fear replaces greed. Human-beings love profit, but hate loss even more. A slightly negative indication brings in a lot of negative emotions and consequently, fear comes in. Initially, investor holds position (while rationally, if he wants to quit, he should book losses at that time only) and once the market’s bottoming out tendency to quit gets bigger (though if investor has been rational, he should have waited for a little longer duration and should have stuck to his position). In this way, it would not be wrong to say that not only fear and greed have negative effect on rational thinking, but they also have adverse effects on the long-term strategies of individual. These two unfortunate passions bring in impulsiveness in the individual’s character and continue to press him to take irrational decisions.

Further, Defense-mechanism of denial used by a person to save his self esteem and his ego are also significant factors which prove dangerous in the long run. An investor is, most of the times, adamant to accept that he has made wrong decision. So, he sticks to his decision and end up holding his loosing position longer than what should have been. The anticipation of ‘being wrong’ by any investor, cuts his losses and enables him to take decisions which help him to recover the loss.

Another aspect of Defense-mechanism of denial is its effect on analytical reasoning. Under emotional state of denial, an individual perceives selectively. He tends to emphasize data and information which confirm his position and viewpoint. It also restricts the individual to rationally analyze any new adverse information. Sometimes, it also generates tendency to overemphasize any subtle good indicator and underemphasize the bad indicators, and so, compel the investor to continue with the loosing position, thus aggravating loses.

These factors always influence the decisions of an individual, but the degree of their influence differs. Now, it depends on the individual how he (or she) manipulates these factors for profit. A good investor is one who not only comes out of loss by applying logical thinking but also makes it profitable one. Moreover, one should not stick to his decisions, if situations have changed. The people with low self-esteem and low EQ stick with their decision and apply defense mechanism. False impression of hope leads them to further losses. They even set aside the direction of necessary indicators.

So, to be a good investor, the proper way to act is not simply to book profit at appropriate time, but also to minimize losses in the adverse situations.

’Never Say Die’

http://ansblog.com/2010/02/factors-influencing-decision-making-process/#ixzz0ehyAKUQA

Buy and Hold — Is It For You?

Let's take a look at what exactly "buy and hold" means. We'll also look at how long is long and when you should sell a stock.

What Does "Buy and Hold" Mean

It's an investment strategy that blends seamlessly with Fundamental Analysis. After you buy a stock, you hold on to it for a while even if its price bounces wildly. You sell only when you have good reason to.

You can see see how this is radically different from a market timing strategy — buy low, sell high.

This brings us to a very important question — how long is long?

Long is relative. From a buy and hold perspective, long would mean at least several weeks. Anything shorter than that would generally fall under another stock investing strategy called day trading.

If you've bought the stock based on the fundamentals, then you should sell only if you have very good reason to. And that brings us to the next important point....

When Do You Sell A Stock?

The best investors are divided when it comes to this question. At one end of the spectrum you have the Warren Buffett camp that says, "Our favorite holding period is forever." At the other end, you had Peter Lynch who held on to most of the stocks in his portfolio for a month or two at the most. His entire list turned over at least once a year. And, he had around 1400 holdings!

It's important to note here that these are big players with billions of dollars in investments. Different rules apply there.

Your decision to sell a stock should be based on the strategy you're using. Since we use Fundamental Analysis, here are our reasons to sell stock:

• When the price of a stock crosses its intrinsic value — the stock is now getting overvalued and with that comes the risk of a sudden drop in price. Time to lock in your profit and exit.



• You realize you made a mistake in your analysis — it happens every once in a while. You find something you don't like about the company or its management. Had you known that before you invested, you would have never bought the stock. If the reasons you bought the stock are no longer valid, it's best to sell. Remove the emotion out of the decision, admit you made a mistake, and sell. You will be better off.



• The fundamentals have deteriorated — the strong past financial performance of the company have now started going south. Evaluate the situation. If it doesn't look like the company will come out of the decline anytime soon, it may be time to sell.



• A better opportunity comes along — you find another company to invest in with great financials and a very attractive price. One small problem .... you don't have enough cash to buy a meaningful amount of stock. Can you sell one or more of the stocks you own that will free up some cash?

The buy and hold strategy does not mean owning a stock indefinitely. Believe it or not, selling a stock is much harder than buying a stock. You tend to get emotionally attached to the stock. It's hard to sell when the price has fallen steeply — you're always hoping that somehow the price will come back up again and you won't loose your money. It's hard to sell when the price rises — you don't want to get in the way of a good thing.

So again, let your stock investing strategy dictate when you should sell. Try and not let emotion get in the way. Remember ... you want to own the stock as long as you don't have a good enough reason to sell it. But if you do have a reason, sell it. Get it over with. Move on.

http://www.independent-stock-investing.com/Buy-And-Hold.html

Dow Jones History — Tracing the Origins of this Popular Index

Before we start tracing the Dow Jones history let's first understand what exactly the Dow Jones is. Next, we'll take a look at how the Dow has performed since it first started. Finally, we'll conclude with understanding how the index is actually calculated.

What Exactly is the Dow Jones?

The Dow Jones Industrial Average (DJIA), more commonly known as theDow, is a stock market index created by Charles Dow and Edward Jones way back in 1896. Today, the Dow Jones & Company owns this index.  Dow Jones & Company is in the publishing and financial information business. Among other publications, they own the Wall Street Journal and Barron's weekly magazine.

Today, the DJIA is made up of 30 large, publicly owned companies based in the United States. The index reflects how the stock price of these 30 companies perform during the trading day.

Dow Jones History

The Early years

Charles Dow, a journalist, and his partner, Edward Jones, a statistician, founded the Dow on May 26, 1896. About twelve years earlier, Charles Dow had created the Dow Jones Transportation Average, consisting entirely of railroad stocks. At that time, the railroad industry was the main industry in the United States.

However, Dow realized that industrial stocks were becoming a small but growing part of the market. This drove the creation of the DJIA.

There were a total of 12 companies in the original index. As listed byWikipedia, these are:

1. American Cotton Oil Company ... now part of Unilever.



2. American Sugar Company ... now Domino Foods, Inc.



3. American Tobacco Company ... broken up in a 1911 antitrust case.



4. Chicago Gas Company ... now an operating subsidiary of Integrys Energy Group.



5. Distilling & Cattle Feeding Company ... now Millennium Chemicals.



6. Laclede Gas Company ... still in operation as the Laclede Group, Inc., but removed from the Dow Jones Industrial Average in 1899.



7. National Lead Company ... now NL Industries, removed from the Dow Jones Industrial Average in 1916.



8. North American Company ... broken up by the U.S. Securities and Exchange Commission (SEC) in 1946.



9. Tennessee Coal, Iron and Railroad Company ... bought by U.S. Steel in 1907. U.S. Steel was removed from the Dow Jones Industrial Average in 1991.



10. U.S. Leather Company ... dissolved in 1952.



11. United States Rubber Company ... changed its name to Uniroyal in 1961, merged with private B.F. Goodrich in 1986, bought by Michelin in 1990.



12. General Electric (GE) ... an integral component of the Dow Jones history since it's the only company from the original 12 to still be part of the DJIA despite being removed twice.

The DJIA didn't gain much popularity outside the confines of Wall Street in its first fifteen years. Why? Primarily because in 1896, investing in the stock market was considered highly speculative. Few people ventured beyond bonds and railroad companies when it came to investing.

The result? Not much attention being paid to an index that tracked stocks.

The Middle Years

Attitudes toward stock investing changed drastically by the time the 1920s rolled around. The average citizen was now investing in stocks. The result?

The Dow climbed from its modest range in the 100s to a whopping 400!

But this didn't last long. The crash of 1929 put a hard ceiling on this number. For the next 25 years the Dow stayed below 400 owing largely to the economic turbulence from both the 1929 crash and World War II.

1950 - 1999

The 1950s saw a meteoric rise in the Dow .... almost 250%. The 60s and 70s didn't see anything as dramatic. It wasn't until the 1980s that the Dow charged ahead into unprecedented heights, a pivotal moment in the Dow Jones history. The 80s and 90s were by far the most prosperous years for the stock market as a whole ... and the Dow rose an astounding 228% during the 80s and 317% during the 90s.

2000 - current

The dotcom crash in early 2000 sent the Dow spiraling downwards. The World Trade Center attacks made the slide even worse. It wasn't until 2003 that the Dow climbed past the 10,000 mark again.

Oct 9, 2007 saw the Dow at its highest point ever.... 14,164.This was an important milestone and it also marked the end of the longest ever US bull market.

The economy in the US and around the world started melting down in 2008. The next couple of years saw sharp swings in the Dow with the overall trend being downward. The Dow teetered up and down the psychological 10,000 point mark. 2010 ended with the Dow at 11,577.51.

How is the Dow Calculated?

A discussion on the Dow Jones history wouldn't be complete without answering this question.

Quite amazingly, the calculation for the Dow has remained almost the same since its inception.

First, you add the prices of the 30 companies that make up the Dow ... the price is picked from the primary exchange the stock is traded on.

Next, you divide this number by a what is called a divisor. This divisor is not simply the number of companies making up the Dow. It's an adjusted value designed to keep the index consistent through stock splits, dividend distributions, etc.

So, for instance, a 3:1 stock split on any of the component companies would triple the number of existing stocks, while the price would tend to drop by a third. The adjusted divisor ensures that this sharp drop in price doesn't plunge the index down.

The formula for the more mathematically curious is:

D_t+1 = D_t * Σ C^a _t /Σ C_t

Where
D_t+1 = Divisor to be effective on trading session t+1
D_t = Divisor on trading session t
C^a _t = Components’ adjusted closing prices for stock dividends, splits, spin-offs and other applicable corporate actions on trading session t
C_t = Components’ closing prices on trading session t

In summary, we looked at what the Dow is, traced the Dow Jones history, and peeked into how the index is actually calculated.

The Dow is indeed the defacto bell-weather of the stock market and is valuable in assessing the overall strength of the market.

http://www.independent-stock-investing.com/Dow-Jones-History.html

How to Find Great Companies to Invest In

Edited bySantosh and 5 others

 Warren Buffett

Ever wonder how successful stock investors pick great companies? Here are a few steps taken from the playbook of investing greats like Warren Buffett, Benjamin Graham, and Peter Lynch.

Steps

1. 1
   Stay within your circle of competence: You are best positioned to identify winning companies within your own field of expertise. If you work in retail, you are more qualified to decide if you should invest in companies like Walmart, Target, Best Buy, etc. than the latest bio-tech company.
   
   
2. 2
   Look for Economic Moats: There are some companies that manage to be virtual monopolies in their area. These companies have, over the years, succeeded in building a "moat" around them to keep their competitors away. They have a durable competitive advantage. Some examples of competitive advantage are:
   
   • Brand - Think Harley Davidson, Coke, BMW. These are brand names etched in the public mind as the best in their class. These companies can raise their prices on the strength of their brands resulting in deeper profits.
   • High Switching Costs - When was the last time you switched banks? Or cell phone providers? Or cigarette brands, if you are a smoker? You get the picture here? Companies that have high switching costs can hold on to their customers a lot longer than companies that don't.
     
   • Low Cost Producer - Companies that are able to make products and sell them at phenomenally lower prices than their competition automatically attract customers - lots of them. As long as quality is not compromised, of course. Walmart and and Dell have perfected this concept to a science.
   • Secret - Large pharmaceutical companies with patents; companies that own copyrights, drilling rights, mining rights, etc. are pretty much the sole producer or service providers in their area. Again, these companies can raise prices without fear of losing customers, resulting in higher profits.
   • Scalability - This is a product or service that has the potential to network or add more users with time. Adobe has become the defacto standard for publishing, Microsoft's Excel for spreadsheets. eBay is a great example of a user network. Each additional user to the network costs the company virtually nothing. The additional revenues that come in as the network expands go straight to the bottom-line.
3. 3
   Check the quality of management: How competent is the management running the company? More importantly, how focused are they toward the company, customers, investors, and employees? In this age of rampant corporate greed, it's always a great idea to research the management of the company. The companies annual reports as well as newspaper/magazine articles are good places to get this information.
4. 4
   Even a great company can be overvalued. Learn to interpret financial statements and fundamental analysis to find one that the market has valued fairly, or undervalued.
   • Price to earnings ratios should be below 20. If the P/E ratio is over 20, then the company could be overpriced for it's earnings. Benjamin Graham popularized this indicator after the great depression.
   • Buy a Price-to-book below 2. The price-to-book ratio is the price of the company divided by the total value of its assets. A low ratio shows that the company's stock is cheap.
   
   

Tips

• Start thinking about everyday companies you come across with this new framework.
• Visit the company’s website and financial websites online that give you varied insights on the stock like Wikinvest.com and Morningstar
• Learn the basics of reading financial statements. Then, check to see how profitable the companies you're interested in are. Check their debt position. See if they have been growing steadily.

Warnings

• Never jump into buying stocks in a company unless you've sat down and done your research.
• Stay away from stock tips -- they are merely someone's grandiose theory about getting rich quick or a salesman that is paid to inflate a stock so that the company can raise money by dumping stock on unsuspecting investors.
• Warren Buffet says that it amuses him how high IQ CEO's mindlesly immitate one another. Warren says that he NEVER gets good ideas listening to others.
• While you should invest in companies you know, do not limit yourself to just one or two sectors. Try to research about companies in a variety of sectors and diversify your stock portfolio.

Related wikiHows

• How to Interpret Financial Ratio

Sources and Citations

• http://news.morningstar.com/classroom2/course.asp?docId=80345&page=1&CN=COM
• http://www.independent-stock-investing.com/Famous-Stock-Market-Investors.html

http://www.wikihow.com/Find-Great-Companies-to-Invest-In

A Primer to Ben Graham's Mr. Market (Video)

Warren Buffett - The Mr. Market Concept

Warren Buffett Secret Millionaires Club (video)

Rule Of Five

The Rule of Five is BetterInvesting's method of letting you know you're not perfect and neither are your stock selections.

It states "For every five stocks you select using BetterInvesting methods, 

• one will do much better than you expected, 
• three will do about as well as you expected, and 
• one will do much worse than you expected."

The Rule of Five forms the basis for the first step of portfolio management, defense.

Here are the three possible outcomes for a stock's fundamentals on the SSG.

Defensive portfolio management's ONLY concern is finding stocks whose FUNDAMENTALS of SALES, PRE-TAX PROFITS, EPS, & PRE-TAX PROFIT MARGIN are not meeting your projections for future quality. Click here for a more indepth discussion of defensive portfolio management or click here to see how the PERT Report is used to implement defensive portfolio management.

---

Last Modified 2005-05-13 


http://biwiki.editme.com/RuleOfFive

Developing Your Emotional Intelligence for the Next Level

by Rande Howell 06-05-2012

Most traders wake up in an emotion, never having seen the tell-tale signs of how an emotion takes over perception and runs a trader's thinking. Yet, the emotion was hiding in plain site - it is the trader's blindness that led them into a decision-making ambush. Working with emotions is not optional in the life of a trader. A trader’s lack of understanding of emotions and how they work is a major obstacle in trading performance, and it will stay that way until the trader learns to deal with emotions effectively. Most traders do not notice an emotion (fear, greed, or euphoria) until it has already corrupted their mindset and hijacked their capacity to think clearly. By the time the trader notices the "feeling" of an emotion, it is too late. When you (the trader) “feel” the emotion, it is already coursing as chemistry in your body and brain and your thinking is compromised in whatever direction the emotion is taking you.

When this happens, there is no way to put the brakes on the emotion and return to clear thinking. The best solution at this moment is let the emotional chemistry “burn” itself out so you can come back to your senses. (You can accomplish this by getting away from trading - i.e. take a walk, go exercise, go for a run – anything that accelerates the burn of the emotional chemistry in the body). But, it does not have to be this way. Let’s take a look at emotions in trading and discover how it is possible to build a path to emotional mastery.

What is an Emotion?

First, emotions are not feelings, although feeling is an element of an emotion. Emotions are not touchy-feely – they are biological. Emotions take over psychology and thinking. They are built to provoke the body and mind into specific forms of action based on the motivation of the emotion. This is why managing them is so important in trading. 

Fear, for instance, is built to avoid threat – both biological and psychological. The emotional brain, once provoked to fear, will manhandle the thinking mind to create explanations that support what the emotional brain believes. This is because all thinking is emotional-state-dependent. The key to successful state of mind management, therefore, is emotional state management. 

Second, an emotion (being biological in its nature) is defined as any disruption to a standard sensorial pattern that the brain has already established. That standard sensorial pattern is often referred to as your "comfort zone". So, as you are trading, if any deviation occurs from a pre-existing homeostasis, an emotion pops up to deal with the disruption.

Now what does that look like in trading? The movement from evaluating set-ups to committing to an entry point is just such a disruption to standard sensorial pattern. Suddenly your cozy comfort zone is disrupted and you are committing capital to risk. For many traders, this represents threat. And, if you do not develop your EQ (emotional intelligence), it will not matter how much you KNOW about trading and risk management while in the safety of your comfort zone, your trader’s hand still freezes and you cannot pull the trigger because the emotional brain dictates how the thinking mind will think. Here, the emotional brain perceives the uncertainty of putting capital to risk as a threat and jumps to fear and hesitation.

Becoming emotionally intelligent is essential to the development of successful traders. Learning how an emotion operates will give the trader an edge in managing his emotions and mastering the mind that he brings to trading.


Elements of an Emotion

Emotions are composed of a number of interlocking elements. The important thing to understand about emotions is that they are biological and they take over your psychology. Learning how emotions operate is the first step to mastering them. Here are the elements of an emotion:

Arousal. First, there is a change in the status of a trade which triggers an emotion based on the trader’s perception of threat (fear) or opportunity (euphoria or greed). What happens next is that the body begins to ramp up for action. Breathing changes. It stops or begins to become shallow and rapid. Muscles tense, getting ready to spring into action. The heart begins to race or miss a beat. You are now experiencing the arousal of an emotion. It is building, readying the body for action. This is the place you want to catch the emotion – before it builds up a head of steam and becomes an out-of-control locomotive. As the emotion’s engine revs up, it reaches a critical mass. It flips an internal switch and it springs into action. It is no longer building up – the switch is flipped and the emotion activates the feeling component.

Feeling. Feeling is the subjective experience of the emotion and is where most traders notice the emotion. However, the feeling element of the emotion is also the chemistry of the emotion coursing through your body. This chemistry is what you “feel”, and this is when the emotion contaminates thinking. In the life of emotional activation, the emotion can easily take 45 minutes to an hour for the chemistry to burn out if it is no longer being stimulated – not good for the trading mind. So you will no longer be in your “right” mind for trading if you are experiencing fear or euphoria. Both fear and euphoria set the trader up for skewed thinking. The feeling element of the emotion produces a belief in the certainty of whatever direction the emotion is provoking you to go.

Motivation. Motivation is where the emotion is taking you. Remember, emotions are biological and are about producing action in a particular direction. Those directions are called emotional motivation and are either avoid (run, hide, freeze, submit), attack, or approach. Feeling and motivation conspire to sweep the trader’s mind away. If you have ever been reviewing your trading day and wondered what happened to your right mind in the heat of trading – this is it. Motivation provided the direction of the e-motion and the feeling provided the certainty of the belief that hijacked your thinking mind.

Meaning. Meaning is the self-belief concerning the trader’s adequacy, worth, mattering, or power to manage uncertainty that becomes attached to the emotion. You can declare that you believe something, but that is only cheerleading. The proof of what you really believe about your capacity to manage uncertainty will be found in your trading account. Most traders avoid looking into their self-limiting beliefs (no matter how boldly their trading account points to them) because it creates discomfort in their comfort zone or current organization of self. This lack of courage is what keeps the trader locked in his self-limiting beliefs, that negatively impact his trading account.

Pre-disposition. Genetic pre-disposition is simply beyond the scope of this article. We are all wired with certain potentialities – it is what we do with our potential that matters, though.




Freedom of Emotion, Not Freedom From Emotion

Emotion is unavoidable in trading. The EQ skill is learning how to use emotions to produce effective states of mind for peak-performance trading. As a trader develops his EQ, he learns to regulate reactive emotionally-based pattern. The first step is to volitionally alter the arousal element of the problem emotion through breathing and tension release. By doing this, he is able to better manage the intensity of the emotion so that it does not activate the feeling state of a reactive emotion while trading. (If that occurs, the trader’s mind is compromised.) 

As he gains the emotional competence to regulate the emotion, he is able to get to the door of the trading mind. This is where he can use new-found courage to examine the beliefs that limits his capacity to manage the uncertainty of probability. Here is where meaning can be transformed - first, by discovering his inherent worth as a human being. This is really important. It is at this point that he can focus on his trading as a performance rather than a characterization of his being. At this point in the journey of a trader, he is re-organizing the meaning of self that is embedded into the emotional structure.

Here, the trader can begin to use emotion as information or data because he is no longer afraid of what he might find out about himself. He begins to see what is manifesting in his trading with far less avoidance and denial and he uses this information to design the mind that trades. No longer does he try to avoid the discomfort of reactive emotions and the self-limiting beliefs that lurk behind them. Instead, he is able to use the emotion as information that tells him where he needs to look for self-limiting patterns. He knows that emotions will lead him to what he needs to know about himself so he can grow as a trader. Fear has been transformed into reverence, vigilance, and concern. These emotional states that give rise to a peak performance state of mind are rooted in discipline, courage, patience, and impartiality.




http://www.traderslaboratory.com/forums/psychology/13312-developing-your-emotional-intelligence-next-level.html