SouthUral State University
The Department of Economic and Management
Work on subject
The Student: Velichko O.S.
The Tutor: Sergeeva L.M.
1. Market place
2. Trading on the stock exchange floor
3. Securities. Categories of common stock
1. Growth stocks
2. Cyclical stocks
3. Special situations
4. Preferred stocks
2. Bonds-U.S. government
4. Convertible securities
8. Commodities and financial futures
5. Stock market averages reading the newspaper quotations
1. The price-earnings ratio
6. European stock marketsЦgeneral trend
1. New ways for old
2. Europe, meet electronics
7. New issues
8. Mutual funds. A different approach
1. Advantages of mutual funds
2. Load vs. No-load
3. Common stock funds
4. Other types of mutual funds
5. The daily mutual fund prices
6. Choosing a mutual fund
1. MARKET PLACE
The stock market. To some itТs a puzzle. To others itТs a source of
profit and endless fascination. The stock market is the financial nerve
center of any country. It reflects any change in the economy. It is
sensitive to interest rates, inflation and political events. In a very real
sense, it has its fingers on the pulse of the entire world.
Taken in its broadest sense, the stock market is also a control center.
It is the market place where businesses and governments come to raise money
so that they can continue and expend their operations. It is the market
place where giant businesses and institutions come to make and change their
financial commitments. The stock market is also a place of individual
The phrase Уthe stock marketФ means many things. In the narrowest
sense, a stock market is a place where stocks are traded Ц that is bought
and sold. The phrase Уthe stock marketФ is often used to refer to the
biggest and most important stock market in the world, the New York Stock
Exchange, which is as well the oldest in the US. It was founded in 1792.
NYSE is located at 11 Wall Street in New York City. It is also known as the
Big Board and the Exchange. In the mid-1980s NYSE-listed shares made up
approximately 60% of the total shares traded on organized national
exchanges in the United States.
AMEX stands for the American Stock Exchange. It has the second biggest
volume of trading in the US. Located at 86 Trinity Place in downtown
Manhattan, the AMEX was known until 1921 as the Curb Exchange, and it is
still referred to as the Curb today. Early traders gathered near Wall
Street. Nothing could stop those outdoor brokers. Even in the snow and rain
they put up lists of stocks for sale. The gathering place became known as
the outdoor curb market, hence the name the Curb. In 1921 the Curb finally
moved indoors. For the most part, the stocks and bonds traded on the AMEX
are those of small to medium-size companies, as contrasted with the huge
companies whose shares are traded on the New York Stock Exchange.
The Exchange is non-for-profit corporation run by a board of directors.
Its member firm are subject to a strict and detailed self-regulatory code.
Self-regulation is a matter of self-interest for stock exchange members. It
has built public confidence in the Exchange. It also required by law. The
US Securities and Exchange Commission (SEC) administers the federal
securities laws and supervises all securities exchange in the country.
Whenever self-regulation doesnТt do the job, the SEC is likely to step in
directly. The Exchange doesnТt buy, sell or own any securities nor does it
set stock prices. The Exchange merely is the market place where the public,
acting through member brokers, can buy and sell at prices set by supply and
It costs money it become an Exchange member. There are about 650
memberships or УseatsФ on the NYSE, owned by large and small firms and in
some cases by individuals. These seats can be bought and sold; in 1986 the
price of a seat averaged around $600,000. Before you are permitted to buy a
seat you must pass a test that strictly scrutinizes your knowledge of the
securities industry as well as a check of experience and character.
Apart from the NYSE and the AMEX there are also УregionalФ exchange in
the US, of which the best known are the Pacific, Midwest, Boston and
There is one more market place in which the volume of common stock
trading begins to approach that of the NYSE. It is trading of common stock
Уover-the-counterФ or УOTCФЦthat is not on any organized exchange. Most
securities other than common stocks are traded over-the-counter. For
example, the vast market in US Government securities is an over-the-counter
market. So is the money marketЦthe market in which all sorts of short-term
debt obligations are traded daily in tremendous quantities. Like-wise the
market for long-and short-term borrowing by state and local governments.
And the bulk of trading in corporate bonds also is accomplished over-the-
While most of the common stocks traded over-the-counter are those of
smaller companies, many sizable corporations continue to be found on the
УOTCФ list, including a large number of banks and insurance companies.
As there is no physical trading floor, over-the-counter trading is
accomplished through vast telephone and other electronic networks that link
traders as closely as if they were seated in the same room. With the help
of computers, price quotations from dealers in Seattle, San Diego, Atlanta
and Philadelphia can be flashed on a single screen. Dedicated telephone
lines link the more active traders. Confirmations are delivered
electronically rather than through the mail. Dealers thousands of miles
apart who are complete strangers execute trades in the thousands or even
millions of dollars based on thirty seconds of telephone conversation and
the knowledge that each is a securities dealer registered with the National
Association of Securities Dealers (NASD), the industry self-regulatory
organization that supervises OTC trading. No matter which way market prices
move subsequently, each knows that the trade will be honoured.
2. TRADING ON THE STOCK EXCHANGE FLOOR
When an individual wants to place an order to buy or sell shares, he
contacts a brokerage firm that is a member of the Exchange. A registered
representative or УRRФ will take his order. He or she is a trained
professional who has passed an examination on many matters including
Exchange rules and producers.
The individualТs order is relayed to a telephone clerk on the floor of
the Exchange and by the telephone clerk to the floor broker. The floor
broker who actually executes the order on the trading floor has an
exhausting and high-pressure job. The trading floor is a larger than half
the size of football field. It is dotted with multiple locations called
Уtrading postsФ. The floor broker proceeds to the post where this or that
particular stock is traded and finds out which other brokers have orders
from clients to buy or sell the stock, and at what prices. If the order the
individual placed is a Уmarket orderФЦwhich means an order to buy or sell
without delay at the best price availableЦthe broker size up the market,
decides whether to bargain for a better price or to accept one of the
orders being shown, and executes the tradeЦall this happens in a matter of
seconds. Usually shares are traded in round lots on securities exchanges. A
round lot is generally 100 shares, called a unit of trading, anything less
is called an odd lot.
When you first see the trading floor, you might assume all brokers are
the same, but they arenТt. There are five categories of market
professionals active on the trading floor.
Commission Brokers, usually floor brokers, work for member firms. They
use their experience, judgment and execution skill to buy and sell for the
firmТs customer for a commission.
Independent Floor Brokers are individual entrepreneurs who act for a
variety of clients. They execute orders for other floor brokers who have
more volume than they can handle, or for firms whose exchange members are
not on the floor.
Registered Competitive Market Makers have specific obligations to trade
for their own or their firmТs accountsЦwhen called upon by an Exchange
officialЦby making a bid or offer that will narrow the existing quote
spread or improve the depth of an existing quote.
Competitive Traders trade for their own accounts, under strict rules
designed to assure that their activities contribute to market liquidity.
And last, but not least, come Stock Specialists. The Exchange tries to
preserve price continuityЦ which means that if a stock has been trading at,
say, 35, the next buyer or seller should be able to an order within a
fraction of that price. But what if a buyer comes in when no other broker
wants to sell close to the last price? Or vice versa for a seller? How is
price continuity preserved? At this point enters the Specialist. The
specialist is charged with a special function, that of maintaining
continuity in the price of specific stocks. The specialist does this by
standing ready to buy shares at a price reasonably close to the last
recorded sale price when someone wants to sell and there is a lack of
buyers, and to sell when there is a lack of sellers and someone wants to
buy. For each listed stock, there are one or more specialist firms assigned
to perform this stabilizing function. The specialist also acts as a broker,
executing public orders for the stock, and keeping a record of limit orders
to be executed if the price of the stock reaches a specified level. Some of
the specialist firms are large and assigned to many different stocks. The
Exchange and the SEC are particularly interested in the specialist
function, and trading by the specialists is closely monitored to make sure
that they are giving precedence to public orders and helping to stabilize
the markets, not merely trying to make profits for themselves. Since a
specialist may at any time be called on to buy and hold substantial amounts
of stock, the specialist firms must be well capitalized.
In today's markets, where multi-million-dollar trades by institutions
(i. e. banks, pension funds, mutual funds, etc.) have become common, the
specialist can no longer absorb all of the large blocks of stock offered
for sale, nor supply the large blocks being sought by institutional buyers.
Over the last several years, there has been a rapid growth in block trading
by large brokerage firms and other firms in the securities industry. If an
institution wants to sell a large block of stock, these firms will conduct
an expert and rapid search for possible buyers; if not enough buying
interest is found, the block trading firm will fill the gap by buying
shares itself, taking the risk of owning the shares and being able to
dispose of them subsequently at a profit. If the institution wants to buy
rather than sell, the process is reversed. In a sense, these firms are
fulfilling the same function as the specialist, but on a much larger scale.
They are stepping in to buy and own stock temporarily when offerings exceed
demand, and vice versa.
So the specialists and the block traders perform similar stabilizing
functions, though the block traders have no official role and have no
motive other than to make a profit.
3. SECURITIES. CATEGORIES OF COMMON STOCK
There is a lot to be said about securities. Security is an instrument
that signifies (1) an ownership position in a corporation (a stock), (2) a
creditor relationship with a corporation or governmental body (a bond), or
(3) rights to ownership such as those represented by an option, subsription
right, and subsription warrant.
People who own stocks and bonds are referred to as investors or,
respectively, stockholders (shareholders) and bondholders. In other words a
share of stock is a share of a business. When you hold a stock in a
corporation you are part owner of the corporation. As a proof of ownership
you may ask for a certificate with your name and the number of shares you
hold. By law, no one under 21 can buy or sell stock. But minors can own
stock if kept in trust for them by an adult. A bond represents a promise by
the company or government to pay back a loan plus a certain amount of
interest over a definite period of time.
We have said that common stocks are shares of ownership in
corporations. A corporation is a separate legal entity that is responsible
for its own debts and obligations. The individual owners of the corporation
are not liable for the corporation's obligations. This concept, known as
limited liability, has made possible the growth of giant corporations. It
has allowed millions of stockholders to feel secure in their position as
corporate owners. All that they have risked is what they paid for their
A stockholder (owner) of a corporation has certain basic rights in
proportion to the number of shares he or she owns. A stockholder has the
right to vote for the election of directors, who control the company and
appoint management. If the company makes profits and the directors decide
to pay part of these profits to shareholders as dividends, a stockholder
has a right to receive his proportionate share. And if the corporation is
sold or liquidates, he has a right to his proportionate share of the
What type of stocks can be found on stock exchanges? The question can
be answered in different ways. One way is by industry groupings. There are
companies in every industry, from aerospace to wholesale distributers. The
oil and gas companies, telephone companies, computer companies,
autocompanies and electric utilities are among the biggest groupings in
terms of total earnings and market value. Perhaps a more useful way to
distinguish stocks is according to the qualities and values investors want.
3.1 Growth Stocks.
The phrase "growth stock" is widely used as a term to describe what
many investors are looking for. People who are willing to take greater-than-
average risks often invest in what is often called "high-growth"
stocksЧstocks of companies that are clearly growing much faster than
average and where the stock commands a premium price in the market. The
rationale is that the company's earnings will continue to grow rapidly for
at least a few more years to a level that justifies the premium price. An
investor should keep in mind that only a small minority of companies really
succeed in making earnings grow rapidly and consistently over any long
period. The potential rewards are high, but the stocks can drop in price at
incredible rates when earnings don't grow as expected. For example, the
companies in the video game industry boomed in the early 1980s, when it
appeared that the whole world was about to turn into one vast video arcade.
But when public interest shifted to personal computers, the companies found
themselves stuck with hundreds of millions of dollars in video game
inventories, and the stock collapsed.
There is less glamour, but also less risk, in what we will callЧfor
lack of a better phraseЧ"moderate-growth" stocks. Typically, these might be
stocks that do not sell at premium, but where it appears that the company's
earnings will grow at a faster-than-average rate for its industry. The
trick, of course, is in forecasting which companies really will show better-
than-average growth; but even if the forecast is wrong, the risk should not
be great, assuming that the price was fair to begin with.
There's a broad category of stocks that has no particular name but that
is attractive to many investors, especially those who prefer to stay on the
conservative side. These are stocks of companies that are not glamorous,
but that grow in line with the economy. Some examples are food companies,
beverage companies, paper and packaging manufacturers, retail stores, and
many companies in assorted consumer fields.
As long as the economy is healthy and growing, these companies are
perfectly reasonable investments; and at certain times when everyone is
interested in "glamour" stocks, these "non-glamour" issues may be neglected
and available at bargain prices. Their growth may not be rapid, but it
usually is reasonably consistent. Also, since these companies generally do
not need to plow all their earnings back into the business, they tend to
pay sizable dividends to their stockholders. In addition to the real growth
that these companies achieve, their values should adjust upward over time
in line with inflationЧa general advantage of common stocks that is worth
3.2 Cyclical Stocks.
These are stocks of companies that do not show any clear growth trend,
but where the stocks fluctuate in line with the business cycle (prosperity
and recession) or some other recognizable pattern. Obviously, one can make
money if he buys these near the bottom of a price cycle and sells near the
top. But the bottoms and tops can be hard to recognize when they occur; and
sometimes, when you think that a stock is near the bottom of a cycle, it
may instead be in a process of long-term decline.
3.3 Special Situations.
ThereТs a type of investment that professionals usually refer to as
Уspecial situationsФ. These are cases where some particular corporate
developmentЦperhaps a merger, change of control, sale of property, etc.Ц
seems likely to raise the value of a stock. Special situation investments
may be less affected by general stock market movements than the average
stock investment; but if the expected development doesnТt occur, an
investor may suffer a loss, sometimes sizable. Here the investor has to
judge the odds of the expected developmentТs actually coming to pass.
4. PREFERRED STOCKS
A preferred stock is a stock which bears some resemblances to a bond
(see below). A preferred stockholder is entitled to dividends at a
specified rate, and these dividends must be paid before any dividends can
be paid on the company's common stock. In most cases the preferred dividend
is cumulative, which means that if it isn't paid in a given year, it is
owed by the company to the preferred stockholder. If the corporation is
sold or liquidates, the preferred stockholders have a claim on a certain
portion of the assets ahead of the common stockholders. But while a bond is
scheduled to be redeemed by the corporation on a certain "maturity" date, a
preferred stock is ordinarily a permanent part of the corporation's capital
structure. In exchange for receiving an assured dividend, the preferred
stockholder generally does not share in the progress of the company; the
preferred stock is only entitled to the fixed dividend and no more (except
in a small minority of cases where the preferred stock is "participating"
and receives higher dividends on some basis as the company's earnings
Many preferred stocks are listed for trading on the NYSE and other
exchanges, but they are usually not priced very attractively for individual
buyers. The reason is that for corporations desiring to invest for fixed
income, preferred stocks carry a tax advantage over bonds. As a result,
such corporations generally bid the prices of preferred stocks up above the
price that would have to be paid for a bond providing the same income. For
the individual buyer, a bond may often be a better buy.
Unlike a stock, a bond is evidence not of ownership, but of a loan to a
company (or to a government, or to some other organization). It is a debt
obligation. When you buy a corporate bond, you have bought a portion of a
large loan, and your rights are those of a lender. You are entitled to
interest payments at a specified rate, and to repayment of the full "face
amount" of the bond on a specified date. The fixed interest payments are
usually made semiannually. The quality of a corporate bond depends on the
financial strength of the issuing corporation.
Bonds are usually issued in units of $1,000 or $5,000, but bond prices
are quoted on the basis of 100 as "par" value. A bond price of 96 means
that a bond of $1,000 face value is actually selling at $960 And so on.
Many corporate bonds are traded on the NYSE, and newspapers carry a
separate daily table showing bond trading. The major trading in corporate
bonds, however, takes place in large blocks of $100,000 or more traded off
the Exchange by brokers and dealers acting for their own account or for
4.2 Bonds-U. S. Government
U.S. Treasury bonds (long-term), notes (intermediate-term) and bills
(short-term), as well as obligations of the various U. S. government
agencies, are traded away from the exchanges in a vast professional market
where the basic unit of trading is often $ 1 million face value in amount.
However, trades are also done in smaller amounts, and you can buy
Treasuries in lots of $5,000 or $10,000 through a regular broker. U. S.
government bonds are regarded as providing investors with the ultimate in
Bonds issued by state and local governments and governmental units are
generally referred to as "municipals" or "tax-exempts", since the income
from these bonds is largely exempt from federal income tax.
Tax-exempt bonds are attractive to individuals in higher tax brackets
and to certain institutions. There are many different issues and the
newspapers generally list only a small number of actively traded
municipals. The trading takes place in a vast, specialized over-the-counter
market. As an offset to the tax advantage, interest rates on these bonds
are generally lower than on U. S. government or corporate bonds. Quality is
usually high, but there are variations according to the financial soundness
of the various states and communities.
4.4 Convertible Securities
A convertible bond (or convertible debenture) is a corporate bond that
can be converted into the company's common stock under certain terms.
Convertible preferred stock carries a similar "conversion privilege". These
securities are intended to combine the reduced risk of a bond or preferred
stock with the advantage of conversion to common stock if the company is
successful. The market price of a convertible security generally represents
a combination of a pure bond price (or a pure preferred stock price) plus a
premium for the conversion privilege. Many convertible issues are listed on
the NYSE and other exchanges, and many others are traded over-the-counter
An option is a piece of paper that gives you the right to buy or sell a
given security at a specified price for a specified period of time. A
"call" is an option to buy, a "put" is an option to sell. In simplest form,
these have become an extremely popular way to speculate on the expectation
that the price of a stock will go up or down. In recent years a new type of
option has become extremely popular: options related to the various stock
market averages, which let you speculate on the direction of the whole
market rather than on individual stocks. Many trading techniques used by
expert investors are built around options; some of these techniques are
intended to reduce risks rather than for speculation.
When a corporation wants to sell new securities to raise additional
capital, it often gives its stockholders rights to buy the new securities
(most often additional shares of stock) at an attractive price. The right
is in the nature of an option to buy, with a very short life. The holder
can use ("exercise") the right or can sell it to someone else. When rights
are issued, they are usually traded (for the short period until they
expire) on the same exchange as the stock or other security to which they
A warrant resembles a right in that it is issued by a company and gives
the holder the option of buying the stock (or other security) of the
company from the company itself for a specified price. But a warrant has a
longer lifeЧoften several years, sometimes without limit As with rights,
warrants are negotiable (meaning that they can be sold by the owner to
someone else), and several warrants are traded on the major exchanges.
4.8 Commodities and Financial Futures
The commodity markets, where foodstuffs and industrial commodities are
traded in vast quantities, are outside the scope of this text. But because
the commodity markets deal in "futures"Чthat is, contracts for delivery of
a certain good at a specified future dateЧ they have also become the center
of trading for "financial futures", which, by any logical definition, are
not commodities at all.
Financial futures are relatively new, but they have rapidly zoomed in
importance and in trading activity. Like options, the futures can be used
for protective purposes as well as for speculation. Making the most
headlines have been stock index futures, which permit investors to
speculate on the future direction of the stock market averages. Two other
types of financial futures are also of great importance: interest rate
futures, which are based primarily on the prices of U.S. Treasury bonds,
notes, and bills, and which fluctuate according to the level of interest
rates; and foreign currency futures, which are based on the exchange rates
between foreign currencies and the U.S. dollar. Although, futures can be
used for protective purposes, they are generally a highly speculative area
intended for professionals and other expert investors.
5. STOCK MARKET AVERAGES READING THE NEWSPAPER QUOTATIONS
The financial pages of the newspaper are mystery to many people. But
dramatic movements in the stock market often make the front page. In
newspaper headlines, TV news summaries, and elsewhere, almost everyone has
been exposed to the stock market averages.
In a brokerage firm office, itТs common to hear the question УHowТs the
market?Ф and answer, УUp five dollarsФ, or УDown a dollarФ. With 1500
common stocks listed on the NYSE, there has to be some easy way to express
the price trend of the day. Market averages are a way of summarizing that
Despite all competition, the popularity crown still does to an average
that has some of the qualities of an antiqueЦthe Dow Jones Industrial
Average, an average of 30 prominent stocks dating back to the 1890s. This
average is named for Charles DowЦone of the earliest stock market
theorists, and a founder of Dow Jones & Company, a leading financial news
service and publisher of the Wall Street Journal.
In the days before computers, an average of 30 stocks was perhaps as
much as anyone could calculate on a practical basis at intervals throughout
the day. Now, the Standard & PoorТs 500 Stock Index (500 leading stocks)
and the New York Stock Exchange Composite Index (all stocks on the NYSE)
provide a much more accurate picture of the total market. The professionals
are likely to focus their attention on these УbroadФ market indexes. But
old habits die slowly, and someone calls out, УHowТs the market?Ф and
someone else answers, УUp five dollars,Ф or УUp fiveФЦitТs still the Dow
Jones Industrial Average (the УDowФ for short) that theyТre talking about.
The importance of daily changes in the averages will be clear if you
view them in percentage terms. When the market is not changing rapidly, the
normal daily change is less than љ of 1%. A change of љ% is still moderate;
1% is large but not extraordinary; 2% is dramatic. From the market
averages, itТs a short step to the thousands of detailed listings of stock
prices and related data that youТll find in the daily newspaper financial
tables. These tables include complete reports on the previous dayТs trading
on the NYSE and other leading exchanges. They can also give you a
surprising amount of extra information.
Some newspapers provide more extensive tables, some less. Since the
Wall Street Journal is available world wide, weТll use it as a source of
convenient examples. YouТll find a prominent page headed УNew York Stock
Exchange Composite TransactionsФ. This table covers the dayТs trading for
all stocks listed on the NYSE. УCompositeФ means that it also includes
trades in those same stocks on certain other exchanges (Pacific, Midwest,
etc.) where the stocks are Уdually listedФ. Here are some sample entries:
|52 Weeks | | |Yld |P-E |Sales | | | |Net |
|High |Low |Stock |Div |% |Ratio|100s |High |Low |Close |Chg. |
|52 |37 5/8|Cons Ed |2.68 |5.4 |12 |909 |49 |48 7/8|49 1/4|+1/4 |
|7/8 | | | | | | |3/8 | | | |
|91 |66 1/2|Gen El |2.52 |2.8 |17 |11924 |91 |89 5/8|90 |-1 |
|1/8 | | | | | | |3/8 | | | |
|41 |26 1/4|Mobil |2.20 |5.4 |10 |15713 |41 |40 1/2|40 7/8|+5/8 |
|3/8 | | | | | | | | | | |
Some of the abbreviated company names in the listings can be a
considerable puzzle, but you will get used to them.
While some of the columns contain longer-term information about the
stocks and the companies, we'll look first at the columns that actually
report on the day's trading. Near the center of the table you will see a
column headed "Sales 100s". Stock trading generally takes place in units of
100 shares and is tabulated that way; the figures mean, for example, that
90,900 shares of Consolidated Edison, 1,192,400 shares of General Electric,
and 1,571,300 shares of Mobil traded on January 8. (Mobil actually was the
12th "most active" stock on the NYSE that day, meaning that it ranked 12th
in number of shares traded.)
The next three columns show the highest price for the day, the lowest,
and the last or "closing" price. The "Net Chg." (net change) column to the
far right shows how the closing price differed from the previous day's
closeЧin this case, January 7.
Prices are traditionally calibrated in eighths of a dollar. In case you
aren't familiar with the equivalents, they are:
Con Edison traded on January 8 at a high of $49.375 per share and a low
of $48 875, it closed at $49.25, which was a gain of $0.25 from the day
before. General Electric closed down $1.00 per share at $90 00, but it
earned a "u" notation by trading during the day at $91 375, which was a new
high price for the stock during the most recent 52 weeks (a new low price
would have been denoted by a "d").
The two columns to the far left show the high and low prices recorded
in the latest 52 weeks, not including the latest day. (Note that the high
for General Electric is shown as 91 1/8, not 91 3/8.) You will note that
while neither Con Edison nor Mobil reached a new high on January 8, each
was near the top of its "price range" for the latest 52 weeks. (Individual
stock price charts, which are published by several financial services,
would show the price history of each stock in detail.)
The other three columns in the table give you information of use in
making judgments about stocks as investments. Just to the right of the
name, the "Div." (dividend) column shows the current annual dividend rate
on the stock Ч or, if there's no clear regular rate, then the actual
dividend total for the latest 12 months. The dividend rates shown here are
$2.68 annually for Con Edison, $2.52 for GE, and $2.20 for Mobil. (Most
companies that pay regular dividends pay them quarterly: it's actually
$0.67 quarterly for Con Edison, etc.) The "Yid." (Yield) column relates tie
annual dividend to the latest stock price. In the case of Con Edison, for
example, $2.68 (annual dividend)/$49.25 (stock price) ==5.4%, which
represents the current yield on the stock.
5.1 The Price-Earnings Ratio
Finally, we have the "P-E ratio", or price-earnings ratio, which
represents a key figure in judging the value of a stock. The price-earnings
ratioЧalso referred to as the "price-earnings multiple", or sometimes
simply as the "multiple"Чis the ratio of the price of a stock to the
earnings per share behind the stock.
This concept is important. In simplest terms (and without taking
possible complicating factors into account), "earnings per share" of a
company are calculated by taking the company's net profits for the year,
and dividing by the number of shares outstanding. The result is, in a very
real sense, what each share earned in the business for the year Ч not to be
confused with the dividends that the company may or may not have paid out.
The board of directors of the company may decide to plow the earnings back
into the business, or to pay them out to shareholders as dividends, or
(more likely) a combination of both; but in any case, it is the earnings
that are usually considered as the key measure of the company's success and
the value of the stock.
The price-earnings ratio tells you a great deal about how investors
view a stock. Investors will bid a stock price up to a higher multiple if a
company's earnings are expected to grow rapidly in the future. The multiple
may look too high in relation to current earnings, but not in relation to
expected future earnings. On the other hand, if a company's future looks
uninteresting, and earnings are not expected to grow substantially, the
market price will decline to a point where the multiple is low.
Multiples also change with the broad cycles of the stock market, as
investors become willing to pay more or less for certain values and
potentials. Between 1966 and 1972, a period of enthusiasm and speculation,
the average multiple was usually 15 or higher. In the late 1970s, when
investors were generally cautious and skeptical, the average multiple was
below 10. However, note that these figures refer to average
multiplesЦwhatever the average multiple is at any given time, the multiples
on individual stocks will range above and below it.
Now we can return to the table. The P-E ratio for each stock is based
on the latest price of the stock and on earnings for the latest reported 12
months. The multiples, as you can see, were 12 for Con Edison, 17 for GE,
and 10 for Mobil. In January 1987, the average multiple for all stocks was
very roughly around 15. Con Edison is viewed by investors as a relatively
good-quality utility company, but one that by the nature if its business
cannot grow much more rapidly that the economy as a whole. GE, on the other
hand, is generally given a premium rating as a company that is expected to
outpace the economy.
You can't buy a stock on the P-E ratio alone, but the ratio tells you
much that is useful. For stocks where no P-E ratio is shown, it often means
that the company showed a loss for the latest 12 months, and that no P-E
ratio can be calculated. Somewhere near the main NYSE table, you'll find a
few small tables that also relate to the day's NYSE-Composite trading.
There's the table showing the 15 stocks that traded the greatest number of
shares for the day (the "most active" list), a table of the stocks that
showed the greatest percentage of gains or declines (low-priced stocks
generally predominate here); and one showing stocks that made new price
highs or lows relative to the latest 52 weeks.
You'll find a large table of "American Stock Exchange Composite
Transactions", which does for stocks listed on the AMEX just what the NYSE-
Composite table does for NYSE-listed stocks. There are smaller tables
covering the Pacific Stock Exchange, Boston Exchange, and other regional
The tables showing over-the-counter stock trading are generally divided
into two or three sections. For the major over-the-counter stocks covered
by the NASDAQ quotation and reporting system, actual sales for the day are
reported and tabulated just as for stocks on the NYSE and AMEX. For less
active over-the-counter stocks, the paper lists only "bid" and "asked"
prices, as reported by dealers to the NASD.
It is worth becoming familiar with the daily table of prices of U.S.
Treasury and agency securities. The Treasury issues are shown not only in
terms of price, but in terms of the yield represented by the current price.
This is the simplest way to get a bird's-eye view of the current interest
rate situationЧyou can see at a glance the current rates on long-term
Treasury bonds, intermediate-term notes, and short-term bills.
Elsewhere in the paper you will also find a large table showing prices
of corporate bonds traded on the NYSE, and a small table of selected tax-
exempt bonds (traded OTC). But unless you have a specific interest in any
of these issues, the table of Treasury prices is the best way to follow the
There are other tables listed. These are generally for more experienced
investors and those interested in taking higher risks. For example, there
are tables showing the trading on several different exchanges in listed
optionsЧprimarily options to buy or sell common stocks (call options and
put options). There are futures pricesЧ commodity futures and also interest
rate futures, foreign currency futures, and stock index futures. There are
also options relating to interest rates and options relating to the stock
6. EUROPEAN STOCKMARKETSЦGENERAL TREND
Competition among EuropeТs securities exchanges is fierce. Yet most
investors and companies would prefer fewer, bigger markets. If the
exchanges do not get together to provide them, electronic usurpers will.
How many stock exchanges does a Europe with a single capital market
need? Nobody knows. But a part-answer is clear: fewer than it has today.
America has eight stock exchanges, and seven futures and options exchanges.
Of these only the New York Stock Exchange, the American Stock Exchange,
NASDAQ (the over-the-counter market), and the two Chicago futures exchanges
have substantial turnover and nationwide pretensions.
The 12 member countries of the European Community (EC), in contrast,
boast 32 stock exchanges and 23 futures and options exchanges. Of these,
the market in London, Frankfurt, Paris, Amsterdam, Milan and MadridЦat
leastЦaspire to significant roles on the European and world stages. And the
number of exchanges is growing. Recent arrivals include exchanges in Italy
and Spain. In eastern Germany, Leipzig wants to reopen the stock exchange
that was closed in 1945.
Admittedly, the EC is not as integrated as the United States. Most
intermediaries, investors and companies are still national rather than pan-
European in character. So is the job of regulating securities markets;
there is no European equivalent of AmericaТs Securities and Exchange
Commission (SEC). Taxes, company law and accounting practices vary widely.
Several regulatory barriers to cross-border investment, for instance by
pension funds, remain in place. Recent turmoil in EuropeТs exchange rate
mechanics has reminded cross0border investors about currency risk. Despite
the Maastricht treaty, talk of a common currency is little more than that
Yet the local loyalties that sustain so many European exchanges look
increasingly out-of-date. Countries that once had regional stock exchanges
have seen them merged into one. A single European market for financial
services is on its way. The EC's investment services directive, which
should come into force in 1996, will permit cross-border stockbroking
without the need to set up local subsidiaries. Jean-Francois Theodore,
chairman of the Paris Bourse, says this will lead to another European Big
Bang. And finance is the multinational business par excellence: electronics
and the end of most capital controls mean that securities traders roam not
just Europe but the globe in search of the best returns.
This affects more than just stock exchanges. Investors want financial
market that are cheap, accessible and of high liquidity (the ability to buy
or sell shares without moving the price). Businesses, large and small, need
a capital market in which they can raise finance at the lowest possible
cost If European exchanges do not meet these requirements, Europe's economy
In the past few years the favoured way of shaking up bourses has been
competition. The event that triggered this was London's Big Bang in October
1986, which opened its stock exchange to banks and foreigners, and
introduced a screen-plus-telephone system of securities trading known as
SEAQ. Within weeks the trading floor had been abandoned. At the time, other
European bourses saw Big Bang as a British eccentricity. Their markets
matched buy and sell orders (order-driven trading), whereas London is a
market in which dealers quote firm prices for trades (quote-driven
trading). Yet many continental markets soon found themselves forced to copy
That was because Big Bang had strengthened London's grip on
international equity-trading. SEAQ's international arm quickly grabbed
chunks of European business. Today the London exchange reckons to handle
around 95% of all European cross-border share-trading It claims to handle
three-quarters of the trading in blue-chip shares based in Holland, half of
those in France and Italy and a quarter of those in GermanyЧthough, as will
become clear, there is some dispute about these figures.
London's market-making tradition and the presence of many international
fund managers helped it to win this business. So did three other factors.
One was stamp duties on share deals done in their home countries, which
SEAQ usually avoided. Another was the shortness of trading hours on
continental bourses. The third was the ability of SEAQ, with market-makers
quoting two-way prices for business in large amounts, to handle trades in
big blocks of stock that can be fed through order-driven markets only when
they find counterparts.
A similar tussle for business has been seen among the exchanges that
trade futures and options. Here, the market which first trades a given
product tends to corner the business in it. The European Options Exchange
(EOE) in Amsterdam was the first derivatives exchange in Europe; today it
is the only one to trade a European equity-index option. London's LIFFE,
which opened in 1982 and is now Europe's biggest derivatives exchange, has
kept a two-to-one lead in German government-bond futures (its most active
contract) over Frankfurt's DTB, which opened only in 1990. LIFFE competes
with several other European exchanges, not always successfully: it lost the
market in ecu-bond futures to Paris's MATIF.
European exchanges armoured themselves for this battle in three ways.
The first was to fend off foreign competition with rules. In three years of
wrangling over the EC's investment-services directive, several member-
countries pushed for rules that would require securities to be traded only
on a recognized exchange. They also demanded rules for the disclosure of
trades and prices that would have hamstrung SEAQ's quote-driven trading
system. They were beaten off in the eventual compromise, partly because
governments realized they risked driving business outside the EC. But
residual attempts to stifle competition remain. Italy passed a law in 1991
requiring trades in Italian shares to be conducted through a firm based in
Italy. Under pressure from the European Commission, it may have to repeal
6.1 New Ways for Old
The second response to competition has been frantic efforts by bourses
to modernize systems, improve services and cut costs. This has meant
investing in new trading systems, improving the way deals are settled, and
pressing governments to scrap stamp duties. It has also increasingly meant
trying to beat London at its own game, for instance by searching for ways
of matching London's prowess in block trading.
Paris, which galvanized itself in 1988, is a good example. Its bourse
is now open to outsiders. It has a computerized trading system based on
continuous auctions, and settlement of most of its deals is computerized.
Efforts to set up a block-trading mechanism continue, although slowly.
Meanwhile, MATIF, the French futures exchange, has become the continent's
biggest. It is especially proud of its ecu-bond contract, which should grow
in importance if and when monetary union looms.
Frankfurt, the continent's biggest stock-market, has moved more
ponderously, partly because Germany's federal system has kept regional
stock exchange in being, and left much of the regulation of its markets at
Land (state) level. Since January 1st 1993 all German exchanges (including
the DTB) have been grouped under a firm called Deutsche Borse AG, chaired
by Rolf Breuer, a member of Deutsche BankТs board. But there is still some
way to go in centralizing German share-trading. German floor brokers
continue to resist the inroads made by the bankТs screen-based IBIS trading
system. A law to set up a federal securities regulator (and make insider-
dealing illegal) still lies becalmed in Bonn.
Other bourses are moving too. Milan is pushing forward with screen-
based trading and speeding up its settlement. Spain and Belgium are
reforming their stock-markets and launching new futures exchanges.
Amsterdam plans an especially determined attack on SEAQ. It is implementing
a McKinsey report that recommended a screen-based system for wholesale
deals, a special mechanism for big block trades and a bigger market-making
role for brokers.
Ironically, London now finds itself a laggard in some respects. Its
share settlement remains prehistoric; the computerized project to modernize
it has just been scrapped. The SEAQ trading system is falling apart; only
recently has the exchange, belatedly, approves plans draw up by Arthur
Andersen for a replacement, and there is plenty of skepticism in the City
about its ability to deliver. Yet the exchangeТs claimed figures for its
share of trading in continental equities suggest that London is holding up
well against its competition.
Are these figures correct? Not necessarily: deals done through an agent
based in London often get counted as SEAQ business even when the
counterpart is based elsewhere and the order has been executed through a
continental bourse. In todayТs electronic age, with many firms members of
most European exchanges, the true location of a deal can be impossible to
pin down. Continental bourses claim, anyway, to be winning back business
lost to London.
Financiers in London agree that the glory-days of SEAQТs international
arm, when other European exchanges were moribund, are gone. Dealing in
London is now more often a complement to, rather than a substitute for,
dealing at home. Big blocks of stock may be bought or sold through London,
but broken apart or assembled through local bourses. Prices tend to be
derived from the domestic exchanges; it is notable that trading on SEAQ
drops when they are closed. Baron van Ittersum, chairman of the Amsterdam
exchange, calls this the УqueenТs birthday effectФ: trading in Dutch
equities in London slows to a trickle on Dutch public holidays.
Such competition-through-diversity has encourage European exchanges to
cut out the red tape that protected their members from outside competition,
to embrace electronics, and to adapt themselves to the wishes of investors
and issuers. Yet the diversity may also have had a cost in lower liquidity.
Investors, especially from outside Europe, are deterred if liquidity
remains divided among different exchanges. Companies suffer too: they
grumble about the costs of listing on several different markets.
So the third response of EuropeТs bourses to their battle has been pan-
European co-operative ventures that could anticipate a bigger European
market. There are more wishful words here than deeds. Work on two joint EC
projects to pool market information, Pipe and Euroquote, was abandoned,
thanks mainly to hostility from Frankfurt and London. Eurolist, under which
a company meeting the listing requirements for one stock exchange will be
entitled to a listing on all, is going forwardЦbut this is hardly a single
market. As ParisТs Mr Theodore puts it, "there is a compelling business
case for the big European exchanges building the European-regulated market
of to-morrow" Sir Andrew Hugh-Smith, chairman of the London exchange has
also long advocated one European market for professional investors
One reason little has been done is that bourses have been coping with
so many reforms at home. Many wanted to push these through before thinking
about Europe. But there is also atavistic nationalism. London, for example,
is unwilling to give up the leading role it has acquired in cross-border
trading between institutions; and other exchanges are unwilling to accept
that it keeps it. Mr. Theodore says there is no future for the European
bourses if they are forced to row in a boat with one helmsman. Amsterdam's
Baron van Ittersum also emphasises that a joint European market must not be
one under London's control.
Hence the latest, lesser notion gripping Europe's exchanges: bilateral
or multilateral links. The futures exchanges have shown the way. Last year
four smaller exchanges led by Amsterdam's EOE and OM, an options exchange
based in Sweden and London, joined together in a federation called FEX In
January of this year the continent's two biggest exchanges, MATIF and the
DTB, announced a link-up that was clearly aimed at toppling London's LIFFE
from its dominant position Gerard Pfauwadel, MATIF's chairman, trumpets the
deal as a precedent for other European exchanges. Mr Breuer, the Deutsche
Borse's chairman, reckons that a network of European exchanges is the way
forward, though he concedes that London will not warm to the idea. The
bourses of France and Germany can be expected to follow the MATIF/DTB lead.
It remains unclear how such link-ups will work, however. The notion is
that members of one exchange should be able to trade products listed on
another. So a Frenchman wanting to buy German government-bond futures could
do so through a dealer on MATIF, even though the contract is actually
traded in Frankfurt. That is easy to arrange via screen-based trading: all
that are needed are local terminals. But linking an electronic market such
as the DTB to a floorbased market with open-outcry trading such as MATIF is
harder Nor have any exchanges thought through an efficient way of pooling
their settlement systems
In any case, linkages and networks will do nothing to reduce the
plethora of European exchanges, or to build a single market for the main
European blue-chip stocks. For that a bigger joint effort is needed It
would not mean the death of national exchanges, for there will always be
business for individual investors, and in securities issued locally Mr
Breuer observes that ultimately all business is local. Small investors will
no doubt go on worrying about currency
risk unless and until monetary union happens. Yet large wholesale
investors are already used to hedging against it. For them, investment in
big European blue-chip securities would be much simpler on a single
wholesale European market, probably subject to a single regulator
More to the point, if investors and issuers want such a market, it will
emergeЧwhether today's exchanges provide it or not. What, after all, is an
exchange? It is no more than a system to bring together as many buyers and
sellers as possible, preferably under an agreed set of rules. That used to
mean a physically supervised trading floor. But computers have made it
possible to replicate the features of a physical exchange electronically.
And they make the dissemination of prices and the job of applying rules to
a market easier.
Most users of exchanges do not know or care which exchange they are
using: they deal through brokers or dealers. Their concern is to deal with
a reputable firm such as S. G. Warburg, Gold-man Sachs or Deutsche Bank,
not a reputable exchange. Since big firms are now members of most
exchanges, they can choose where to trade and where to resort to off-
exchange dealsЧwhich is why there is so much dispute over market shares
within Europe This fluidity creates much scope for new rivals to undercut
established stock exchanges.
6.2 Europe, Meet Electronics
Consider the experience of the New York Stock Exchange, which has
remained stalwartly loyal to its trading floor. It has been losing business
steadily for two decades, even in its own listed stocks. The winners have
included NASDAQ and cheaper regional exchanges. New York's trading has also
migrated to electronic trading systems, such as Jeffries & Co's Posit,
Reuters's Instinct and Wunsch (a computer grandly renamed the Arizona Stock
Something similar may happen in Europe. OM, the Swedish options
exchange, has an electronic trading system it calls Click. It recently
renamed itself the London Securities and Derivatives Exchange. Its chief
executive, Lynton Jones, dreams of offering clients side-by-side on a
screen a choice of cash products, options and futures, some of them
customised to suit particular clients The Chicago futures exchanges,
worried like all established exchanges about losing market share, have
recently launched "flex" contracts that combine the virtues of homogeneous
exchange-traded products with tailor-made over-the-counter ones.
American electronic trading systems are trying to break into European
markets with similarly imaginative products Instinet and Posit are already
active, though they have had limited success so far. NASDAQ has an
international arm in Europe. And there are homegrown systems, too.
Tradepoint, a new electronic order-driver trading system for British
equities, is about to open in London. Even bond-dealers could play a part.
Their trade association, ISMA, is recognized British exchange for trading
in Eurobonds; it has a computerized reporting system known as TRAX; most of
its members use the international clearing-houses Euroclear and Cedel for
trade settlement. It would not be hard for ISMA to widen its scope to
include equities or futures and options. The association has recently
announced a link with the Amsterdam Stock Exchange.
Electronics poses a threat to established exchanges that they will
never meet by trying to go it alone. A single European securities market
(or derivatives market) need not look like an established stock exchange at
all. It could be a network of the diverse trading and settlement systems
that already exists, with the necessary computer terminals scattered across
the EC. It will need to be regulated at the European level to provide
uniform reporting; an audit trail to allow deals to be retraced from seller
to buyer; and a way of making sure that investors can reach the market
makers offering the best prices. Existing national regulators would prefer
to do all this through co-operation; but some financiers already talk of
need for a European SEC. An analogy is European civil aviationТs reluctant
inching towards a European system of air-traffic control.
Once a Europe-wide market with agreed regulation is in place,
competition will window out the winners and losers among the member-
bourses, on the basis of services and cost, or of the rival charms of the
immediacy and size of quote-driven trading set against the keener prices of
order-driven trading. Not a cosy prospect; but if the ECТs existing
exchanges do not submit to such a European framework, other artists will
step in to deny them the adventure.
7. NEW ISSUES
Up to now, we have talked about the function of securities markets as
trading markets, where one investor who wants to move out of a particular
investment can easily sell to another investor who wishes to buy. We have
not talked about another function of the securities markets, which is to
raise new capital for corporationsЦand for the federal government and state
and local governments.
When you buy shares of stock on one of the exchanges, you are not
buying a Уnew issueФ. In the case of an old established company, the stock
may have been issued decades ago, and the company has no direct interest in
your trade today, except to register the change in ownership on its books.
You have taken over the investment from another investor, and you know that
when you are ready to sell, another investor will buy it from you at some
New issues are different. You have probably noticed the advertisements
in the newspaper financial pages for new issues of stocks or bondsЦlarge
advertising which, because of the very tight restrictions on advertising
new issues, state virtually nothing except the name of the security, the
quantity being offered, and the names of the firms which are УunderwritingФ
the security or bringing it to market.
Sometimes there is only a single underwriter; more often, especially if
the offering is a large one, many firms participate in the underwriting
group. The underwriters plan and manage the offering. They negotiate with
the offering company to arrive at a price arrangement which will be high
enough to satisfy the company but low enough to bring in buyers. In the
case of untested companies, the underwriters may work for a prearranged
fee. In the case of established companies, the underwriters usually take on
a risk function by actually buying the securities from the company at a
certain price and reoffering them to the public at a slightly higher price;
the difference, which is usually between 1% and 7%, is the underwritersТ
profit. Usually the underwriters have very carefully sounded out the demand
is disappointingЦor if the general market takes a turn for the worse while
the offering is under wayЦthe underwriters may be left with securities that
canТt be sold at the scheduled offering price. In this case the
underwriting УsyndicateФ is dissolved and the underwriters sell the
securities for whatever they can get, occasionally at a substantial loss.
The new issue process is critical for the economy. ItТs important that
both old and new companies have the ability to raise additional capital to
meet expanding business needs. For you, the individual investor, the area
may be a dangerous one. If a privately owned company is Уgoing publicФ for
the fist time by offering securities in the public market, it is usually
does so at a time when its earnings have been rising and everything looks
particularly rosy. The offering also may come at a time when the general
market is optimistic and prices are relatively high. Even experienced
investors can have great difficulty in assessing the real value of a new
offering under these conditions.
Also, it may be hard for your broker to give you impartial advice. If
the brokerage firm is in the underwriting group, or in the Уselling groupФ
of dealers that supplements the underwriting group, it has a vested
interest in seeing the securities sold. Also, the commissions are likely to
be substantially higher than on an ordinary stock. On the other hand, if
the stock is a Уhot issueФ in great demand, it may be sold only through
small individual allocations to favored customers (who will benefit if the
stock then trades in the open market at a price well above the fixed
If you are considering buying a new issue, one protective step you can
take is to read the prospectus The prospectus is a legal document
describing the company and offering the securities to the public. Unless
the offering is a very small one, it can't be made without passing through
a registration process with the SEC. The SEC can't vouch for the value of
the offering, but it does act to make sure that essential facts about the
company and the offering are disclosed in the prospectus.
This requirement of full disclosure was part of the securities laws of
the 1930s and has been a great boon to investors and to the securities
markets. It works because both the underwriters and the offering companies
know that if any material information is omitted or misstated in the
prospectus, the way is open to lawsuits from investors who have bought the
In a typical new offering, the final prospectus isn't ready until the
day the securities are offered. But before that date you can get a
"preliminary prospectus" or "red herring"Чso named because it carries red
lettering warning that the prospectus hasn't yet been cleared by the SEC as
meeting disclosure requirements
The red herring will not contain the offering price or the final
underwriting arrangements But it will give you a description of the
company's business, and financial statements showing just what the
company's growth and profitability have been over the last several years It
will also tell you something about the management. If the management group
is taking the occasion to sell any large percentage of its stock to the
public, be particularly wary.
It is a very different case when an established public company is
selling additional stock to raise new capital. Here the company and the
stock have track records that you can study, and it's not so difficult to
make an estimate of what might be a reasonable price for the stock The
offering price has to be close to the current market price, and the
underwriters' profit margin will generally be smaller But you still need to
be careful. While the SEC has strict rules against promoting any new
offering, the securities industry often manages to create an aura of
enthusiasm about a company when an offering is on the way On the other
hand, the knowledge that a large offering is coming may depress the market
price of a stock, and there are times when the offering price turns out to
have been a bargain
New bond offerings are a different animal altogether. The bond markets
are highly professional, and there is nothing glamorous about a new bond
offering. Everyone knows that a new A-rated corporate
bond will be very similar to all the old A-rated bonds. In fact, to
sell the new issue effectively, it is usually priced at a slightly higher
"effective yield" than the current market for comparable older bondsЧeither
at a slightly higher interest rate, or a slightly lower dollar price, or
both. So for a bond buyer, new issues often offer a slight price advantage.
What is true of corporate bonds applies also to U.S. government and
municipal issues. When the Treasury comes to market with a new issue of
bonds or notes (a very frequent occurrence), the new issue is priced very
close to the market for outstanding (existing) Treasury securities, but the
new issue usually carries a slight price concession that makes it a good
buy. The same is true of bonds and notes brought to market by state and
local governments; if you are a buyer of municipals, these new offerings
may provide you with modest price concessions. If the quality is what you
want, there's no reason you shouldn't buy themЧeven if your broker makes a
little extra money on the deal.
8. MUTUAL FUNDS. A DIFFERENT APPROACH
Up until now, we have described the ways in which securities are bought
directly, and we have discussed how you can make such investments through a
But a brokerage account is not the only way to invest. For many
investors, a brokerage has disadvantagesЦthe difficulty of selecting an
individual broker, the commission costs (especially on small transactions),
and the need to be involved in decisions that many would prefer to leave to
professionals. For people who feel this way, there is an excellent
alternative availableЧmutual funds.
It isn't easy to manage a small investment account effectively. A
mutual fund gets around this problem by pooling the money of many investors
so that it can be managed efficiently and economically as a single large
unit. The best-known type of mutual fund is probably the money market fund,
where the pool is invested for complete safety in the shortest-term income-
producing investments. Another large group of mutual funds invest in common
stocks, and still others invest in long-term bonds, tax-exempt securities,
and more specialized types of investments.
The mutual fund principle has been so successful that the funds now
manage over $400 billion of investors' moneyЧnot including over $250
billion in the money market funds.
8.1 Advantages of Mutual Funds
Mutual funds have several advantages. The first is professional
management. Decisions as to which securities to buy, when to buy and when
to sell are made for you by professionals. The size of the pool makes it
possible to pay for the highest quality management, and many of the
individuals and organizations that manage mutual funds have acquired
reputations for being among the finest managers in the profession.
Another of the advantages of a mutual fund is diversification. Because
of the size of the fund, the managers can easily diversify its investments,
which means that they can reduce risk by spreading the total dollars in the
pool over many different securities. (In a common stock mutual fund, this
means holding different stocks representing many varied companies and
The size of the pool gives you other advantages. Because the fund buys
and sells securities in large amounts, commission costs on portfolio
transactions are relatively low And in some cases the fund can invest in
types of securities that are not practical for the small investor.
The funds also give you convenience First, it's easy to put money in
and take it out The funds technically are "open-end" investment companies,
so called because they stand ready to sell additional new shares to
investors at any time or buy back ("redeem") shares sold previously You can
invest in some mutual funds with as little as $250, and your investment
participates fully in any growth in value of the fund and in any dividends
paid out. You can arrange to have dividends reinvested automatically.
If the fund is part of a larger fund group, you can usually arrange to
switch by telephone within the funds in the groupЧsay from
a common stock fund to a money market fund or tax-exempt bond fund, and
back again at will. You may have to pay a small charge for the switch. Most
funds have toll-free "800" numbers that make it easy to get service and
have your questions answered.
8.2 Load vs. No-load
There are "load" mutual funds and "no-load" funds. A load fund is
bought through a broker or salesperson who helps you with your selection
and charges a commission ("load")Чtypically (but not always) 8.5% of the
total amount you invest. This means that only 91.5% of the money you invest
is actually applied to buy shares in the pool. You choose a no-load fund
yourself without the help of a broker or salesperson, but 100% of your
investment dollars go into the pool for your account.
Which are betterЧload or no-load funds? That really depends on how much
time and effort you want to devote to fund selection and supervision of
your investment. Some people have neither the time, inclination nor
aptitude to devote to the taskЧfor them, a load fund may be the answer. The
load may be well justified by long-term results if your broker or
salesperson helps you invest in a fund that performs outstandingly well.
In recent years, some successful funds that were previously no-load
have introduced small sales charges of 2% or 3%. Often, these "low-load"
funds are still grouped together with the no-loads, you generally still buy
directly from the fund rather than through a broker. If you are going to
buy a high-quality fund and hold it a number of years, a 2% or 3% sales
charge shouldn't discourage you.
8.3 Common Stock Funds
Apart from the money market funds, common stock funds make up the
largest and most important fund group. Some common stock funds take more
risk and some take less, and there is a wide range of funds available to
meet the needs of different investors.
When you see funds "classified by objective", the classifications are
really according to the risk of the investments selected, though the word
"risk" doesn't appear in the headings. "Aggressive growth" or "maximum
capital gain" funds are those that take the greatest risks in pursuit of
maximum growth. "Growth" or "long-term growth" funds may be a shade lower
on the risk scale. "Growth-income" funds are generally considered middle-of-
the-road. There are also common stock "income" funds, which try for some
growth as well as income, but stay on the conservative side by investing
mainly in established companies that pay sizable dividends to their owners.
These are also termed "equity income" funds, and the best of them have
achieved excellent growth records.
Some common stock funds concentrate their investments in particular
industries or sectors of the economy. There are funds that invest in energy
or natural resource stocks; several that invest in gold-mining stocks,
others that specialize in technology, health care, and other fields.
Formation of this type of specialized or "sector" fund has been on the
8.4 Other Types of Mutual Funds
There are several types of mutual funds other than the money market
funds and common stock funds. There are a large number of bond funds,
investing in various assortments of corporate and government bonds There
are tax-exempt bond funds, both long-term and shorter-term, for the high-
bracket investor There are "balanced" funds which maintain portfolios
including both stocks and bonds, with the objective of reducing risk And
there are specialized funds which invest in options, foreign securities,
8.5 The Daily Mutual Fund Prices
One advantage of a mutual fund is the ease with which you can follow a
fund's performance and the daily value of your investment. Every day,
mutual fund prices are listed in a special table in the financial section
of many newspapers, including the Wall Street Journal. Stock funds and bond
funds are listed together in a single alphabetical table, except that funds
which are part of a major fund group are usually listed under the group
heading (Dreyfus, Fidelity, Oppenheimer, Vanguard, etc.).
The listings somewhat resemble those for inactive over-the-counter
stocks. But instead of "bid" and "asked", the columns are usually headed
"NAV" and "Offer Price". "NAV" is the net asset value per share of the
fund. it is each share's proportionate interest in the total market value
of the fund's portfolio of securities, as calculated each night It is also,
generally, the price per share at which the fund redeemed (bought back)
shares submitted on that day by shareholders who wished to sell The "Offer
Price" (offering price) column shows the price paid by investors who bought
shares from the fund on that day. In the case of a load fund, this price is
the net asset value plus the commission 01 "load" In the case of a no-load
fund, the symbol "N.L." appears in the offering price column, which means
that shares of the fund were sold to investors at net asset value per
share, without commission. Finally, there is a column on the far right
which shows the change in net asset value compared with the previous day.
8.6 Choosing a Mutual Fund
Very few investments of any type have surpassed the long-term growth
records of the best-performing common stock funds. It may help to say more
about how you can use these funds.
If you intend to buy load funds through a broker or fund salesperson,
you may choose to rely completely on this person's recommendations. Even in
this case, it may be useful to know something about sources of information
on the funds.
If you have decided in favor of no-load funds and intend to make your
own selections, some careful study is obviously a necessity. The more you
intend to concentrate on growth and accept the risks that go with it, the
more important it is that you entrust your money only to high-quality,
There are several publications that compile figures on mutual fund
performance for periods as long as 10 or even 20 years, with emphasis on
common stock funds. One that is found in many libraries is the Wiesenberger
Investment Companies Annual Handbook. The Wiesen-berger Yearbook is the
bible of the fund industry, with extensive descriptions of funds, all sorts
of other data, and plentiful performance statistics. You may also have
access to the Lipper Mutual Fund Performance Analysis, an exhaustive
service subscribed to mainly by professionals. It is issued weekly, with
special quarterly issues showing longer-term performance. On the
newsstands, Money magazine publishes regular surveys of mutual fund
performance; Barren's weekly has quarterly mutual fund issues in mid-
February, May, August and November; and Forbes magazine runs an excellent
annual mutual fund survey issue in August.
These sources (especially Wiesenberger) will also give you description
of the funds, their investment policies and objectives. When you have
selected several funds that look promising, call each fund (most have toll-
free "800" numbers) to get its prospectus and recent financial reports. The
prospectus for a mutual fund plays the same role as that described in "New
Issues." It is the legal document describing the fund's history and
policies and offering the fund's shares for sale. It may be dry reading,
but the prospectus and financial reports together should give you a picture
of what the fund is trying to do and how well it has succeeded over the
latest 10 years.
In studying the records of the funds, and in requesting material, don't
necessarily restrict yourself to a single "risk" group. The best investment
managers sometimes operate in ways that aren't easily classified. What
counts is the individual fund's record.
Obviously, you will want to narrow your choice to one or more funds
that have performed well in relation to other funds in the same risk group,
or to other funds in general. But don't rush to invest in the fund that
happens to have performed best in the previous year; concentrate on the
record over five or ten years. A fund that leads the pack for a single year
may have taken substantial risks to do so. But a fund that has made its
shareholders' money grow favorably over a ten-year period, covering both up
and down periods in the stock market, can be considered well tested. ItТs
also worth looking at the year-to-year record to see how consistent
management has been.
You will note that the range of fund performance over most periods is
quite wide. DonТt be surprised. As we have stressed, managing investments
is a difficult art. Fund managers are generally experienced professionals,
but their records have nevertheless ranged from remarkably good to mediocre
and, in a few cases, quite poor. Pick carefully.