One of history's top-selling investment guides--800,000 copies sold!--is now updated for a new generation of investors
Praise for previous editions of Understanding Wall Street:
"One of those rare publications that delivers exactly what it promises . . .consistently good."
"Among the best for the novice investor."
--Los Angeles Times
"A good practical education on the stock market."
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Over the past quarter century, Understanding Wall Street has helped investors at every level understand exactly how the stock market works, and how they can build strong portfolios while limiting their exposure to risk. Now completely updated to help investors prosper in the new, no-limits market environment, the "little green book" includes:
- Two all-new chapters, updated charts and graphs, and nearly 40 percent updated, revised, or new material
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About the Author
Jeffrey B. Little has been a stock market professional for four decades, and currently writes and publishes Wall Street books and software. Formerly a senior analyst with Morgan Stanley and vice president with T. Rowe Price Associates, he also wrote The Great Index Mania.
Read an Excerpt
Understanding Wall Street
By Jeffrey B. Little, Lucien Rhodes
The McGraw-Hill Companies, Inc.Copyright © 2004Jeffrey B. Little
All rights reserved.
What is a share of stock?
Introduction Every business day millions of shares of stock are bought and sold. How did these shares originate and how are the prices determined? For shares to be traded from one person to another, a company must be created. How does it begin? Where does the money come from?
In this chapter, the New-Design Chair Company is born and its officers confront the problems all successful corporations must solve. Directors are elected, shares are issued, profits are reinvested into the business, and dividends are declared. In the process, the reader will see capitalism at work and will gain an appreciation for a system that has produced the most advanced economy in the world.
The New-Design Chair Company
Charlie, a young inventor, has just built a new light weight, folding chair having a superior design. Encouraged by family and friends, he decides to turn his hobby of building chairs into a full-time business rather than sell his patents to a large furniture company.
Although Charlie has savings that could be put into the venture, the amount is far short of the total capital necessary. He estimates the total cost of the factory, machinery, and initial money needed for product inventory to be approximately $2 million.
These "assets" (the factory, machinery, inventory, and remaining capital) would be used to produce the chairs and maintain the new business. The more chairs Charlie can produce using these assets, the more profitable the business would be.
Charlie has calculated that if he could make and sell at least 100,000 chairs annually, it would cost about $20 to manufacture each chair. In addition, he estimates the sales and marketing expenses for each chair to be roughly $10. Since each new chair would be sold to his customers at the competitive price of $35, his profit (before paying federal, state, and local taxes) would be $5 per chair.
Charlie believes his new enterprise would be beneficial in several ways. Thousands would enjoy using the new chairs, many people in his community would be earning a living by making and selling the chairs and the business would also contribute to the welfare of his community, state, and country through the payment of taxes. If Charlie could, indeed, manufacture and sell 100,000 chairs, this activity would no longer be a hobby; it would be a sizable business.
Now Charlie faces a major problem. Where will he get almost $2 million for the factory, machinery, and working capital? He is unable to borrow such a large amount without collateral.
He decides to find others, frequently called "venture capitalists," who might also see the potential for his idea and be willing to risk some capital to get the venture started. To interest others, Charlie must divide his new business into smaller pieces to give them some ownership. Charlie realizes, too, that by relinquishing some ownership, he would no longer be entitled to all the profits.
However, he is willing to do this to secure the help of others.
After exploring the advantages and disadvantages of the various legal forms of businesses, he decides to establish a "corporation." The principal reason for choosing a corporation rather than a partnership or any other form was financial liability. Charlie learned that no matter which legal structure is used, creditors always have first claim on the assets if the business fails. However, a corporation, as a legal entity, limits the financial risk of the owners to the amount of capital invested. In other words, stockholders of a corporation are not liable for more than they invest.
Charlie forms the corporation under the laws of the state, names it the "New- Design Chair Company," and selects a few individuals to act as the board of directors until the first annual meeting of stockholders. At that time, a board of directors will be formally elected by the stockholders. The directors decide to "issue" 250,000 shares of stock of the 400,000 total possible shares authorized by the company's founding charter (when the company was organized this was the number determined to be the most convenient for the company's needs). The 250,000 shares are divided between Charlie and the venture capitalists in proportion to their agreed ownership, determined by the contribution of each. Charlie still owns a meaningful amount because of his importance to the company, his chair patents, and his initial capital. Now it can be said they are, indeed, "stockholders in common."
Each stockholder is a part owner in the company although the extent of ownership depends upon the number of shares held (an individual who holds 50 shares of the total 250,000 shares issued owns 1/5000th of the entire company, whereas a person who has 10,000 shares owns 1/25th of the company). The remaining 150,000 shares might be issued by the directors at a later date if the company finds it necessary. However, at the present time, the company's ownership is divided into 250,000 pieces. In other words, there are currently 250,000 shares outstanding of 400,000 shares authorized.
The members of the board of directors, including Charlie, are elected by these stockholders to oversee the affairs of the company. Each share outstanding, according to the company's charter, is entitled to an equal vote in the annual election of the directors.
The New-Design Chair Company is now a "private" corporation owned solely by its small group of founders. However, later, they might allow the public to participate. If so, stock would be sold to these new investors through the company's "Initial Public Offering" (or "IPO"). But, first, a "track record" needs to be established before "going public."
Most of the initial $2 million has been contributed in the form of "equity capital" by the venture capitalists. To raise the remaining capital, the company decides to go into debt. If the company were to borrow this money expecting to repay it in a relatively short period of time, a bank could be approached for a loan. If a longer time period is needed, a few years or more, the company might consider selling bonds.
The New-Design Chair Company, being a young, unproven business, would probably be unable to issue bonds solely on its word or good name (if it could, bonds of this type would be called "debentures"). Lenders are usually reluctant to loan money to a new firm without security. Consequently, the New-Design Chair Company might be asked to put up some property as collateral (bonds of this type are often called "mortgage bonds").
Although the New-Design Chair Company would have to pay interest on the money it borrows, present holders would not have to give up ownership as Charlie did when the new stock was issued for equity capital. On the other hand, the lenders (the bondholders) do have first claim on the company's property if the company fails to repay the debt (such a failure is called a "default").
The Importance of Profits Why would Charlie and his associates risk their personal savings to build a factory to manufacture the chairs? They could have deposited their money into a bank account rather than investing in the new enterprise. The money would have been safe and the bank would have paid them interest. Why would anybody be willing to risk money – let alone $2 million – to start the New-Design Chair Company? The answer is simple: PROFITS.
Charlie and his associates saw an opportunity to make a good profit on each chair manufactured if the company met its business objectives. The stockholders also saw the possibility of increasing their profits in later years if more chairs could be manufactured and sold. In short, Charlie and hi
Excerpted from Understanding Wall Street by Jeffrey B. Little. Copyright © 2004 by Jeffrey B. Little. Excerpted by permission of The McGraw-Hill Companies, Inc..
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Table of Contents
What is a Share of Stock?
Wall Street – How it Works
Analyzing Your Company
Reading the Financial Pages
Investing and Trading
Manias, Fads, and Panics
Bonds, Preferred Stocks and the Money Market
Gold & Silver
The Principles of Technical Analysis
Most Helpful Customer Reviews
This book is great for any level to read. It gives you graphs, charts, photos which allow you to actually see what is being talked about. Everything said has an example accompanying it, which makes the book a lot easier to understand than most. Im beginning to learn about the field and this book has given me a great base, my father also read it, and he said he was able to expand on his previous knowledge.
This book starts off with a history of wallstreet, then delves into the deep murky waters of wallstreet finance that we thought we would never comprehend or was just too intimitdated. And what is great it is all in simple english--come on, if the last reviewer was sixteen and i myself a nineteen got through this book, it is real safe to say that you will too. So, if this is really of interest to you, dig deep in the recesses of your couch, garner your quarters, or break your piggy bank and go out and purchase this book--I did.