daily volume. If volume is light, there may be a liquidityrisk. This kind of stock is said to be thinly traded, and should be carefully considered before you purchase it. In addition, the fewer shares outstanding, the morevolatile the stock might be.
Liquidity: The ease with which an asset can be converted to cash in the marketplace. A large number of buyers and sellers and a high volume of trading activity provide high liquidity.
With any company, there is business risk. Companies continually face new competition and difficulties that, if not effectively addressed and dealt with, will eventually have an adverse effect on earnings and the stock price. This might even lead toa company going out of business—and your stock certificates becoming your onlyreminder of an investment turned worthless.A company may have a lot of shares outstanding (issued), but a majorpercentage is held by insiders (management, family-owned, etc.). Theremaining shares traded by outside investors are called the float. For example, acompany may have 3 million shares outstanding, but 1 million shares areclosely held, which would make the float 2 million shares.
Given the myriad of risks, why bother trading stocks? Because stocks havehistorically offered the best returns of any investment vehicle over time. Wellmanaged companies have been able to grow their earnings, and shareholders havebeen well rewarded. Without question, there are periods when stocks drop. Whenyou measure market performance over the course of several years, the trend is up,easily outdistancing any other investment.If the prospect of a high rate of growth is appealing, you’re able to withstandprice fluctuations, and your time horizon is suitably long, then stock investing willmost likely be your primary investment choice. Once you feel that you meet thesecriteria, recall that there are three basic methods of stock investing: buying/sellingindividual stocks, owning a mutual fund, or trading index shares. Figure 1.7 provides a general overview of the advantages and disadvantages associated with each.
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WELCOME TO THE STOCK MARKETMethods of Stock Investment
Individual Stocks
Mutual Funds
Advantages• Highestpotential returnon investment.• Allows tradersto customizetheir portfoliosto meet theirinvesting needs.• Easy to adjustthe portfoliomix withoutdisrupting thewhole account.
Advantages• Professional money managerswatch your money. They havemore time and resources thanmost individuals who try tomanage their own investments.• Offers excellent diversification.• Can benefit from up moves ina basket of stocks, and protectsinvestors from company riskassociated with investing inindividual stocks.• The safest way to investoverseas, because funds havemanagers watchinginternational companies onwhich individual investorswould find it difficult to gatherinformation.
Disadvantages• Takes moretime to managethan otherchoices.• Extremelyvolatile andsusceptible tobad news froma company,sectorproblems, andthe whims ofthe market ingeneral.• Have to knowhow to pick awinning stockopportunity.• Have to learnhow to filter outunnecessaryinformation.
Figure 1.7
Disadvantages• Tax considerations. Investorsmay have to pay taxes oncapital gains even if theirportfolios are down.• It is difficult to follow whatstocks make up the mutualfund portfolio.• If a team manages the fund,the members who created agood performance record lastyear may have left the fundunbeknownst to you.• Fund will likely produce onlyaverage market gains unless itconcentrates in aggressivesectors, thus losing some of theadvantages of diversification.
Index SharesAdvantages• Allows investors todiversify theirholdings with onedecision by investingin a group of stocks asopposed to just one.• If one stock is goingdown, it won’t hurtthe overall fund toomuch. The poorlyperforming stock willbe balanced out byothers that areadvancing.• Requires little time tomanage.Disadvantages• Indexes represent aset group of stocks ina fixed proportion.This selection mayexclude companiesthat you want toinvest in. You mayalso be forced toinvest in companiesthat you don’t wantto invest in justbecause thesecompanies are part ofthe index.• Index shares aretraded on theexchanges, andsometimes the marketprice will fall belowthe actual value ofthe index.• Fees andcommissions.
Advantages and Disadvantages of the Three Basic Stock Investments
ASSESSING YOUR OWN NEEDS
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Risks and rewards are associated with all investments, and stocks are no exception. For some people, they just aren’t suitable, either for emotional reasons (theycannot tolerate any price fluctuations) or because their time horizons are too short.For most people, however, they are the best vehicles for preserving the purchasingpower of their capital.Inflation erodes your purchasing power, and that’s why beatinginflation is the main reason to invest in the first place.
The growing popularity of the mutual fund industry is as much a result of convenience as diversification. The toughest part is picking the right fund. To build andmanage your own portfolio is a much more daunting challenge, but it can be done.This book seeks to show you how.
ASSESSING YOUR OWN NEEDSBefore you do anything, you need to consider your own personal financial situation.Many people think that all you have to do to start trading is open an account with abrokerage firm, buy a few shares of a volatile high-tech stock, and watch the profitsroll in. I can’t tell you how many times I’ve been asked for a specific recommendation, as if knowing which stock is about to take off translates into an easy millionand early retirement. Before you begin looking for a broker, opening an account, orplacing your hard-earned money in a high-flying stock, there are several things youcan do to maximize your chances of long-term success.First, you have to figure out how much money you can safely afford to invest. Anadequate time horizon is critical, because if you are forced to sell, the market maynot be at an opportune place, forcing you to sell at a loss. Therefore, be certain youhave enough money in reserve to meet any financial emergency or unforeseen expense without having to access your equity account. Things have a habit of goingwrong at the worst possible time, so be prepared.To determine your financial capabilities, take a discerning look at your liquid assets by objectively assessing how much cash you have readily available. You can dothis by calculating your cash on hand and placing a value on any assets that can bereadily converted into cash. Never invest your rent or mortgage funds, food money,or any dollars critical to your current lifestyle or your family’s immediate future. Irecommend that you leave a three- to six-month cushion in your savings account,just in case. By using funds that are above and beyond your immediate needs, youwill make the investing process less stressful and be able to invest with far lessstress and apprehension.To determine exactly how much money you can afford to invest, you need to assess your financial condition. To help accomplish this task, we have included threeuseful templates in Appendix A:
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WELCOME TO THE STOCK MARKET1. Personal balance sheet2. Monthly income statement3. Risk tolerance and investment goals worksheet
A balance sheet is designed to help you figure out exactly where you stand financially. A monthly income report can help you to track how you spend your moneyeach month. Although it is tempting to skip over these tables, think of the process aspart of your investment education. Filling out this information will help you to determine how much money can be safely put into your investment plan. If you arelearning how to break into the world of investments, this is your first step.The final worksheet provides for a method of detailing your personal risk tolerance and investment goals. Once again I highly recommend you take the time to fillthis form out. The findings are an important clue to analyzing your trading approach. As far as I’m concerned, anything that helps beginners to define their goalsis a thoroughly worthwhile pursuit.
ROADMAP TO SUCCESSObjective
Course of Action
Stocks
A security or certificate representing fractional ownership of acompany purchased as an investment.
Stock Market
An all-encompassing name for the overall facilitation of thebuying and selling of shares of ownership in companies.
Risk and theMarketDo I have to take“chances” in orderto make money inthe stock market?
The Risk of Inflation• Inflation erodes the purchasing power of money.• Cash in a mattress is certain to decline in value due to its lossin purchasing power caused by inflation.• Investments must overcome inflation.• Inflation should be calculated at 3% to 5% per year.• “Real rate of return” is the annual return (realized orunrealized) minus inflation. This is how much yourinvestment grew in purchasing power.• “Safest investments” may not grow faster than inflation—realrate of return is actually negative!• Breaking even after inflation is a long-term losing strategy—higher returns are necessary.
Investments:The Spectrum ofRisk Categories
Risk/reward ratio: The lower the risk, the smaller the rate ofreturn that can be expected; the greater the risk, the higher theexpected rate of return.• Lowest-risk (safest) investments:Cash and equivalents; U.S. Treasury notes: lowest return—virtually no risk.• Moderate-risk investments:Blue-chip stocks; investment-grade bonds.
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• Growth investments:Possible to achieve high return on investment.Risk is time, business, possible liquidity risk.The first task is tounderstand risk.
What types of risks exist and understanding how to manage them.• Inflationary risk: The erosion of purchasing power.• Business risk: Investing in a company that goes out ofbusiness altogether; loss of most if not all of investment.• Timing risk: Liquidating an investment at an inopportunetime; for example, the market is in a down cycle.• Market risk: (1) There is an extended down (bear) marketthat exceeds your initial investment time estimate; or(2) you lose money in a trade due to market conditionsthat were unforeseeable or somehow misinterpreted.
The second task isto develop a lowstress investmentplan that willenable you tobuild yourknowledge basesystematically.
When you buy a stock, you are 100% at the mercy of marketconditions and direction.• Market goes through up and down cycles.• Bull market: Trend is up; increasing prices.• Bear market: Trend is down; decreasing prices.• “Directional” decisions are 50/50 propositions.• Investments work or don’t work.• Often time is required to allow investment to work out.What if I’m right? What if I’m wrong?• Develop a strategy to reduce stress.• Risk is minimized.• Return is still attractive.
Third, beginnersneed to start byspecializing in oneor two markets ata time.
To become successful, in-depth knowledge and understandingof an industry is a big advantage.• Understand that anything is possible.• Your learning curve limits you.• Developments may occur too fast to track effectively.• Watch for ample opportunity to invest successfully in one ortwo sectors.• Different sectors perform differently, even at the sametime.• By specializing, it is possible to take advantage of newproduct developments, mergers, and acquisitions.• Long-term vision is attained by asking: What kind of growthwill this sector experience? Who will be the winners andlosers?• Long-term outlook reduces stress of day-to-day marketfluctuations.• Better information leads to better investment decisions (andresults!).
Fourth, define yourlimits in terms ofthe amount ofmoney you canafford to lose.
Stress avoidance comes from a clear picture of your financialcondition.• Net monthly income.• Subtract rent/mortgage, car payment, groceries, andmiscellaneous expenses.
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WELCOME TO THE STOCK MARKET• Entertainment allowance! (If you don’t leave money for thefun stuff, you’ll end up resenting your budget, and you’ll stopfollowing it.)• Three–six months of cash reserves.Now you know how much you can invest!
Becoming Familiarwith “PerformanceReporting” fromPublic Companies
SEC requires full disclosure.• Annual reports.• Quarterly reports (known as 10-Qs).• Quarterly earnings released at end of each quarter.• “Warnings” issued if company is experiencing a slowdown toalert that results will be below analysts’ expectations.• Financials are required to be audited.
Trading Locations:Exchanges and theNasdaq
Stock exchanges—Physical locations for the organized buyingand selling of stocks.• New York Stock Exchange (NYSE).• American Stock Exchange (AMEX).• Pacific Exchange.• Regional exchanges.• Auction style.• Membership required.The Nasdaq (National Association of Securities DealersAutomated Quotations system)• Decentralized; trades done electronically by telephone andcomputer.• Must be licensed broker-dealer for membership.• Trading permitted by “registered representative” (astockbroker) only.• Created in 1988, operates separately.• Created new “fund stocks.”• Nasdaq 100 (QQQ) index shares.• Internet Index (HHH).• Check out this great web site for answers to Nasdaqquestions: www.marketdata.nasdaq.com/mr_section2.html#8Over-the-counter stocks• Too small to be traded on the Nasdaq.• Includes penny stocks; low-priced stocks whose quotes arefound in the Pink Sheets.
CompanyIdentification
Ticker symbol—Assigned to each company’s stock for easieridentification.• NYSE and AMEX—one, two, or three symbols.• Nasdaq/OTC—four–five symbols.
Regulatory Agencies Securities and Exchange Commission (SEC)• Oversees all exchanges, including the Nasdaq.NASD (National Association of Securities Dealers)• Oversees Nasdaq and OTC markets.• Overseen by SEC.
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A Roster of People • Broker: Also known as a “registered representative,” a brokerInvolved with Stockis licensed to dispense investment information, recommendTradinginvestments, determine suitability of an investment for aninvestor, and to enter an order on behalf of an investor.• Floor trader: An exchange member who executes ordersfrom the floor of the exchange only for his or her ownaccount.• Specialist: A trader on the exchange floor assigned to fillbids/orders in a specific stock out of his or her own account.• Market makers: An independent trader or trading firm that isprepared to buy and sell shares or contracts in a designatedmarket. Market makers must make a two-sided market (bidand ask) in order to facilitate trading.Terminology UsedMost Often inTrading
• Trade: To buy or sell a stock, bond, or option.• Margin: The use of borrowed funds to purchase a stock; the(security) capital required to adequately pay for the risk onan option transaction.• Volume: The total number of shares traded in a particulartime period on a specific stock.• Bull market: A market with a strong upward bias; stock isbeing accumulated.• Bear market: A market with a downward bias; distribution ofstock is occurring.• Short sell: To sell short means that a person believes a stockwill soon decline in value, so he or she borrows it from abrokerage firm and sells it, in hopes of repurchasing it at alower price. Upon repurchase, the stock is returned to thebrokerage firm it was borrowed from.• Fill: The term applied to the price at which a trade is executed.
The Three Facesof Stocksmiths
Traders on the floor of the NYSE fall into three categories:• The “professional”—Also known as an “institutionalinvestor,” professionals typically trade stocks on behalf ofother people. They are hired to make buying and sellingdecisions and are paid for their work.• The short-term trader—A person who buys and sells often,even intraday, looking for price swings and situations onecan make money on.• The individual investor—Retail investor dealing in 1,000share lots at the most, and generally much less. Prone to“rookie” mistakes, the individual investor is often seen as acontrary indicator: when he’s buying, it’s a sign of a markettop. Odd-lot sales are his identifying mark.
Putting in theOrder: Terms YouNeed to Know!
To buy or sell a stock, these terms and phrases will be veryhelpful to understand:• Bid—What a buyer is willing to pay. If you are selling astock, the best or highest bid is the easiest price at which toget a fill.
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WELCOME TO THE STOCK MARKET• Ask (or “Offer”)—If you’re buying a stock, the lowest “offer”or “asking price” is the easiest price to get an order filled.• Inside quote—Used to describe the best bid and lowest offer.Also known as a “current quote.”• Market order—When buying or selling, a market order willget your trade executed at the lowest offer or best bid at thatparticular time!• Limit order—This indicates the minimum or maximum priceyou’re willing to buy or sell a stock (or option) at.
Research—Findingthe InformationYou Need
Research information abounds. Finding pertinent data is thekey.Newspapers• Wall Street Journal (interactive.wsj.com).• Investor’s Business Daily (www.investors.com).Web Sites• EDGAR Online (www.edgar-online.com).• Microsoft Investor (www.investor.msn.com).• Motley Fool (www.fool.com).• Quote.com (www.quote.com).• TheStreet.com (www.thestreet.com).• Wall Street City (wallstreetcity.com).• Yahoo! Finance (quote.yahoo.com).• Zack’s Investment Research (www.zacks.com).
Mutual Funds
Where to find their records and ratings:• Investor’s Business Daily—“Making Money with Mutuals”(second half of paper).• Multex (www.multex.com).• Morningstar.com (www.morningstar.com).• Value Line (www.valueline.com).• VectorVest (www.vectorvest.com).
Mutual Funds—What’s Important
You’re picking a manager, not the fund!• Open-ended or closed-ended?• Load or no-load fund?• Look at past earnings performance.• Is the same portfolio manager still there?• If not, what’s the manager’s past record?• What fund did he or she come from?• Portfolio turnover indicates how much the fund trades. Areading of 50% indicates it traded half of the portfolio awayand replaced it with new stocks. A high percentage hereindicates an aggressive stance.• Biggest positions: What are the fund’s largest holdings?
Mutual FundClasses of Shares
Load funds have different classes; three ways to pay your load:• Class A—Pay up front. If the load is 3%, for every dollarinvested, three cents is taken off the top, leaving $0.97actually invested.
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• Class B—Pay when you withdraw the money. This probablyis more expensive, because the amount you withdraw will(hopefully) be greater than the amount deposited. Whichwould you rather pay?• Class C—Pay as you go. No initial charge, but rather a“trailing” commission is assessed. Also known as a 12(b)-1fee (look at prospectus), this is deducted from your account,meaning you’ll end up paying a lot of commission andachieving a lesser rate of return overall.Index Funds
A portfolio of stocks that mirror the composition of a majorindex or sector. Reasons they’ve grown in popularity:• Lower fees.• Historically better performance than managed funds.• SPDR (SPY).• HOLDRs—Merrill Lynch products—sector-specific.
After-Hours Trading New venues facilitate expanded trading hours.• Electronic communications networks (ECNs). For example,Island and Instinet.• Anonymity (no one can tell who the buyers and sellers are).• People who trade there are “for real”; no tactics are used tomanipulate market price.Advantages• Trade on news releases after the NYSE/Nasdaq close.• Greater flexibility for those unable to trade during markethours.Disadvantages• No guarantee the markets will agree with your decisionwhen they reopen.• Could be buying at top.• Could be selling at bottom.• Liquidity not 100% proven.The Economy andthe Market
Interest Rates, the Economy, and the Market• Risk/reward: The lower the rate of interest, the moreattractive stocks become.• Interest rates are set by the Federal Reserve Board.• If economy gets too hot, rates are increased to cool it down.• If economy gets too sluggish, rates are lowered to stimulateit.• Good economic reports will sometimes send the marketdown, because traders fear the Fed will hike interest rates.• Higher interest rates means investors have to move furtherout on the risk/reward curve to beat what they can get withlittle or no risk.• Investors can see where interest rates are by looking at thebond market, specifically the 30-year Treasury bond.
2Solving the Broker Dilemma
Today’s brokerage firms have evolved from a time when “the market” was the soledomain of powerful businessmen, their workings shrouded in mystery from the publicat large. To own stock most often signified wealth beyond the average person’smeans. The stock market itself had little to do with everyday life for the vast majorityof Americans. Today it’s a whole new ball game, with more people owning equities,either directly or indirectly vis-à-vis mutual funds and pension funds, than at any timebefore. The bull market that began in 1982 with the Dow below 1,000 has now soaredtenfold from that level, fueled in part by the entrance of the small investor.Brokerage firm: A firm that charges commissions for executing buy and sellorders submitted by individuals or other firms.
But as common as it is today, many people still view the world of public offerings, stockbrokers, leveraged buyouts, and analyst recommendations like theywould the engine in a car: “I know it’s there but I don’t know exactly how it works.”Let’s first take a look at the reasons brokerages exist, and then investigate how theywork and why we need to have a basic knowledge of their universe.Public offering: The sale of securities by an issuing corporation to the generalinvesting public.
WAY BACK WHENBrokerage firms can trace their heritage back to when America was just gettingstarted. Their principal purpose was to raise capital (money) to help finance America’sgrowth. Those early years saw companies like General Electric, Ford, Standard Oil,and the like emerge as they took an active part in the creation of the infrastructure we36
THE ROLE OF THE BROKER
37
take for granted today. Few people could spare the money to own stock, and the oneswho did saw their portfolio values skyrocket as the country grew. Tremendous fortunes were amassed by names synonymous with power and wealth: Rockefeller,Carnegie, DuPont, and so on. Investment bankers worked closely with corporations toaccess public markets. Prior to the stock market crash of 1929, the world of investment bankers and the stock market in general was a wild and untamed place. Hugeprice swings and shady manipulations were the order of the day. As the industry matured, increased scrutiny was placed on the industry. The boom-bust cycles were significantly mitigated, but not vanquished. Many new requirements were implemented,designed to protect the investing public and to prevent fraud.Investment bank: A financial institution in the business of raising capital for corporations and municipalities through initial public offerings, secondary offerings, and debt (bond) offerings.
Following World War II, the United States entered what arguably was the mostsignificant growth era we have ever known. This period saw the birth of the babyboom generation, whose mind-set altered everything from the way we styled ourhair to the way we saved money.The wealth created in the postwar era made the demand for goods and servicessoar. Investment bankers were more than happy to assist the companies that madeand provided them. Firms with names like Merrill Lynch, Morgan Stanley DeanWitter, Reynolds Funds, and Salomon Brothers provided valuable expertise in funding our growth, and in turn made great strides in educating a greater number of investors about the possibility of equity ownership.
THE ROLE OF THE BROKERIn the first half of the twentieth century the stockbroker emerged as the intermediarybetween investment bankers and the investing public. Initially the stockbroker’srole and image in society was on a par with the family attorney, physician, andneighborhood banker. Brokers studied companies and monitored price movementfrom the comfort of luxurious offices through the use of the ever-mysterious tickertape machine. These brokers would “read the tape” as it came out on long ribbons,and would then convey this information to their clientele at opportune moments.The stockbroker was a valuable and trusted financial adviser, and was well compensated for his services.
Ticker-tape machines: Glass-domed machines of yesteryear that reported stocktransactions on the various exchanges using stock symbols and prices.
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SOLVING THE BROKER DILEMMA
As technology improved, an electronic tape replaced the ticker tape. Eventuallydesktop monitors were introduced, greatly enhancing the efficiency of price dissemination and lowered the learning curve required to enter the brokerage community.This, of course, fueled the expansion of brokerage firms as their charter soonevolved from one of investment bankers to marketing entities. Not only could WallStreet firms finance public offerings, they now had the ability to sell the stockquickly and profitably. The overall wealth of our country increased, and in turn thenumber of households that owned securities—be it stocks or bonds—also rose. Feescharged for buy or sell orders were much higher than what we see today, and the income potential attracted many ambitious people to a career as a stockbroker.Wall Street: Specifically refers to the financial district at the lower end of Manhattan in New York City where the New York and American Stock Exchangesas well as various brokerages are located. In general, the term “Wall Street”describes the investment community as a real-world entity that receives andreacts to information on a daily basis.
THE BROKERAGE INDUSTRY TODAYThe brokerage business was so profitable it began attracting more participants, customers and brokers alike. As World War II veterans began to reach retirement age,many of them sought out stocks and bonds as a way to ensure comfortable retirements. Brokerage firms began growing more quickly than ever, so new brokerswere hired and trained. Their compensation was, and is, primarily commissionbased; therefore, the new stockbroker needed to develop a “book” of clients toavoid starving. How do you create a new client base after you’ve contacted all yourfamily and friends? The answer was the cold call.Telemarketing is a nice word given to a decidedly unpleasant task: cold callingpeople at home or work to offer “valuable” investment services and products tothose with the means and proclivity to take advantage of them. A good stockbrokermeant large commission revenues to the brokerage firm. A hardworking and persistent cold caller could build a valuable book of business in a year or two. Branchmanagers of brokerage firms began separating the wheat from the chaff in search ofthe Next Big Producer. A parade of likely candidates materialized, their appearanceseeming to coincide with the great bull market of 1982. Novice brokers began attracting novice investors as well as experienced ones. But how would the brokerknow what to recommend? A poor recommendation could result in a loss, not onlyinvestment-wise, but also the loss of the customer as well.The need for solid ideas and strategies spelled the emergence of the analyst, aperson who would study and analyze a particular industry and generate reports thatforetold of tremendous opportunities or potential disasters. These reports werecrafted either for the public in general or for “internal use only” to keep the brokers
A DISTRIBUTION SYSTEM
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informed. This financial food chain meant the broker could be educated relativelyquickly and easily, as well as kept abreast of changing market conditions. This wasextremely critical to all concerned because as a broker developed relationships withinvestors, the broker’s recommendations had better be right the majority of the timeor clients would take their accounts to another firm down the street, meaning a lossof revenue to both the broker and the brokerage firm.
A DISTRIBUTION SYSTEMOnce the retail base was established, the other half of the brokerage firm, the investment bankers, not only were able to structure complex transactions—such as initialpublic offerings, secondary offerings, and debt (bond) offerings—but also could ensure the stock was sold, too, meaning they made money two ways: underwriting theoffering and selling it to investors. The better they did at both sides of the deal, themore attractive they were to companies that sought to enter the public arena. Thisvertical system of marketing has become the hallmark of most of the big investmenthouses today.Initial public offering (IPO): The first sale of common stock by a corporation to thepublic at large. IPOs usually represent young, small companies seeking outside equity capital as well as a public market for their stock. Investors purchasing stock inIPOs must be prepared to accept very large risks for the possibility of big gains.Secondary offering: A sale of securities that occurs when one or more majorstockholders in a company sell all or a large portion of their holdings. Such anoffering primarily occurs when the founder or one of the original financial backers of a business determines that there is more to be gained by going public thanby staying private.
The amount of money made was astonishing. Stories abounded of huge paychecks being earned by 20-somethings fresh out of school. Alluring profits heightened competition among all levels of investment firms. The relationship betweenbroker and customer was important to the firm’s success, and the role of the investment banker side of the firm was even more critical.The role of the aforementioned analyst in this situation began to get complicated.Suppose Don Doe is an analyst for XYZ Investments. Mr. Doe covers the semiconductor sector, and sees a big slowdown coming. The investment bankers are close tosigning a contract with Chips America, the largest chipmaker in the world. If theyget the deal, it will mean huge profits for XYZ Investments. The analyst knows theslowdown is coming, and it will be very bearish for the sector. If he downgradesthe group, it will hurt the chances of XYZ getting Chips America as a client. If hedoesn’t tell XYZ’s clients of the slowdown, they’ll be caught in what will certainlybe a drastic sell-off when another firm does make the announcement.
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SOLVING THE BROKER DILEMMA
This is not a true story, but the conflicting interests are very real. This is why wehear analysts say anything but “sell” if they feel a slowdown is coming. Investorsneed to learn how to interpret these softened downgrades, to read between the linesif you will. An “outperform” gets dropped to “market perform.” An “aggressivebuy” gets dubbed “accumulate.” This way everyone saves face. The clients get thewarning message without offending the company the analyst is following.It is wise for any investor or trader to become familiar with the analysts coveringthe sector they’re invested in. Some analysts clearly have a better grasp of what’shappening within a company or sector, and others miss it badly. In the summer of2000, one analyst called for a slowdown in the semiconductor sector, and it causeda sell-off in the semiconductor stocks. It was worth noting that this analyst was singular in his opinion. Semiconductor analysts at other firms defended their estimates,and the sector went on to post very impressive gains. It