UNDERSTANDING WALL STREET FIFTH EDITION This page intentionally left blank UNDERSTANDING WALL STREET FIFTH EDITION Jeffrey B Little and Lucien Rhodes New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul Singapore Sydney Toronto Copyright © 2010, 2004, 1991, 1987, 1980, 1978 by Jeffrey B Little All rights reserved Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher ISBN: 978-0-07-163321-5 MHID: 0-07-163321-9 The material in this eBook also appears in the print version of this title: ISBN: 978-0-07-163322-2, MHID: 0-07-163322-7 All trademarks are trademarks of their respective owners Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefit of the trademark 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MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE McGraw-Hill and its licensors not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom McGraw-Hill has no responsibility for the content of any information accessed through the work Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise To Helen T Walbran Years Ahead of Her Time This page intentionally left blank Contents Preface ix What Is a Share of Stock? how a company is organized the meaning of profits and dividends how stock prices are determined Wall Street—How It Works 15 a pictorial and narrative description of Wall Street’s colorful history the role of the investment banker an explanation of listed and over-the-counter trading Analyzing Your Company 37 how to identify the best companies and interpret their financial statements using the reinvestment rate calculating financial ratios other highlights of security analysis Reading the Financial Pages 57 the history and calculations of the Dow Jones Averages how to read the stock tables, earnings reports, stock split announcements, and other important news items Investing and Trading 81 finding a stockbroker or investment advisor opening a brokerage account setting investment objectives understanding the margin account how to make money in a bear market investment clubs exchange traded funds (ETFs) Growth Stocks 117 the meaning of “the growth stock theory” of investing how companies grow identifying growth companies a guide on how much to pay for growth stocks Manias, Fads, and Panics 143 recognizing investment bubbles examples and the pitfalls of emotional investing the stock market crashes of 1929 and 1987 the recent dot-com bubble CONTENTS vii From Wall Street to Main Street 167 the Great Real Estate Bubble a new investment landscape government versus business greed and atrocities bankruptcies and “bailouts” Bonds, Preferred Stocks, and the Money Market 185 an explanation of bonds and the bond tables calculating “yield to maturity” investing in convertible bonds tax advantages of municipal bonds understanding the Federal Reserve the use of T-bills and other money market instruments 10 The Internet 211 the background of this fast-growing medium how today’s investors are using the World Wide Web 11 Global Investing 223 the emerging global market the Japanese stock market the markets in London, Germany, France, and elsewhere ADRs participating through mutual funds 12 Gold and Silver 239 learning from the past gold and silver as a store of value supply and demand, production, and stockpiles the investment opportunities and risks a few equities 13 The Principles of Technical Analysis 255 methods for improving market timing constructing bar charts and point & figure charts how to read charts the WST Ratio and other reliable technical indicators 14 Stock Options and Other Derivatives 287 how to use “put” and “call” options the two dimensions of a premium valuing option premiums index options simple explanations of various option strategies other derivatives explained, including interest rate swaps and credit default swaps 15 Personalities of Wall Street 325 key players during the early days of Wall Street tycoons and stock traders great investors the “movers and shakers” of today Sources 339 a dictionary of Wall Street useful business publications investment services Appendix 353 historical annual statistics for the Dow Industrials and Consumer Price Index (CPI) viii Illustration Credits 357 Index 359 CONTENTS Preface When Understanding Wall Street was first published more than thirty years ago, we never imagined that it would eventually become a “classic,” available in four languages—English, Spanish, Russian, and Chinese Moreover, with the passing of time, the original work has been enhanced with each new version This Fifth Edition is no exception In this book’s early days, explaining the financial pages of a newspaper was paramount This is no longer true Today, investors can quickly find all the necessary information on the Internet So, the facts are the same, but the lessons here are totally different In addition, the changes on Wall Street have been never-ending with the introduction of new products Just since the Fourth Edition alone, the popularity of exchange traded funds (ETFs) has exploded, requiring new sections The collapse of the real estate market in 2007 and the subsequent meltdown of the entire financial system is now part of this text And any investor today who can- not explain the term “credit default swap” is missing an important link between Wall Street and Main Street Initially, Understanding Wall Street was intended mainly as a “primer,” since the stock market is rarely taught in high school And even on the college level, investment courses are typically selected only by students with specialized business interests Today, this book is no longer just a primer In fact, many Wall Street professionals are also using it as an everyday reference Finally, it is interesting to note how the audience for Understanding Wall Street has shifted over the years This has, of course, been largely influenced by the maturing baby boomer generation The millions of people who now own shares of stock through their retirement plans suddenly have a “need to know.” So, armed with a reasonable degree of common sense, along with the immense quantities of timely information available today, we believe it is still possible to be a successful investor—with the guidance of this new book PREFACE ix Bankers’ acceptances, 206, 209 Bankruptcy, 176, 181 Banks: commercial, 206, 207 in Germany, 232 and gold, 242 in Japan, 229, 230 trust departments of, 90 Bar charts, 258–260 Barclays PLC, 176 Barrick Gold Corp., 252 Barron’s, 59, 279, 294 Baruch, Bernard, 83, 151 Basic industries, 54 Basis points, 183 BBSS (Broker Booth Support System), 34 Bear market(s): 1930-1932, 156 growth stocks during, 123 reverse stock splits during, 74 strategies for investing and trading, 100–103 and WST ratio, 280 Bear Stearns, 176 Bearer bonds, 188 Berkshire Hathaway, 41, 337 Berlin Wall, fall of, 232 Berners-Lee, Tim, 214 Beta, 272 BetterInvesting, 105 Bezos, Jeff, 164 “Big Bang” (International Stock Exchange), 233 BigCharts.com, 218, 266 Bimetallism, 242, 245 Biofuels, 140 Biogen, 162 Biotechnology, 140, 162–163 Black & Decker, 235 Black Thursday, 152–154 Block trade, 27 Blue List of Current Municipal Offerings, 200 Bluhdorn, Charlie, 335 Blunt, Sir John, 149 Boards of directors: in company organization, 5–6, 12 elections of, 177 of mutual funds, 107 Bond funds, 108 Bonds, 187–201 calling, 193–194 and company organization, 6–7 convertible, 196–199 corporate, 91, 92, 189 denominations of, 189 function of, 188 interest rates, 190 mortgage, municipal, 199–201 in OTC market, 33 ratings, 194–196 yields, 190–193 zero-coupon convertible, 198–199 (See also Government bonds) Book value, 44 360 INDEX Bradford, William, 329 Breakeven points, 320 Breakouts, 260–261, 274 Bretton Woods Agreement, 244 Bristol-Myers, 165 Broadband Internet access, 214 Broker Booth Support System (BBSS), 34 Brokerage accounts, 88–90 Brokerage commissions, 26, 62–63 Brokerage firms: arbitrage at, 104 differentiation of, 27–28 on Internet, 219–330 in Japan, 229 Brokers/dealers, 32–33, 62–63 Brunswick, Corp., 161 Buffett, Warren, 128, 140, 182, 336–337 Buick Company, 334 Bull market(s): in 1792, 20 in Germany, 232 and market cycles, 135 post-World War II, 61 and WST ratio, 280 Bulletin boards, 218 Bullion, 250 BullsOrBears.com, 280 Bureau of the Public Debt, 204 Burr, Aaron, 177 Business cycle, 77 Business news, 76 BusinessWeek, 106 Buttonwood Agreement, 22 Buybacks, 51 BXM (Chicago Board Options Exchange Standard & Poor’s 500 Buy/Write Index), 303 C Calendar spread, 316–318 Call options, 101, 294 Calling (bonds), 193–194 Canada, 246 Capital: equity, risk, 84 working, 44 Capital appreciation, 13 Capital expenditures plans, 77 Capital structure, 50–51 Carnegie, Andrew, 332 Cash flow analysis, 51–52 CBOE (see Chicago Board Options Exchange) CDs (certificates of deposit), 206 CDSs (credit default swaps), 291–292 Certificates of deposit (CDs), 206, 208–209 CFA (Chartered Financial Analyst) program, 56 Chadbourn Gotham, Inc., 157, 158 Chain reactions, 182–183 Chambers, John, 164 Chart patterns, 260–269 Chartered Financial Analyst (CFA) program, 56 Chartered Market Technician (CMT) program, 56 Charts: bar, 258–260 Japanese candlestick, 274–275 patterns in, 260–269 point-and-figure, 272–274 Chat rooms, 218 Chevrolet, Louis, 334 Chicago Board Options Exchange (CBOE), 101 FLEX products, 323 and global marketplace, 228 stock options on, 292–294, 297–298 and WST ratio, 280 Chicago Board Options Exchange Standard & Poor’s 500 Buy/Write Index (BXM), 303 Chicago Board Options Exchange Volatility Index, 280, 282 China, 225, 233–234 Chiron, 162 Chrysler, 156, 181 Churning, 86 Circuit breakers, 34–36 Cisco Systems, 164, 296 Citigroup, 296–297, 336 Civil War, 243, 328 Claims, on preferred stocks, 201 Clark, James, 163 Classes (options), 296 Cleveland, Grover, 332 Closed-end funds, 106, 235–236 Closing sale transaction, 298 CMOs (collateralized mortgage obligations), 170–171 CMT (Chartered Market Technician) program, 56 CNA Financial, 336 Coconuts (film), 165 Collateralized mortgage obligations (CMOs), 170–171 Commercial banks, 206, 207 Commercial paper, 206, 209, 283 Commissions: of brokers/dealers, 33, 62–63 on selling options, 318 of stockbrokers, 26–27, 87 and straddle strategy, 320 Commodity Research Bureau (CRB) Futures Index, 248 Commodity Research Bureau (CRB) Index, 77 Common stock, 196, 197 Common stock certificates, 189 Common stock funds, 107–108 Compagnie des Indes, 148 Compagnie d’Occident, 147 Company organization, 4–8 Compounding values, 120, 121 Computer programs, 258 Conglomerates, 161–162 Consumer confidence, 77 Consumer Price Index (CPI), 77, 276 Consumer staples, 142 Continentals, 243 Contra-market stocks, 100–101 Conversion prices, 198 Convertible bonds, 196–199 Corporate bonds, 91, 92 Corporate certificates, 189 Corporate dividends, 152 Corporate profits, 152 Corporation, Corre’s Hotel, 22 Corundum, 125 Corvis, 138–139, 164 Cost of products sold, 43 Country funds, 235 Coupons, 188 CPI (see Consumer Price Index) CRB (Commodity Research Bureau) Futures Index, 248 CRB (Commodity Research Bureau) Index, 77 “Creative accounting,” 39 Credit: and automobile industry, 181 consumer, 150 Credit crisis, 183 Credit default swaps (CDSs), 291–292 Credit rating agencies, 176 Cumulative preferred stocks, 201 The Curb, 23 Curb Market Agency, 23 Curbstone brokers, 23 Currency, 227 Current ratio, 50 Current yield, 191 Customers’ Afternoon Letter, 330 Cycles: business, 77 growth, 125–126 in stock market, 278–279 D Daily bar charts, 258, 259 Daiwa, 229 Darden Restaurants, 124 DAX (Deutscher Aktienindex), 232–233 De Beers Consolidated Mines, 235 Dealers, 31–32 Debentures, 6, 189, 196–197 Debit, 316, 317 Debit balance, 95 Debt: on annual report, 44 and gold, 248–249 margin, 283 DecisionPoint.com, 218 Deere & Co., 93, 157 Deflation, 77–78 Dell, Michael, 125, 215 Dell Computer, 124–125, 215 Demand, for gold, 245–248 Denominations: of bonds, 189 of certificates of deposit, 209 of Treasury bills, 202 Department of Housing and Urban Development (HUD), 171 Depreciation: on annual report, 43 INDEX 361 Depreciation (continued) in Japan, 231 Derivatives, 289–292 credit default swaps, 291–292 foreign exchange, 291 interest-rate swaps, 290–291 probabilities, 290 (See also Options) Designated market makers (DMMs), 34 Designated Order Turnaround (DOT) System, 32 Deutsche Bank Group, 236, 291 Deutsche Börse Group, 232 Deutscher Aktienindex (DAX), 232–233 DIA (Dow Jones Industrial Average Diamonds), 321 Dial-up Internet access, 214 Digital photography, 126, 128, 178, 249 Direct dividend reinvestment plans (DRIPs), 99 Disclosure requirements, 25 Discount brokers, 87–88 Discount mechanism, 207 Discounted cash flow models, 51 Discounting values, 55 Disney, 235 Diversification, 123 Dividend(s), 72–75 corporate, 152 defined, 7–8 from growth stocks, 120–123 from Microsoft, 124 from preferred stocks, 201 from trading, 13 of underlying stock, 303 from Wal-Mart Stores, 131 Dividend yield, 9–10 DJIA (see Dow Jones Industrial Average) DMMs (designated market makers), 34 Dodd, David L., 133 Dollar cost averaging, 98–99 DOT (Designated Order Turnaround) System, 32 Dot-com bubble, 84–85, 138, 163–164 Double taxation, 121 “Doubling up,” 103 Dow, Charles H., 60, 330 Dow Jones & Company, 330 Dow Jones Averages, 60–62 Dow Jones Industrial Average (DJIA), 60–62 2008 decline of, 110 as benchmark, 283 and Dow Theory, 270 and Eastman Kodak, 126 and future earnings, 137 price levels of, 35 price/earnings ratio, 132 and stock market crash of 1929, 151–156 and stock market crash of 1987, 160, 161 and 3M, 67 Dow Jones Industrial Average Diamonds (DIA), 321 Dow Jones Industrial Average fund, 99 Dow Jones Railroad Average, 60, 330 Dow Jones Transportation Average, 270 Dow Jones Utility Average, 60 Dow Theory, 265, 270 Drake, Edwin, 331 362 INDEX Drew, Daniel, 329, 332 Drexel, Anthony, 331 Drexel, Morgan & Company, 331 DRIPs (direct dividend reinvestment plans), 99 Drugstore.com, 164 du Pont, Pierre, 334 Dual listings, 28 Duke d’Orleans, 147 Duke Energy, 189–190 DuPont, 155 Durant, William, 151, 333–334 E Earnings before interest, taxes, depreciation, and amortization (EBITDA), 53 Earnings per share: analysis, 52 and company organization, Earnings reports, 66–73 East Germany, 232 Eastman, George, 126, 127 Eastman Chemicals, 128 Eastman Kodak, 126–128, 178 eBay, Inc., 164 EBITDA (earnings before interest, taxes, depreciation, and amortization), 53 e-Brokers, 34 Economic crisis of 2008-2009, 169–183 automobile industry, 178–182 chain reactions, 182–183 credit crisis, 183 government involvement, 177–178 greed and atrocities, 181–182 real estate bubble, 169–177 Edgar Online, 217 Edison, Thomas, 133 Edison “dome” stock ticker, 30 Edison Electric Illuminating Company, 332 8-K Report, 68 Elections, by stockholders, Elections, of company directors, 41 Electronic trading, 297–298 Elliott Wave Theory, 270 EMA (exponential moving average), 282 Emotions, 146, 149, 279 Enron, 182 Enterprise value, 54 EPS/T-bill yield ratio, 277 Equity capital, Equity turnover, 53 ETNs (exchange-traded notes), 114 Euromoney, 291 European Central Bank, 247 European Equity Fund, 236 European Union, 247 Exchange-listed stocks, 27 Exchanges, 30–33 Exchange-traded funds (ETFs): and broad market indexes, 62 global investing with, 236–237 and gold, 253 and investing/trading, 99–100, 102, 109–114 and NYSE ARCA, 34 popularity of, 36 Exchange-traded notes (ETNs), 114 Executives, 12 Exercise, 318 Expense ratios, 110 Expiration dates, 294, 296, 303, 310, 313–317 Exponential moving average (EMA), 282 External financing, 124 Extra dividends, 73 Extraordinary Popular Delusions and the Madness of Crowds (Charles Mackay), 145 Extrinsic value, 305 Exxon, 235 F Fads, 160–163 biotechnology (1989-1992), 162–163 conglomerates (1962-1967), 161–162 fertilizer stocks (1964-1967), 162 leisure-time stocks (1957-1961), 161 nifty fifty (1970-1974), 162 Family financial planning, 84 Fannie Mae (Federal National Mortgage Association), 170–171, 177, 205, 292 FCF (free cash flow), 51–52 Federal Advisory Council, 207 Federal budget, 78 Federal Deposit Insurance Corporation (FDIC), 156 Federal Hall, 20 Federal Home Loan Mortgage Corporation (see Freddie Mac) Federal Housing Finance Agency (FHFA), 177 Federal National Mortgage Association (see Fannie Mae) Federal Open Market Committee (FOMC), 207 Federal Reserve Act, 206–207 Federal Reserve Bank of New York, 176, 207, 208 Federal Reserve Banks, 204, 207 Federal Reserve Board (FRB): and business cycle, 77 and chain reactions, 182–183 establishment of, 151 and real estate bubble, 171, 173, 175 regulation of security credit by, 94 Federal Reserve System: and gold, 242, 250 history of, 206–207, 277 interest rate regulation by, 190 monetary policy of, 207–208 and stock market crash of 1929, 151 Fertilizer stocks, 162 FHFA (Federal Housing Finance Agency), 177 Financial Accounting Standards Board, 45 Financial Industry Regulatory Authority (FINRA), 26, 55, 85 Financial liability, Financial news: Consumer Price Index, 77 earnings announcements, 66–68 mutual funds, 75–76 stock market activity, 64 stock splits, 75 stock tables, 63 Financial pages, 59 Financial planning, 84 Financial reports, 8–9 Financial services, 85 Financial statements, 41–45 Financing, 8, 124 FINRA (see Financial Industry Regulatory Authority) Fisher, Irving, 333 Fisk, James, 329–330, 332 Fixed-rate mortgages, 173 Flagler, Henry, 331 FLEX products, 323 Flexible products, 323 Flip this House! (television program), 175 FOMC (Federal Open Market Committee), 207 Ford, Henry, 135 Foreign companies, 30 Foreign exchange, 291 Foreign stocks, 33 Forex, 291 Frank, Barney, 171 Frankfurt Stock Exchange (FSE), 232, 233 FRB (see Federal Reserve Board) Freddie Mac (Federal Home Loan Mortgage Corporation), 170–173, 177, 205 Free cash flow (FCF), 51–52 Freeport Sulphur, 162 FSE (see Frankfurt Stock Exchange) Fuel cells, 140 Fuels, alternative, 140–141 Fulton, Robert, 329 Fundamental analysis, 55 (See also Analysis) Funds: aggressive growth, 107 balanced, 108 bond, 108 closed-end, 106, 235–236 common stock, 107–108 country, 235 growth, 107–108 hedge, 278 income, 108 index, 108 international mutual, 237 money market, 108 no load, 106 performance, 335 sinking, 194 special-purpose, 108 volatility of, 113 (See also Exchange-traded funds; Mutual funds) G GAAP (Generally Accepted Accounting Principles), 45 Gaps, on bar charts, 264 Gasoline prices, 175, 181, 183 Gate, Bill, 124 Gates, Horatio, 329 Geneen, Harold, 335 Genentech, 162 General Electric, 60, 155, 332 INDEX 363 General Mills, 122–124 General Motors, 178, 179, 181, 216, 334 General obligation bonds, 200 Generally Accepted Accounting Principles (GAAP), 45 George I, King, 148 Germany, 225, 226, 231–233, 236 Ginnie Mae (Government National Mortgage Association), 205 Glamis Gold, 252 Glasspar, 161 GlaxoSmithKline, 235 Global investing, 225–237 with American Depositary Receipts, 234–235 in China, 233–234 with closed-end funds, 235–236 with exchange-traded funds, 236–237 in Germany, 231–233 in Japan, 228–231 in London stock market, 233 in modern marketplace, 227–228 with multinational companies, 235 Global market, 36 Goba (afternoon trading session), 229 Gold, 241–254 depletion of, 332 and Gresham’s Law, 245 mining companies, 252–253 and money supply, 248 production of, 246–247 reserves of, 247 risks of investing in, 250 in South America, 148 strategies for investing in, 250–251 supply of/demand for, 245–248 value of, 242–245 Gold Reserve Act, 244 Gold standard, 243–244 Gold Standard Act, 243 Goldcorp, 252–253 Goldman Sachs, 177 Good ‘til canceled (GTC) order, 98 Google, 164 Gould, Jay, 329–330, 332 Government, 177–178 Government bonds, 189, 204–205 and Bank of the United States, 20 benefits of, 202 and risk/reward, 91, 92 Government National Mortgage Association (see Ginnie Mae) Government spending, 77 Graham, Benjamin, 9, 133, 139, 337 Granville, Joe, 336 Great Depression: decline of Dow Jones Industrial Average during, 61 and market cycles, 135 Greed, 181–182 Green, Henrietta Robinson, 332–333 Greenbacks, 243, 332 Greenspan, Alan, 173, 175 Gresham, Sir Thomas, 245 364 INDEX Gresham’s Law, 245 Gross profit, 43 Growth cycle, 125–126 Growth funds, 107–108 Growth industries, 54 Growth stocks, 119–142 defined, 120 examples of, 122–128 future of, 140–141 and growth cycle, 125–126 and growth rate, 121–122 long-term perspective on, 129–131 potential for, 141–142 and stock market manias, 138–139 and value investing approach, 139 value of, 131–138 Grumman, 157 GTC (good ‘til canceled) order, 98 Gulf & Western, 161 H Halliburton Company, 72, 74 Hamilton, Alexander, 20, 177, 328, 329 Hamilton, Elizabeth, 329 Harley, Robert, 148 Health care companies, 141–142 Hecla Mining, 253 Hedge funds, 278 Hedging, 302, 318–319 Hewitt & Tuttle, 330 Hidden assets, 230, 231 Hitachi Ltd., 231 Holland, 146–147 Home equity, 175–176 Home insurance, 290 Homestake Mining, 252 Homestore.com, 164 Honda, 231 Hoover, Herbert, 150, 151 Horizontal dimension, 310–313 HTML (HyperText Markup Language), 214 HTTP (HyperText Transfer Protocol), 214 HUD (Department of Housing and Urban Development), 171 Hudson River Railroad, 329 Hurricane insurance, 290 Hybrid automobiles, 178 Hypertext and CERN (Tim Berners-Lee), 214 HyperText Markup Language (HTML), 214 HyperText Transfer Protocol (HTTP), 214 I IBD (see Investor’s Business Daily) IBM, 74, 162 IMF (International Monetary Fund), 247 Income funds, 108 Income statements, 42, 43 Index arbitrage, 323 Index funds, 108 Index of Leading Indicators, 77 Index options, 321–322 India, 249 Industrial revenue bonds, 200 Inflation: in 1980s, 159 in business cycle, 77–78 gold prices during, 243, 249, 250 immunity of T-bills from, 204 and money supply indicators, 276 and valuing stocks, 131 Initial public offerings (IPOs), 6, 18 Institutional houses, 28 Insurance, 290 Insurance firms, 229 Intangible assets, 54–55 Interest rates: and bonds, 190 levels, 131–132, 134 and options, 312 and real estate bubble, 171, 173, 176 short-term, 303 on Treasury Inflation-Protected Securities, 204–205 on Treasury notes, 204 trends, 77, 249 Interest-rate swaps, 290–291 Internal financing: at Air Products & Chemicals, 124 defined, Internal Revenue Code, 313 Internal Revenue Service (IRS), 113 International investing (see Global investing) International Monetary Fund (IMF), 247 International mutual funds, 237 International Securities Exchange (ISE), 294, 298 International Stock Exchange (London), 233 International Telephone, 155 Internet, 213–221 and analysis, 40 bar charts on, 259 and brokerage firms, 219 and company Web sites, 216–217 and competition, 178 and dot-com bubble, 163, 164 earnings reports on, 68 and growth stocks, 140 history of, 214–215 and investing, 215–216 investment information on, 217–218 retail trades on, 36 and retail vs institutional houses, 28 Securities and Exchange Commission Web site, 217 selection of stockbroker using, 87 stock information on, 59 technical analysis services on, 218–219 Internet companies, 141 Internet scams, 218 Interpolation, 183 Intrinsic value, 305, 309, 310, 314 Inverse-performing exchange-traded funds, 112–113 Investing and trading, 83–115 as approach to stock market, 12 arbitrage in, 104–105 bear market strategies for, 100–103 dollar cost averaging in, 98–99 and exchange-traded funds, 99–100, 102, 109–114 family financial planning for, 84 and Internet, 215–216 and investment clubs, 105 and investment companies, 105–106 and mutual funds, 106–109 objectives in, 90–91 opening account for, 88–90 opening margin account for, 94–97 professional counsel for, 90 risk and reward in, 91, 92 selection and timing in, 91, 93 stockbroker selection for, 84–88 and taxes, 103–104 total return in, 93–94 types of orders in, 97–98 Investment analysts, 55 Investment bankers, 25 Investment clubs, 105 Investment companies, 105–106 Investment Company Institute, 108 Investment information, 217–218 Investor pools, 150–151 Investor’s Business Daily (IBD): calculations used by, 272 information in, 76 mutual fund listings in, 75 Web site, 219 Investors.com, 219 IPOs (see Initial public offerings) IRS (Internal Revenue Service), 113 ISE (see International Securities Exchange) IT&T, 161 J Jackson, Andrew, 242 Japan, 225, 226, 228–231 Japanese candlestick charts, 274–275 JDS Uniphase, 139, 164 Jewelry, 248 Johnson & Johnson, 74, 216–217, 235 J.P Morgan, 150, 177, 331 JPMorgan Chase, 176 K Kennedy, John F., 178 Kenyes, John Maynard, 241 Knickerbocker Trust Company, 177 Koito Manufacturing, 231 L Law, John, 147, 148 Lehman Brothers, 112, 176–177, 292 Leisure-time stocks, 161 Leveraged buyout, 51 Leveraged exchange-traded funds, 112, 113 Liabilities, 43–44 Liberty Bonds, 178 LIBOR (London Interbank Offered Rate), 291 Limit order, 97 INDEX 365 Line-item veto, 78 Liquid Yield Option Note (LYON), 198 Liquidation, 77 Liquidity, 202 Litton Industries, 161 Livermore, Jesse, 151, 156, 334 Load fund, 106 Loans, 6, 209 London, 233 London Interbank Offered Rate (LIBOR), 291 London stock market, 233 Long-term debt, 44 Louis XIV, King, 147 LYON (Liquid Yield Option Note), 198 M M-2 money supply, 248 MACD (moving-average convergence/ divergence), 271 Madoff, Bernard, 182 Managers, portfolio, 272 Manhattan Company, 177 Manhattan Fund, 336 Manias, 138–139, 146–147 Margin accounts: opening of, 94–97 writing options in, 301 Margin debt, 283 Margin in equities, 150 Market breadth, 65–66, 282 Market Diary tables, 65 Market order, 97 MarketWatch.com, 218 Markups/markdowns, 26 Marshall Plan, 226 Marx, Groucho, 165 MBSs (see Mortgage-backed securities) McClellan, Marion, 282 McClellan, Sherman, 282 McClellan Oscillator, 282–283 McCormick, Edward, 23, 36 McNerney, W James, Jr., 67 Medical devices, 140 Meehan, Michael J., 150, 335 Member short-sale ratio, 279 Mendels, Emanuel S., Jr., 23 Merck & Company, 122–123 Merger arbitrageur, 104 Merrill Lynch, 176 Messenger boys, 178 MetaStock, 219 Mexico Fund, 236 Microsoft Corporation, 120, 124–125 Mills Building, 23, 24 Mining, 246, 252–253 Mining stocks, 250, 251 Minors, 89–90 Mississippi Scheme (1718-1720), 147–148 Mitchell, Charles, 335 Money market, 205–206 Money market funds, 108 Money market instruments, 208–209 Money supply, 248, 276–277 366 INDEX Moody’s Investors Service Incorporated ratings, 194–195 Morgan, John Pierpont, 331–332 Morgan Stanley, 177 Mortgage Bankers Association, 176 Mortgage bonds, Mortgage-backed securities (MBSs), 170, 176 Mosaic, 214 Moving average, 271–272 Moving-average convergence/divergence (MACD), 271 Moving-average deviation, 270–272 Multinational companies, 235 Municipal bonds, 199–201 Muruntau open-pit mine (Uzbekistan), 246 Mutual funds, 75–76 international, 237 and investing/trading, 106–109 trading of, in OTC market, 33 N NAFI, 161 NAIC (National Association of Investors Corporation), 105 Naked call writing, 301–303 Nasdaq, 18, 20, 26 and brokers/dealers, 33 and regional exchanges, 30 requirements for listings on, 28 Nasdaq 100 Index, 99 Nasdaq 100 Trust (QQQ), 321 Nasdaq OMX, 228 Nasdaq VXN, 282 Nasdaq.com, 237 National Association of Investors Corporation (NAIC), 105 National Association of Security Dealers Automatic Quotation System (see Nasdaq) National debt, 248–249 Net profit margin, 50 Netscape Communications, 163, 214 Nevada, 246 New Germany Fund, 236 New options, 296 New York & Harlem Railroad, 329 New York Central Railroad, 329 New York Curb Market Association, 23, 25 New York Stock and Exchange Board, 22 New York Stock Exchange (NYSE): American Depositary Receipts on, 235 Arms Index, 282 ASA Ltd on, 251 country funds on, 236 floor transactions on, 30–33 founding of, 328 history of, 22–23 listings, 63 number of shares reported by, 65 requirements for listings on, 28 requirements for margin accounts, 89, 94, 96 short interest figures announcements, 277–278 and S&P 500 Index, 62 and stock market crash of 1929, 152 and stock splits, 74 and technical analysis, 283 and 3M, 67 trading limits imposed by, 229 New York Times, 59, 75 Newmont Mining, 253 News, financial (see Financial news) Newspapers: advertising in, 20 earnings reports in, 66 options in, 297 Nexus, 214 Nikkei Stock Average, 228 No load funds, 106 Nomura Holdings, Inc., 177, 229 Non-member firms, 27 Notes payable, 44 NYSE (see New York Stock Exchange) NYSE ARCA: and exchange-traded funds, 112 and Wall Street, 33–34 NYSE Euronext: exchange-traded funds, 36 and global marketplace, 228 and Wall Street, 18, 25, 28, 30, 33–34 NYSE “Next Generation” Market, 34 O Odd lots, 32, 73 Odd-lot investors, 278–279 Oil, 175, 178, 183, 226, 248, 331 Olds Corporation, 334 Online conference calls, 40 OPEC, 183 Open end fund, 106 Open market operations, 207, 208 Open order, 98 Open-outcry trading, 297–298 Operating profit, 43 Operating profit margin, 49 Options, 292–323 buying, 299–300 calendar spread, 316–318 defined, 294 hedging, 318–319 history of, 292–294 horizontal dimension, 310–313 index, 321–322 information, 294–297 in modern market, 296–297 new, 296 premium valuation of, 303, 305 puts and calls combined, 319–321 reducing risk with, 313 vertical dimension, 305–310 vertical spread, 313–316 writing, 101, 300–304 Options Clearing Corporation, 298 Orders, 97–98 Ortmann, Guy, 282 Osaka Securities Exchange, 230 OTC trading (see Over-the-counter trading) Outboard Marine, 161 Over-the-counter (OTC) trading, 27, 32, 33 (See also Nasdaq) of bonds, 200 listings, 63 stock options, 292–294 P Pan American Silver, 253 Panic of 1907, 332 Panic of 1929, 61 Par value, 44 Participating preferred stocks, 201 P/E ratio (see Price/earnings ratio) Pearl Harbor attack, 157 Penn Central, 206 PepsiCo, 157 Performance funds, 335 Philadelphia Stock Exchange, 217, 328 Photography, 126–128, 178, 249 Pickens, T Boone, 231 Pivot point, 261 Placer Dome, 252 Point-and-figure charts, 272–274 Polaroid, 126, 138, 162 Politics, 78–79, 251 Ponzi schemes, 182 Portfolio diversification, 123 Portfolio managers, 272 Precious metals (see Gold; Silver) Preferred stocks, 44, 195, 201–202 Premium valuation, 303, 305–313 Premiums, 294, 305, 309–312, 314, 319–320 Present value, 55 Pretax profit margins, 49 Price, Thomas Rowe, Jr., 335 Price concession, 305, 309, 310 Price resistance patterns, 261 Price support patterns, 260 Price to earnings growth ratio, 53 Price/earnings (P/E) ratio: and discounting values, 55 of Dow Industrials, 156 function of, 9, 10 and gold, 251 of growth stocks, 119, 120, 132–134 and investment environment, 132 of Japanese stocks, 230 and PEG ratio, 53 and stock market crash of 1987, 160 Primary market, 25–26 Primerica, 336 Private corporations, Pro forma statements, 45 Probabilities, 290 Procter & Gamble, 122–123, 235 Professional counsel, 90 Profitability analysis, 53 Profits: corporate, 152 gross, 43 importance of, 7–9 operating, 43 for stockholders, 7–8, 72–73 INDEX 367 Program trading, 34, 323 ProShares, 110, 112, 113 Prospectus, 25 Proxy statements, 41, 89 Publicdebt.treas.gov, 216 Purchasing power, 131 Put options (puts), 101, 300 Put writing, 302–303 Puts and calls combined, 319–321 Q Quarterly interim reports, 66 Quote.com, 218, 268 Risk: in investing and trading, 91, 92 with options, 309, 313 reducing, with options, 313–319 in writing naked calls, 302 Risk capital, 84 Rockefeller, John D., Sr., 137, 330–332 ROE (see Return on equity) Rogers, Will, 104, 170, 230 Roosevelt, Franklin D., 244 Round lots, 73 Round-trip commissions, 320 Russell, Richard, 336 R Radio Corporation of America (RCA), 150–151 Rare coins, 251 Ratings (bonds), 194–196 RCA (Radio Corporation of America), 150–151 R&D (research and development), 126 Real estate, 230–231 Real estate bubble (1997-2005), 165–166 boom in housing prices, 173–175 causes of, 175 companies affected by, 176–177 Fannie Mae, 170–171 home equity, 175–176 lower interest rates, 171, 173 Recessions, 123, 135 Regional exchanges, 28, 30 Registered bonds, 188 Registered representatives, 26 Reinvestment rates, 48–49, 121–122 Relative strength, 272 Reports: annual, 41–44 earnings, 66–73 financial, 8–9 quarterly interim, 66 research, 40 Republicans, 79 Repurchase agreements, 209 Research and development (R&D), 126 Research reports, 40 Reserves, gold, 247 Restructuring, 45 Retail companies, 142 Retail houses, 27 Retail trades, 36 Retained earnings, Retention rate, 47–49 Retirement programs, 84 Return on equity (ROE): analysis, 45–46, 48, 54 and growth stocks, 121 Return on total assets, 49 Reuters, 219 Reuters Holdings, 235 Revenue bonds, 200 Revenue growth, 72 Reversal patterns, 264 Reverse stock splits, 74–75 S Sales, 43 Sales growth, 53 Sarbanes-Oxley Act of 2002, 182 Sasson, Steven, 126 Saturation, 131, 141 Saturday trading, 152 Savings accounts, 91, 92 SBA (Small Business Administration), 183 Scams, 218 Search engine directories, 215 Sears, 155 Seasonal market trends, 284 Secondary market, 26–30, 202 Securities and Exchange Commission (SEC): buying and selling activity reported to, 283 disclosure requirements, 25 Edgar database, 68 establishment of, 156 Financial Industry Regulatory Authority, 26 regulation of mutual funds by, 107 regulation of Wall Street by, 18, 294 Web site of, 217 Securities Exchange Act (1934), 18, 94 Security Analysis (David L Dodd, Sidney Cottle, and Benjamin Graham), 132 Security Investors Protection Corporation (SIPC), 27 Selection: in investing and trading, 91 and technical analysis, 258 Self-financing companies, 48 Senior securities, 201 September 11 terrorist attacks, 157, 159, 175, 225 Serial maturity, 199–200 Series 86 test, 56 Series E savings bonds, 205 Series I savings bonds, 205 Settlement dates, 88 Share of stock, 91, 92 “Shares ahead of you,” 97 Short interest, 75, 277–278 Short selling, 75, 101–103 Short-sale hedging, 319 Short-term interest rates, 303 Silver, 249–254 and Gresham’s Law, 245 mining companies, 252–253 risks of investing in, 250 368 INDEX in South America, 148 strategies for investing in, 250–251 Silver halide photography, 178 Sinking funds, 194 SIPC (Security Investors Protection Corporation), 27 Small Business Administration (SBA), 183 Small investors, 13 Solar power, 140–141 Sony Corp., 235 Soros, George, 336 South Africa, 243, 246, 251 South-Sea Bubble (1719-1720), 148–149 South-Sea Company, 148–149 Soviet Union, 225, 246 S&P 100 Index (OEX) (see Standard & Poor’s 100 Index) S&P 500 Spider (see Standard & Poor’s 500 Spider) Spam, 215 SPDR (see Standard & Poor’s Depositary Receipt) Special tax bonds, 200 Special-purpose funds, 108 Specie Circular (1836), 242 Speculating, 12 Spreading, 313 Spreads: calendar, 316–318 of credit default swap, 291 defined, 31 and SuperDOT, 32 vertical, 313–316 SPY (Standard & Poor’s 500 Spider), 321 Standard & Poor’s (S&P) 100 Index (OEX), 321, 322 Standard & Poor’s (S&P) 500 Index, 62, 112, 115, 139, 277 Standard & Poor’s (S&P) 500 Spider (SPY), 321 Standard & Poor’s chart subscription services, 265 Standard & Poor’s Corporation ratings, 194–195 Standard & Poor’s Depositary Receipt (SPDR), 99, 112 Standard Oil Company, 137, 331 State-issued notes, 148 Statement of cash flows, 42, 51 Statements of income, Steel industry, 178 Stochastics, 271 Stock certificates, 12 Stock Exchange Office, 22 Stock manipulation, 150–151 Stock market activity, 64–66 Stock market crash of 1929, 149–156 aftermath of, 156 chronology of, 152–155 corporate dividends, 152 corporate profits, 152 Federal Reserve System, 151 margin in equities, 150 stock manipulation, 150–151 Stock market crash of 1987, 159–160 and circuit breakers, 34–35 recovery from, 61 Stock options (see Options) Stock power, 89 Stock prices: determination of, 9–10 and options, 305, 309 Stock splits, 72–75 Stock tables, 62–64 Stockbrokers, 26, 63–64, 84–88 StockCharts.com, 267 Stockholders: common characteristics of, 35–36 election of company directors by, 41 elections by, profits for, 7–8, 72–73 Stockholders’ equity, 42–44 Stocks: exchange-listed, 27 fertilizer, 162 foreign, 33 growth (see Growth stocks) Japanese, 230 leisure-time, 161 mining, 250, 251 preferred, 44, 195, 201–202 reasons for buying, 12–14 Stop limit order, 98 Stop loss orders, 155 Stop orders, 97–98 Straddle strategy, 319–320 Strap strategy, 321 Street name, 89 Striking price, 294, 305, 309 Strip strategy, 321 Strong, Benjamin, 151 Stuttgart Stock Exchange, 232 SuperDOT, 32 Supply, of gold, 245–247 Supply and demand, 226, 227 Support and resistance patterns, 260 Sutter’s Mill, 242–243 Syndicates, 25 T T Rowe Price Associates, 76, 109, 335 T Rowe Price New Horizons Fund, 121 TALF (Term Asset-Backed Securities Loan Facility), 183 Tangible book value, 54–55 Tax anticipation bills, 209 Tax rates, 49–50 Taxes: on annual report, 43 on bonds, 199–201 increases and cuts, 77 and investing/trading, 103–104 and stock yields, 132 and total return, 93 on U.S government securities, 202 Teaser rates, 173 Technical analysis, 257–285 bar charts in, 258–260 beta in, 272 candlestick charts in, 274–275 chart patterns in, 260–269 INDEX 369 Technical analysis (continued) Dow Theory in, 265, 270 Elliott Wave Theory in, 270 moving-average deviation in, 270–272 online services offering, 218–219 point-and-figure charts in, 272–274 relative strength in, 272 technical indicators in, 275–284 Technical analysts, 55 Technical indicators, 275–284 CBOE Volatility Index, 280, 282 EPS/T-bill yield ratio, 277 market breadth, 282 McClellan Oscillator, 282–283 member short-sale ratio, 279 money supply indicators, 276–277 odd-lot investors, 278–279 short interest, 277–278 stock market cycles, 278–279 WST ratio, 279–280 Technology companies, 141 Tennessee Eastman Company, 126 Term Asset-Backed Securities Loan Facility (TALF), 183 Terrorism, 215, 225 Texas Gulf Sulphur, 162 Third Market, 27, 233 Thornton, Tex, 335 3M Company, 63–64, 67, 68, 72, 125–126, 162, 235 Time, 309, 310, 316–317 Time Warner, 163 Timing: in investing and trading, 93 and technical analysis, 258 TIPS (Treasury Inflation-Protected Securities), 204–205 Tokyo Stock Exchange (TSE), 228–229, 231 Tokyo Stock Price Index (TOPIX), 228–229 Tontine Coffee House, 22 Toronto Stock Exchange, 110 Total return, 93–94 Toxic assets, 176 Toyota, 178, 179, 181, 231 Trade dates, 88 Trading (see Investing and trading) Transparency, 39 Treasury bills, 91–95, 202–204, 206, 208, 277 Treasury Inflation-Protected Securities (TIPS), 204–205 Treasury notes, 202, 204 TreasuryDirect, 202 Treaty of Utrecht, 148 Truman, Harry, 78 Tsai, Gerald, Jr., 335–336 TSE (see Tokyo Stock Exchange) Tulip Mania, 138, 146–147 Turnover ratios, 110 Tutankhamen, King, 242 Twain, Mark, 162, 332 Twelve-year Present Value Method, 135–138 Typewriters, 178 370 INDEX U UBS AG, 291 Underlying security, 294 Underwriting, 25–26 Unemployment, 157, 250 Uniform Gifts to Minors Act, 90 Union Carbide & Carbon, 155 Union Pacific, 330 United States Bank, 242 United States Steel Corporation, 332 Universal Resource Locator (URL), 215, 216 Unlisted Securities Market, 233 U.S Congress, 20, 78, 79, 171, 243 U.S Constitution, 79 U.S government securities, 202–205 U.S Steel, 154–156, 178 U.S Treasury, 332 USS Arizona, 156, 157 V Value: enterprise, 54 extrinsic, 305 of gold, 244–245 growth stock, 131–138 of growth stocks, 131–138 intrinsic, 305, 309, 310, 314 par, 44 present, 55 tangible book, 54–55 Value investing approach, 139 Vanderbilt, Cornelius, 329, 330, 332 Vanguard, 109 Variable hedging, 302 Variety, 155 Venture capitalists, 5–6 Vertical dimension, 305–310 Vertical spread, 313–316 Virus attacks, 215 Volatility, 280, 282 of funds, 113 of options, 318 of underlying stock, 303 of U.S stock market, 229 and valuation, 310 Volume, 274 W “Walking up” an option, 311 Wall Street, 17–36 circuit breakers, 34–36 designated market makers, 34 early days of, 328 exchanges, 30–33 history of, 20–25, 328–337 as marketplace, 18 during nineteenth century, 328–333 NYSE ARCA, 33–34 NYSE “Next Generation” Market, 34 OTC trading, 33 primary market, 25–26 program trading, 34 secondary market, 26–30 during twentieth century, 333 during twenty-first century, 336–337 Wall Street (film), 13 Wall Street Journal, 59, 66, 68 development of, 330 indication of stock splits in, 74 mutual fund listings in, 75 Wall Street Trader (WST), 219, 280 Wal-Mart Stores, 121, 129–131 War Bonds, 178 Washington, George, 20, 328 Washington Mutual, 292 Watson, Thomas J., Sr., 139 Web sites, 216–217 Weekly bar chart, 258–260 Weisner, Jerome, 219 West Germany, 226, 231 Western Union, 178, 330 Wilder, J Welles, Jr., 272 Wilson, Woodrow, 206–207 Wind power, 140–141 Wireless communications, 141, 220 Working capital, 44 World War I, 135, 178 World War II, 135, 157–158, 178 World Wide Web, 214 Writing options, 101, 300–304 WSJ.com, 59 WST (see Wall Street Trader) WST ratio, 279–280 X Xerox, 138, 162, 235 Y Yahoo!, 139, 164 Yamana Gold Inc., 253 Yield to maturity, 191 Yields: bond, 190–193 dividend, 9–10 Z Zenba (morning trading session), 229 Zero-coupon convertible bonds, 198–199 INDEX 371 This page intentionally left blank About the Authors Jeffrey B Little, a finance graduate of New York University, began his Wall Street career in the early 1960s Initially, he worked as an accountant in the margin department of a leading brokerage firm and additionally served as an instructor of technical analysis in a Wall Street training center Later, as a highly respected technology analyst, he became a portfolio manager and advisory committee member for one the largest funds at T Rowe Price Associates, a Baltimore-based global asset management firm Mr Little has been a Fellow of the Financial Analysts Federation, a member of the New York Society of Security Analysts, as well as a vice president of T Rowe Price Associates As an Investment Analyst, he was registered with FINRA (Series 7, 86, and 87) and retired from Wall Street in late 2009 Presently, Mr Little is a writer and publisher of biographies and computer software in Deerfield Beach, Florida, where he and his wife, Judith, now reside Lucien Rhodes, an economics graduate of Dartmouth College, has several years’ experience as a securities analyst and portfolio manager in both commercial and investment banking He has been registered on the New York Stock Exchange and is a past member of the Baltimore Society of Security Analysts Mr Rhodes is also a respected financial journalist His articles have appeared in various well-known publications, including the Baltimore Sun, Fortune, Wired, and INC magazine, where he received a national journalism award for his work In addition to his background in finance, he is also expert in various computer technologies In recent years, he has combined these interests to serve as an Internet consultant to financial services companies and venture capital start-ups in California’s Silicon Valley Mr Rhodes currently lives near San Francisco with his wife, Nancy UNDERSTANDING WA LL STREET Video The highlights of this classic book are now available on DVD for your viewing pleasure This two-hour video begins with the startup of a new business and the colorful history of Wall Street, tracing its origin as a dirt path, along with an explanation of how the markets work You will also learn details about evaluating a company for potential investment This up-to-date video, explains Wall Street in its contemporary investment setting with lively graphics, appropriate video footage, and clever chapter organization The Understanding Wall Street video is perfect as a home reference or as an educational medium It can be ordered quickly and easily with an 800 number and any one of the three major credit cards Thank you, but I would prefer to order by mail copies of the new Understanding Wall Street DVD Enclosed is $39.95 plus $7 shipping and handling for each video ordered ■ Visa ■ Master Card ■ Amex Credit Card Number ■ Check or Money Order Expires _ Name Address City State _ Zip _ Signature _ Mail To: LIBERTY PUBLISHING COMPANY, INC P.O Box 4485 Deerfield Beach, FL 33442 Toll-free call for immediate service: (800) 251-3345 Company Offices: (954) 426-9677 Liberty Publishing Company, Inc can also be reached at BullsOrBears.com (Florida residents please add applicable 6% sales tax Prices are subject to change Orders outside the U.S must be prepaid with international money orders, payable in U.S dollars) .. .UNDERSTANDING WALL STREET FIFTH EDITION This page intentionally left blank UNDERSTANDING WALL STREET FIFTH EDITION Jeffrey B Little and Lucien Rhodes New York Chicago... 1980, 1978 by Jeffrey B Little All rights reserved Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by... was established in Philadelphia in 1790 In 1789, the first Congress of the United States met in Federal Hall on Wall Street, the place where George Washington had been inaugurated as president