Work on subject
Trading on the stock exchange floor
Securities. Categories of common stock
Commodities and financial futures
Stock market averages reading the newspaper quotations
The price-earnings ratio
European stock markets–general trend
New ways for old
Europe, meet electronics
Mutual funds. A different approach
Advantages of mutual funds
Load vs. No-load
Common stock funds
Other types of mutual funds
The daily mutual fund prices
Choosing a mutual fund
1. MARKET PLACE
The stock market. To some it’s a puzzle. To others it’s 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
The phrase “the stock market” means many things. In the narrowest sense,
a stock market is a place where stocks are traded – that is bought and
sold. The phrase “the stock market” 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 doesn’t do the job,
the SEC is likely to step in directly. The Exchange doesn’t 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 demand.
It costs money it become an Exchange member. There are about 650
memberships or “seats” 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 “regional” 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 “over-the-counter” or “OTC”–that 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 market–the 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-counter.
While most of the common stocks traded over-the-counter are those of
smaller companies, many sizable corporations continue to be found on the
“OTC” 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 “RR” 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 individual’s 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 “trading posts”. 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 “market order”–which means an
order to buy or sell without delay at the best price available–the
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 trade–all
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 aren’t. 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 firm’s 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 firm’s accounts–when called upon by an Exchange
official–by 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 continuity– 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 proceeds.
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
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» stocks—stocks 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
There is less glamour, but also less risk, in what we will call—for lack
of a better phrase—»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
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 inflation—a general
advantage of common stocks that is worth repeating.
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
3.3 Special Situations.
There’s a type of investment that professionals usually refer to as
“special situations”. These are cases where some particular corporate
development–perhaps a merger, change of control, sale of property, etc.–
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 doesn’t
occur, an investor may suffer a loss, sometimes sizable. Here the
investor has to judge the odds of the expected development’s 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 grow).
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
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 institutions.
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 safety.
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
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
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 apply.
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 life—often 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
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»—that is, contracts for
delivery of a certain good at a specified future date— 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, it’s common to hear the question “How’s the
market?” and answer, “Up five dollars”, or “Down a dollar”. 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 information.
Despite all competition, the popularity crown still does to an average
that has some of the qualities of an antique–the Dow Jones Industrial
Average, an average of 30 prominent stocks dating back to the 1890s.
This average is named for Charles Dow–one 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 & Poor’s 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
“broad” market indexes. But old habits die slowly, and someone calls
out, “How’s the market?” and someone else answers, “Up five dollars,” or
“Up five”–it’s still the Dow Jones Industrial Average (the “Dow” for
short) that they’re 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 1/2 of 1%. A change of 1/2% is
still moderate; 1% is large but not extraordinary; 2% is dramatic. From
the market averages, it’s a short step to the thousands of detailed
listings of stock prices and related data that you’ll find in the daily
newspaper financial tables. These tables include complete reports on the
previous day’s 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, we’ll use it as a source of
convenient examples. You’ll find a prominent page headed “New York Stock
Exchange Composite Transactions”. This table covers the day’s trading
for all stocks listed on the NYSE. “Composite” means that it also
includes trades in those same stocks on certain other exchanges
(Pacific, Midwest, etc.) where the stocks are “dually listed”. Here are
some sample entries:
Yld P-E Sales
High Low Stock Div % Ratio 100s High Low Close Chg.
52 7/8 37 5/8 Cons Ed 2.68 5.4 12 909 49 3/8 48 7/8 49 1/4 +1/4
91 1/8 66 1/2 Gen El 2.52 2.8 17 11924 91 3/8 89 5/8 90 -1
41 3/8 26 1/4 Mobil 2.20 5.4 10 15713 41 40 1/2 40 7/8 +5/8
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 close—in 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 — 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 ratio—also referred to as the «price-earnings multiple»,
or sometimes simply as the «multiple»—is 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 —
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
multiples–whatever 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
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 situation—you 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 bond market.
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 options—primarily options to buy or sell common stocks (call
options and put options). There are futures prices— 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 index futures.
6. EUROPEAN STOCKMARKETS–GENERAL TREND
Competition among Europe’s 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 Madrid–at
least–aspire 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 America’s 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 Europe’s
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 suffers.
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 London’s example.
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
Germany—though, as will become clear, there is some dispute about these
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 it.
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
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 Bank’s 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 bank’s
screen-based IBIS trading system. A law to set up a federal securities
regulator (and make insider-dealing illegal) still lies becalmed in
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
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 exchange’s 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 today’s 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 SEAQ’s 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 “queen’s birthday effect”: 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
So the third response of Europe’s 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
forward–but this is hardly a single market. As Paris’s 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
emerge—whether 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 deals—which 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 Exchange).
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
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
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
aviation’s reluctant inching towards a European system of air-traffic
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 EC’s
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 corporations–and 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 “new issue”. 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 price.
New issues are different. You have probably noticed the advertisements
in the newspaper financial pages for new issues of stocks or bonds–large
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
“underwriting” 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 underwriters’ profit. Usually the underwriters have very
carefully sounded out the demand is disappointing–or if the general
market takes a turn for the worse while the offering is under way–the
underwriters may be left with securities that can’t be sold at the
scheduled offering price. In this case the underwriting “syndicate” 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. It’s 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 “going
public” 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 “selling
group” 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 “hot issue” 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 offering price)
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 securities.
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»—so 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
bonds—either 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 them—even 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 brokerage account.
But a brokerage account is not the only way to invest. For many
investors, a brokerage has disadvantages–the 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 available—mutual 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
The mutual fund principle has been so successful that the funds now
manage over $400 billion of investors’ money—not 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 industries.)
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
If the fund is part of a larger fund group, you can usually arrange to
switch by telephone within the funds in the group—say 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»)—typically (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 better—load 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 task—for 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 increase.
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, etc.
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,
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, tested managements.
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. It’s 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. Don’t 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