Dandelion

In share trading, contra is the buy and subsequent selling of shares without payment. One is given 3 days to pay up for shares that have been bought. If one sells the purchased shares within these 3 days without paying or "picking up", this is known as contra trading.

Assuming you bought $10,000 worth of stocks at $1 on a Monday. On the Wednesday, the price went up to $1.05 and you decide to sell it off. Based on this, you do not have to pay up for the $10,000 because you have already sold the stocks. In fact, the firm would credit to you 5cents of profit per share, all without you putting up a single dollar. Literally making money out of thin air.
The dangers of this is that most investors would not be able to understand the risks involved, and would end up buying more than they can afford. Do note, that most contra traders actually lose money.

Before you start investing in the stock market it is a good idea to ask yourself, “How does the stock market work?” The answer to this question is simple. Companies go public by offering a specific number of shares in their company to the public through the stock exchange. Investors then can use the stock exchange to buy and sell stocks of companies that they are interested in. While this basic description of how the stock market works is adequate enough to understand what the stock market is, to get a better understanding of how it actually works it will be important to learn about some of the terms that are commonly used when discussing the stock exchange including stock prices and market capitalization.

The first term that you may hear when you start learning about how the stock market works is stock prices. Stock prices are the price that a specific stock sells for. This price is set by several market factors including the health of the economy, trading trends, spending trends, and financial or technical reports put out by a company or an independent third party. The next term that you may hear about is market capitalization. Market capitalization is the value of the company or the stock that is being offered. To calculate the market capitalization of a company, or stock, simply use this formula: The number of outstanding shares X the price of the stock = market capitalization of the company.

After you learn about the basics features of the stock exchange you will next need to learn how to buy and sell shares. To buy a stock you will need to establish some kind of investment account. In most cases you will open an investment account with a stock broker that works at a local firm. However, today you can also open an online investment account and make trades without the help of a stock broker. After you have set up your account you will need to fund it before you can make a purchase. Once your account is funded you will be able to enter your order for a stock purchase. When you are ready to sell your shares you will either tell your stock broker that you want to sell X number of shares of Company A, or you will need to enter a sell order via your online investment account.

Tip 1: Volume and breakout
Volume is an important indicator in breakouts above resistance levels (or breakouts below support levels). Volume often spikes sharply when a breakout occurs.

A surge in volume often precedes a price breakout, then the breakout point through the area of resistance becomes a level of support a few days later. A decline in volume during down days is often a sign that the sell off is only a temporary setback in a generally upward trend.

There is a tendency for round numbers to stop advances or declines, at least in the short term. These round numbers, such as 50, 80, 100 will often act as psychological support or resistance levels. A trader can use this information to his or her advantage and begin taking profits, or enter the market, when round numbers are approached. to be continued...

Tip 2: The market told me to do it....
Often it is safer to let the market tell you if it is okay to buy into something. If we rally, make a fast profit and take it. But if we are weak, sit it out and watch for a while.

Tip 3: It can be very powerful...
Sometimes you will see a stock consolidating in a "cone pattern" where you see lower highs and higher lows, basically compressing it smaller and smaller. Often on patterns like this, when the break out comes (in either direction but more times than not its up) it
is very powerful.

Once you've decided to diversify your portfolio with a fixed income investment, you'll need to decide whether bond funds or individual bonds may better suit your risk tolerance, goals, income needs, and desire for liquidity. In many cases, a bond fund may be more appropriate as it offers a convenient, liquid, and cost-effective way to invest in the fixed income asset class.

*When you sell shares in a fund, you receive the current net asset value (NAV), less any redemption fee, if applicable.

Money – Value stock investing is for those investors who are interested in the financial workings of the companies in which they buy stocks. This type of investing is based on analyzing the potential for a stock based on its company's earnings and current financial picture.

Mutual Fund Investing:
Look at More Than a Fund's Past Performance

You can't open a newspaper or read a magazine without seeing ads promoting the stellar performance of "hot" mutual funds. But past performance is not as important as you may think, especially the short-term performance of relatively new or small funds. As with any investment, a fund's past performance is no guarantee of its future success. Over the long-term, the success (or failure) of your investment in a fund also will depend on factors such as:

• the fund's sales charges, fees, and expenses;
• the taxes you may have to pay when you receive a distribution;
• the age and size of the fund;
• the fund's risks and volatility; and
• recent changes in the fund's operations.

So, look at more than the fund's past performance when making your investment decisions. Read the fund's prospectus and shareholder reports, and consider these tips:

• Scrutinize the fund's fees and expenses.
  
  Funds charge investors fees and expenses. A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time. For example, if you invested $10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly $49,725. But if the fund had expenses of only 0.5%, then you would end up with $60,858. It takes only minutes to use a mutual fund cost calculator to compute how the costs of different mutual funds add up over time and eat into your returns.

• Know how the fund impacts your tax bill.The law generally requires a fund to make a capital gains distribution to shareholders if it sells a security for a profit that can't be offset by a loss. If you receive a capital gains distribution from a fund, you will likely owe taxes on it – even if the fund has had a negative return since you invested in it. For this reason, you should call the fund to find out when it makes distributions so you can time your investment in the fund to avoid receiving a capital gains distribution immediately upon investing and paying more than your fair share of taxes. Some funds post that information on their websites.

• Consider the age and size of the fund. Before investing in a fund, read the prospectus to find out how long the fund has been operating and the asset size of the fund. Newly created or small funds sometimes have excellent short-term performance records. Because these funds may invest in only a small number of stocks, a few successful stocks can have a large impact on their performance. But as these funds grow larger and increase the number of stocks they own, each stock has less impact on the fund's performance. This may make it more difficult to sustain initial results. You can get a better picture of a fund's performance by looking at how the fund has performed over longer periods and how it has weathered the ups and downs of the market.

• Consider the fund's portfolio turnover rate. A fund's portfolio turnover rate measures the frequency with which it buys and sells securities. A fund that rapidly buys and sells securities may generate higher trading costs and capital gains taxes.

• Think about the volatility of the fund. While past performance does not necessarily predict future returns, it can tell you how volatile a fund has been. Generally, the more volatile a fund, the higher the investment risk. If you'll need your money to meet a financial goal in one year, you probably can't afford the risk of investing in a fund with a volatile history because you will not have enough time to ride out any declines in the stock market. Read the fund's prospectus and annual report, and compare its year-to-year performance figures. These figures can help tell you whether the fund earned most of its returns in a few small bursts or whether its returns came in a steadier stream. For example, over ten years, two funds may have gained 12% per year on average, but they may have taken drastically different routes to get there. One might have had a few years of spectacular performance and a few years of low (or negative) returns, while the performance of the other may have been much steadier from year to year.

• Factor in the risks the fund takes to achieve its returns. Read the fund's prospectus and shareholder reports to learn about its investment strategy and associated risks. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals. For example, a fund that invests primarily in stocks whose prices may change quickly – like initial public offerings or high-tech stocks – will usually be riskier than other types of funds. But remember that all funds carry some level of risk. Just because a fund invests in government or corporate bonds does not mean it does not have significant risk. For example, the fund's investments could be very sensitive to interest rate changes. Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you.

• Ask about recent changes in the fund's operations. Has the fund's investment adviser or investment strategy changed recently? Has the fund merged with another fund? Operational changes such as these can affect future fund performance. For instance, the investment adviser or portfolio manager who generated the fund's successful performance may no longer be managing the fund.

• Check the types of services offered and fees charged by the fund.
  Read the fund's prospectus to learn what services it provides to shareholders. Some funds provide special services, such as toll-free telephone numbers, check-writing privileges, and automatic investment programs. You should find out how easily you can buy and sell shares and whether the fund charges a fee for buying and selling shares. You can expect funds that require extra work by their managers, such as international funds, to have higher costs.

• Assess how the fund will impact the diversification of your portfolio.
  Generally, the success of your investments over time will depend largely on how much money you have invested in each of the major asset classes – stocks, bonds, and cash – rather than on the particular securities you hold. When choosing a mutual fund, you should consider how your interest in that fund affects the overall diversification of your investment portfolio. Maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk.

In a bull market, people wait eagerly for dips, hoping to buy, feeling foolish they had not gotten in earlier. This eagerness to buy on dips limits the downside -- and people know it does, which feeds the bullishness, which can last a long time. At the top, there may even be books with ridiculous titles like, "Dow 36,000."

In a bear market, people wait eagerly for rallies, hoping to sell, feeling foolish they missed the chance to sell much higher. This eagerness to sell limits the rallies -- and people know it does, which feeds the gloom. This, too, can go on for a long time.

Ultimately, of course, a bull market will be brought down by . . . something (usually, rising interest rates followed by a recession), and stock prices that may have climbed above all reasonable levels of valuation will decline back toward those levels. Indeed, they will often keep falling well past reasonable valuations.

And then at some point -- very quickly or only after a long time (one only knows with hindsight) -- the bear market will end, as selling pressure is exhausted and psychology turns (possibly because the Fed has signaled that high interest rates can safely begin a downward trend).

Where are we in this cycle? Your guess is as good as mine. The market certainly doesn't feel very bullish here, yet prices of most stocks are hardly cheap, let alone irrationally so. So we may be in just the early stages of a bear market.

Or we may already have weathered the worst of it, in large part because some highly positive trends that underpinned the bull market may continue:

• Tremendously exciting advances in technology that greatly enhance human productivity. (But by making price comparisons so easy, and price competition so fierce, might they also decimate profits?)
• Generally lower defense spending that frees up capital and labor for more productive endeavors. (But are arms build-ups gone forever? Are major conflicts a thing of the past?)
• Generally freer trade that works to make the world economy more prosperous and efficient (see Ec 1: the rules of comparative advantage).
• Globalized communication that works in favor of democracy (it's hard to keep people in the dark, or keep them from organizing, once there's a modem in the village) . . . and that, thus, works in favor of peace (democratic governments do not start wars). But what do we do if one of these viruses ever DOES destroy all the world's data? You remember the Plague that devastated Europe? Now we have a new kind of plague to worry about. CyberPlague.

So who knows where we are? You decide: are you, personally, eager for dips so you can buy -- or for rallies so you can sell?

And how will you feel five minutes from now, when stocks have switched directions?

A measure of a corporation's profitability that reveals how much profit a company generates with the money shareholders have invested.

Calculated as:

= Net Income / Shareholder's Equity

Also known as "return on net worth" (RONW).

The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

There are several variations on the formula that investors may use:

1. Investors wishing to see the return on common equity may modify the formula above by subtracting preferred dividends from net income and subtracting preferred equity from shareholders' equity, giving the following: return on common equity (ROCE) = net income - preferred dividends / common equity.

2. Return on equity may also be calculated by dividing net income by average shareholders' equity. Average shareholders' equity is calculated by adding the shareholders' equity at the beginning of a period to the shareholders' equity at period's end and dividing the result by two.

3. Investors may also calculate the change in ROE for a period by first using the shareholders' equity figure from the beginning of a period as a denominator to determine the beginning ROE. Then, the end-of-period shareholders' equity can be used as the denominator to determine the ending ROE. Calculating both beginning and ending ROEs allows an investor to determine the change in profitability over the period.

1. Spam. Best way to lose money in the stock market? By trading on those ridiculous spam email stock alerts that we all get in our inboxes. You've got people accumulating huge chunks of shares in these worthless companies, looking to unload at the slightest sign of an uptick when you decide that you are going to buy some shares. These are bad news, and you should stay far, far away.

2. Following the herd. The real money is made by following economic trends and trying to become a contrarian. Everyone is betting on oil rising right now and plowing into oil stocks. They might make a few dollars, but chances are good that they will end up losing. The herd is almost never right. The real money is made identifying the bottom of cycles and putting your money into your idea when you think that the time is right.

3. Buying a stock without doing Due Diligence. A tip from a friend. An overheard conversation. A recommendation from Cramer. A tout from your boss. Tips are fine, but do you own research BEFORE buying. Buying a stock without doing research of your own, based on a "tip", is always a bad idea.

4. Buying a stock after earnings. XYZ comes out with earnings after the bell and says that earnings will be stronger than expected. You say to yourself, "Cool, I am going to buy!" Then the next day, the stock plummets and you take a loss. Why? There can be many reasons. Maybe earnings were strong but revenues were soft. Maybe they lost a big customer. Maybe their CFO quit. Maybe their international business is down. Or maybe the earnings were strong, but not quite as wildly strong as expected. There are many reasons why a stock can fall after reporting stronger than expected earnings. Always a bad idea to buy right after an earnings report.

5. Getting married to a stock. You buy a stock at $10 and it slowly ticks lower. $9. $8. $6. You really like the company, so you are going to hold on and ride it into the ground. Another bad idea. Research stop losses and use them. If a stock hits your stop loss, file for a divorce and fire it out of your portfolio.

6. Buying a stock cause it "looks cheap." Just because a stock used to trade at $30 and now traded at $3 doesn't make it "cheap." It means that the stock is severely flawed. It means that likely the company has some very real problems that it has to deal with. It means that the company might be spinning towards bankruptcy. It means that the company might be suffering from slipping sales. It can mean a lot of things that would make it not very "cheap."

7. Buying a stock based on the "Peter Lynch" principles. You walk into a store and note that it's very busy, so you go home and buy the stock. BAD IDEA. This can help you find great ideas, but you also need to examine the fundamentals of the company as well. There are quite a few retailers out there that are losing money hand over fist even though their stores are busy. Research first. Always.

8. Buying because of Cramer. Buying a stock because Jim Cramer recommended that you buy it is NOT a good course of action. Cramer can be right, and Cramer can be wrong. Picking one stock out of many that Cramer has recommended and sinking your money into it WITHOUT researching the stock on your own first is a very bad idea.

9. Penny stocks. It's fun to buy 20,000 shares of a stock that is trading for pennies. It is fun to imagine the stock trading up to $5 while you are holding a big chunk of the company. There is a reason why penny stocks are penny stocks; the companies are usually involved in highly experimental and unproven technology or they have major problems, and sometimes a combination of both. Penny stocks can be fun if you are fully prepared to lose the money that you invest in them. If not, stay away.

10. Trading options or forex if you don't know what you are doing. Forget the get-rich books that claim you can easily make millions trading options or forex. This is simply not true, and you need to have an advanced and sophisticated knowledge of the markets to make money this way.

Things You’ll Need:

Brokerage Accounts

Step 1:
Shop for undervalued companies.

Step 2:
Find stocks that have price-earnings ratios significantly lower than those of their peer group.

Step 3:
Watch for bad news. Wall Street often overreacts to bad news such as missed earnings, which will drive a stock lower than it should go.

Step 4:
Pick the jockey, not the horse. Find out who is running the company and where the executives worked previously.

Step 5:
Look for strong balance sheets. Companies with low debt loads, positive cash flow and consistently good earnings are good prospects.

Step 6:
Check out the portfolios of successful mutual-fund companies. If they are getting great returns year after year, they are holding stocks you might want to buy.

Step 7:
Know when to cut your losses. You want to invest for the long term, but you don't want to stick with a consistent loser.

Step 8:
Work hard. Do research. Read financial news. Study quarterly and annual reports as well as registration statements, looking for trends and opportunities.

Step 9:
Grill your broker. If the broker is recommending XYZ stock, ask for a detailed explanation, with an eye to growth prospects and historical performance.

Discover How Warren Buffet Invest in Stock

Buy and hold approach rests upon the assumption of in the long run; five or more years, stock prices will increase.

One hundred years of stock market historical data support this fact; stock prices have consistently increased with a few recessions in between.

The logic behind this rise is that in a capitalist society, the economy will keep on expanding and profits will subsequently keep on growing.

Consequently, both stock prices and stock dividends will increase as well. Short term stock price fluctuations are unavoidable because of business cycles or rising in inflation. But in long term, the market as a whole will rise.

Buy and hold types of investors are usually sell their stocks when they have reached their financial goals. The goals might be making enough money for retirement, children’s education or buying own house.

But from what I have observe nowadays, most investors put most of their effort into buying stocks, a little into selling them, but none into owning any of them. This might be because, as soon as they buy some stocks, they promptly turn their attention to the next candidate.

To them, buy and hold is so boring.

Another school of thought supports buying and holding stocks is without fundamental values as they believe that as long as investors hold the stocks for a long period of time, they are guaranteed to make money. This is another shallow interpretation of buy and hold strategies.

The long term stock investing approach should focus on selecting quality companies with current market values that are at a bargained price. By accumulating these stocks selectively over time and holding them, not only do we minimise transaction costs but also maximise the possibility of enjoying long term returns. In other words, you should not hold stocks for the sake of just holding them.

Now, let see why some stock investors failed to make money using buy and hold approach.

Firstly, if they need the money urgently (for example, retirement money) in a couple of years, holding stocks may not be the best thing to do. These buy and hold approach depends on how much time you are willing to wait before cashing in the stocks.

The average compounded return in stock market is between eight to 15 per cent per year. If you hold the stock for more than ten years, your stock performance is most likely will be much closer to these historical annual returns. However, if you hold stocks for less than a year, the chances of you losing money are very high.

Thus, the key in long term stock investing is patience. A good start is ten years (or at least make it five years). But if you do not have that much time, the buy and hold technique may be risky for you.

Secondly, regardless of how cheap some stocks may be and how long they are kept, buying bad stocks will only hurt your portfolio. Buying bad stocks at a very high price is even worse!

Imagine that you have bought Internet-related stock for $130 whereas their intrinsic value is only $3; you may never ever gain any profit regardless of how long you hold on to it. Therefore, another key to using this method is buying very high QUALITY stocks.

If you do not buy only quality stocks, in the long run, your portfolio of poorly chosen stocks won’t outperform the money left under your pillow.

As you can see, successful long term stock investing has very much to do with buying QUALITY stocks and holding them over LONG period of time.

I will not buy a stock just because it is cheap in price, but we should be the bargain hunters looking for quality stocks that sell at an attractive price.

The price/earnings ratio (P/E) is the best known of the investment valuation indicators. The P/E ratio has its imperfections, but it is nevertheless the most widely reported and used valuation by investment professionals and the investing public. The financial reporting of both companies and investment research services use a basic earnings per share (EPS) figure divided into the current stock price to calculate the P/E multiple (i.e. how many times a stock is trading (its price) per each dollar of EPS).

It's not surprising that estimated EPS figures are often very optimistic during bull markets, while reflecting pessimism during bear markets. Also, as a matter of historical record, it's no secret that the accuracy of stock analyst earnings estimates should be looked at skeptically by investors. Nevertheless, analyst estimates and opinions based on forward-looking projections of a company's earnings do play a role in Wall Street's stock-pricing considerations.

Historically, the average P/E ratio for the broad market has been around 15, although it can fluctuate significantly depending on economic and market conditions. The ratio will also vary widely among different companies and industries.

Formula:
Price/Earnings Ratio = Stock Price per Share / Earning Per Share (EPS)

Components:
Price / Earnings Ratio = ($67.44) / ($732.5 / $247.1) = 22.8

The dollar amount in the numerator is the closing stock price for Zimmer Holdings as of December 31, 2005 as reported in the financial press or over the Internet in online quotes. In the denominator, the EPS figure is calculated by dividing the company's reported net earnings (income statement) by the weighted average number of common shares outstanding (income statement) to obtain the $2.96 EPS figure. By simply dividing, the equation gives us the P/E ratio that indicates (as of Zimmer Holdings' 2005 fiscal yearend) its stock (at $67.44) was trading at 22.8-times the company's basic net earnings of $2.96 per share. This means that investors would be paying $22.80 for every dollar of Zimmer Holdings' earnings.

Variations:
The basic formula for calculating the P/E ratio is fairly standard. There is never a problem with the numerator - an investor can obtain a current closing stock price from various sources, and they'll all generate the same dollar figure, which, of course, is a per-share number.

However, there are a number of variations in the numbers used for the EPS figure in the denominator. The most commonly used EPS dollar figures include the following:

• Basic earnings per share - based on the past 12 months as of the most recent reported quarterly net income. In investment research materials, this period is often identified as trailing twelve months (TTM). As noted previously, diluted earnings per share could also be used, but this is not a common practice. The term "trailing P/E" is used to identify a P/E ratio calculated on this basis.
• Estimated basic earnings per share - based on a forward 12-month projection as of the most recent quarter. This EPS calculation is not a "hard number", but rather an estimate generated by investment research analysts. The term, estimated P/E ratio, is used to identify a P/E ratio calculated on this basis.
• The Value Line Investment Survey's combination approach - This well-known and respected independent stock research firm has popularized a P/E ratio that uses six months of actual trailing EPS and six months of forward, or estimated, EPS as its earnings per share component in this ratio.
• Cash Earnings Per Share - Some businesses will report cash earnings per share, which uses operating cash flow instead of net income to calculate EPS.
• Other Earnings Per Share - Often referred to as "headline EPS", "whisper numbers", and "pro forma", these other earnings per shares metrics are all based on assumptions due to special circumstances. While the intention here is to highlight the impact of some particular operating aspect of a company that is not part of its conventional financial reporting, investors should remember that the reliability of these forms of EPS is questionable.

Commentary:
A stock with a high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to the overall market, as investors are paying more for today's earnings in anticipation of future earnings growth. Hence, as a generalization, stocks with this characteristic are considered to be growth stocks. Conversely, a stock with a low P/E ratio suggests that investors have more modest expectations for its future growth compared to the market as a whole.

The growth investor views high P/E ratio stocks as attractive buys and low P/E stocks as flawed, unattractive prospects. Value investors are not inclined to buy growth stocks at what they consider to be overpriced values, preferring instead to buy what they see as underappreciated and undervalued stocks, at a bargain price, which, over time, will hopefully perform well.

Note: Though this indicator gets a lot of investor attention, there is an important problem that arises with this valuation indicator and investors should avoid basing an investment decision solely on this measure. The ratio's denominator (earnings per share) is based on accounting conventions related to a determination of earnings that is susceptible to assumptions, interpretations and management manipulation. This means that the quality of the P/E ratio is only as good as the quality of the underlying earnings number.

Whatever the limitations of the P/E ratio, the investment community makes extensive use of this valuation metric. It will appear in most stock quote presentations on an updated basis, i.e., the latest 12-months earnings (based on the most recent reported quarter) divided by the current stock price. Investors considering a stock purchase should then compare this current P/E ratio against the stock's long-term (three to five years) historical record. This information is readily available in Value Line or S&P stock reports, as well as from most financial websites, such as Yahoo!Finance and MarketWatch.

It's also worthwhile to look at the current P/E ratio for the overall market (S&P 500), the company's industry segment, and two or three direct competitor companies. This comparative exercise can help investors evaluate the P/E of their prospective stock purchase as being in a high, low or moderate price range.

A valuation ratio of a company's current share price compared to its per-share earnings.

Calculated as:

= Market Value per Share / Earnings per Share (EPS)

For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95).

EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters.

Also sometimes known as "price multiple" or "earnings multiple".

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company's own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.

The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.

It is important that investors note an important problem that arises with the P/E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number.

EPS manipulation might be the second oldest profession, but there is a relatively easy way for investors to protect themselves. This article will show you how to evaluate the quality of any kind of EPS, whether it's GAAP, pro forma, or otherwise.

Overview
The evaluation of earnings per share should be a relatively straightforward process, but thanks to the magic of accounting, it has become a game of smoke and mirrors, accompanied by constantly mutating versions that seem to have come out of Alice in Wonderland. Instead of Tweedle-dee and Tweedle-dum we have pro forma EPS and EBITDA. And, despite rumors to the contrary, the whisper number - the cheshire cat of Wall Street - continues to exist as guidance.

To be fair, this situation cannot be totally blamed on management. Wall Street deserves as much blame due to its myopic focus on the near-term and knee-jerk reactions to one-cent misses. A forecast is always only a guess - nothing more, nothing less - but Wall Street often forgets this. This, however, does create opportunities for investors who can evaluate the quality of earnings over the long run and take advantage of market overreactions.


EPS Quality
High-quality EPS means that the number is a relatively true representation of what the company actually earned (i.e. cash generated). I use the word 'relatively' because while evaluating EPS cuts through a lot of the accounting gimmicks, it does not totally eliminate the risk that the financial statements are misrepresented. While it is becoming harder to manipulate the statement of cash flows, it can still be done.

A low-quality EPS number does not accurately portray what the company earned. GAAP EPS (earnings reported according to generally accepted accounting principals) may meet the letter of the law but may not truly reflect the earnings of the company. Sometimes GAAP requirements may be to blame for this discrepancy; other times it is due to choices made by management. In either case, a reported number that does not portray the real earnings of the company can mislead investors into making bad investment decisions.

How to Evaluate the Quality of EPS

The best way to evaluate quality is to compare operating cash flow per share to reported EPS. While this is an easy calculation to make, the required information is often not provided until months after results are announced, when the company files its 10-K or 10-Q with the SEC.

To determine earnings quality, I rely on operating cash flow. The company can show a positive earnings on the income statement while also bearing a negative cash flow. This is not a good situation to be in for a long time, because it means that the company has to borrow money to keep operating. And at some point, the bank will stop lending and want to be repaid. A negative cash flow also indicates that there is a fundamental operating problem: either inventory is not selling or receivables are not getting collected. 'Cash is king' is one of the few real truisms on Wall Street, and companies that don't generate cash are not around for long. Want proof? Just look at how many of the dotcom wonders survived!

If operating cash flow per share (operating cash flow divided by the number of shares used to calculate EPS) is greater than reported EPS, earnings are of a high quality because the company is generating more cash than is reported on the income statement. Reported (GAAP) earnings, therefore, understate the profitability of the company.

If operating cash flow per share is less than reported EPS, it means that the company is generating less cash than is represented by reported EPS. In this case, EPS is of low quality because it does not reflect the negative operating results of the company and overstates what I feel are the true (cash) operating results.

An Example
Let's say that Behemoth Software (BS for short) reported that its GAAP EPS was $1.00. Assume that this number was derived by following GAAP and that management did not fudge its books. And assume further that this number indicates an impressive growth rate of 20%. In most markets, investors would buy this stock.

However, if BS's operating cash flow per share were a negative $0.50, it would indicate that the company really lost $0.50 of cash per share versus the reported $1.00. This means that there was a gap of $1.50 between the GAAP EPS and actual cash per share generated by operations. A red flag should alert investors that they need to do more research to determine the cause and duration of the shortfall. The $0.50 negative cash flow per share would have to be financed in some way, such as borrowing from a bank, issuing stock, or selling assets. These activities would be reflected in another section of the cash flow statement.

If BS's operating cash flow per share were $1.50, this would indicate that reported EPS was of high quality because actual cash that BS generated was $0.50 more than was reported under GAAP. A company that can consistently generate growing operating cash flows that are greater than GAAP earnings may be a rarity, but it is generally a very good investment.

Trends Are Also Important
Because a negative cash flow may not necessarily be illegitimate, investors should analyze the trend of both reported EPS and operating cash flow per share (or net income and operating cash flow) in relation to industry trends. It is possible that an entire industry may generate negative operating cash flow due to cyclical causes. Operating cash flows may be negative also because of the company's need to invest in marketing, information systems and R&D. In these cases, the company is sacrificing near-term profitability for longer-term growth.

Evaluating trends will also help you spot the worst case scenario, which occurs when a company reports increasingly negative operating cash flow and increasing GAAP EPS. As discussed above, there may be legitimate reasons for this discrepancy (economic cycles, need to invest for future growth), but if the company is to survive, the discrepancy cannot last long. The appearance of growing GAAP EPS even thought the company is actually losing money can mislead investors. This is why investors should evaluate the legitimacy of a growing GAAP by analyzing the trend in debt levels, times interest earned, days sales outstanding and inventory turnover.

The Bottom Line
Without question, cash is king on Wall Street, and companies that generate a growing stream of operating cash flow per share are better investments than companies that post increased GAAP EPS growth and negative operating cash flow per share. The ideal situation occurs when operating cash flow per share exceeds GAAP EPS. The worst situation occurs when a company is constantly using cash (causing a negative operating cash flow) while showing positive GAAP EPS. Luckily, it is relatively easy for investors to evaluate the situation.

The portion of a company's profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company's profitability.

Calculated as:

= (Net Income - Dividends on Preferred Stock) / Average Outstanding Shares

In the EPS calculation, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period.

Diluted EPS expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number.

Earnings per share is generally considered to be the single most important variable in determining a share's price. It is also a major component of the price-to-earnings valuation ratio.

For example, assume that a company has a net income of $25 million. If the company pays out $1 million in preferred dividends and has 10 million shares for half of the year and 15 million shares for the other half, the EPS would be $1.92 (24/12.5). First, the $1 million is deducted from the net income to get $24 million, then a weighted average is taken to find the number of shares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).

An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) - that company would be more efficient at using its capital to generate income and, all other things being equal, would be a "better" company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures.

Visit the business section of any decent library. You'll find shelves full of books on how to pick stocks. I've read most of them over the last thirty years and some are pretty good. Most are not. It isn't easy, but sorting the good stuff from the not-so-good stuff is absolutely necessary. Anyone who has read John Rothchild's book "A Fool and His Money, " knows what I mean.

The biggest obstacle to finding a winning stock picking system is that no system works all the time. Even the great Peter Lynch picked bummers once in a while. Nevertheless, there are some simple, common sense rules that can improve anyone's stock picking skills regardless of the system they use. Here they are:

Rule I: Favor Undervalued Stocks. The first step in picking stocks is to favor stocks of companies that are making money, lots of money. Study stocks of companies with rapidly growing earnings and choose stocks of companies which consistently make more money than they did the year before.

The question of price arises even if you do the above. Profitable, high growth stocks usually sell at very high prices. How high of a price is too high? The only way to answer this question is to know what a stock is really worth. If a stock's Value is more than its Price, the stock is undervalued. It's a candidate for selection.

Undervalued stocks offer a higher probability of achieving gains, the potential for very large gains and lower downside risk. In other words, undervalued stocks increase the odds of winning, increase the rewards for winning and decrease the risk of losing compared to overvalued stocks. So, favor undervalued stocks.

Rule II:

Favor Safe Stocks. Have you ever noticed that the prices of stocks like Coca Cola and McDonalds never seem to cause any excitement, yet go up year after year? Stocks like Chrysler are always in the news, and go up and down like a yo-yo. There's a very simple reason for this contrast. The former have track records of steady earnings performance while the latter has an erratic earnings record. Price volatility is a reflection of fear and uncertainty.

Price volatility and risk arise from many sources...rumors, political assassinations, earthquakes and so on. Shareholders with little confidence in their company tend to overreact to rumors and bad news. Consequently, the stock prices of companies with erratic earnings performance suffer more when unfortunate things happen. Stocks of companies with steady, predictable earnings can weather nearly any storm.

Obviously, there's less risk in holding stocks of financially stable companies. Consequently, I analyze the risk factors of stocks very carefully before buying.

The second key factor in picking stocks is to favor safe stocks.

Rule III:

Favor Stocks with Rising Prices. The hardest thing for most investors to do is buy a stock while its price is rising. Most of us have been taught to wait for a stock to go down before buying it. The idea of buying stock at a lower price makes a lot of sense, but is fallacious.

First of all, you'll miss a lot of good opportunities. Really good stocks usually don't look back once they have started moving upward. Witness the hundreds of stocks that have doubled and tripled over the last few years with nary a downturn.

Even more importantly, you never know where the bottom is when buying a stock whose price is falling. Remember when IBM went from 175 7/8 to 37 5/8. Who'd of believed it? I did because VectorVest did not reflect IBM as being undervalued or safe as it was going down. However, when things started turning around and IBM's price started rising again, we gave it a buy signal.

Buying stocks on the way down lessens your chances of winning. Most of us dream of buying a stock at its low point and riding it to the moon. It's a great dream, but the chances of doing so are virtually nil. The low points on good stocks don't last long. You have to be very lucky to bag a bottom.

Picking stocks with rising prices not only obviates the above problems, but offers several advantages. First, a stock that is rising in price is already doing what you want it to do. (You don't have to break a rising stock of a bad habit.)

Buying stocks with rising prices does not preclude the idea of buying them right after they hit bottom. Bottom Fishing is a great sport. You just have to know when the price trend has gone from down to up.

Finally, a stock that is hitting new highs has essentially no overhead resistance. There are no unhappy buyers waiting to get their money back. I especially like to buy stocks hitting their very first 52-WEEK high. These stocks have had plenty of time to consolidate, and are showing new signs of life.

It's fun to own stocks with rising prices. So pick stocks with rising prices.

Rule of Rules:

Pick Safe, Undervalued Stocks with Rising Prices. That's easy to say, but how does one find safe, undervalued stocks rising in price? Try following these steps:

1. Look at the financial section of your local paper, the Wall Street Journal, Investors Business Daily, Barrons, the internet or whatever. Find the list of stocks that have just hit new 52-WEEK highs. All of these stocks are definitely rising in price.

2. Rank all these stocks in ascending order of Price to Earnings ratio, i.e., P/E ratio. This may take some work, but low P/E ratio stocks of course, are undervalued.

3. Assess each stock for safety. Since the subject of safety is not touched upon in the papers, you'll have to turn to other sources. Take a look at Value Line, for example or Standard & Poor's Stock Guide.

4. Now put all the information together in a logical, quantitative, unemotional way. Pick the ones you think are the safest, most undervalued and rising in price the fastest.

Once you have prepared your list of stocks, check them out using VectorVest OnLine. VectorVest's stock analysis and graphics software analyzes over 8,000 stocks every day for Value, Safety and Timing. It unifies these factors into a comprehensive indicator called VST-Vector. Stocks with the highest VST-Vector ratings have the best combinations of Value, Safety and Timing.

There's no need to spend hours and hours doing what a computer can do. You can obtain a complete, rank analysis of any list of stocks with VectorVest in just a few minutes. Our records show that stocks with the highest VST-Vector ratings outperform the market over the long-term.

This comes as no surprise. Common sense and simple logic dictate that picking safe, undervalued stocks rising in price should result in above average performance.

If you want to invest in the stock market, you need to find a stock broker. Most people just use brokers that either their friends or family use or they see an advertisement on TV. Most of the time, these brokers are just fine. But with a little bit of research, you should be able to find the best stock broker for you. Here are the factors that you should consider when shopping around for a broker:

Place trades through the Internet: Some brokers allow you to place trades via phone, in-person, or through the Internet. Whatever the case is, the key is that you need to be able to place a trade online. Placing a trade online will generally cost you between $7-$15, whereas placing a trade over the phone or in-person can cost you anywhere between $25-$100. The difference in savings between making an $8 trade and a $10 trade is nowhere near the difference in making a $10 trade and a $50 trade. So whatever you do, make trades online.

Any advice or research they give is generally useless. Don't pay much for it: Some firms justify higher prices based on 'personalized research' or 'excellent investment advice.' Almost always, these perks are worth little. Again, if it's the difference between making $8 trades with no help and $10 trades with some help, go with the $10 trades if you want the advice or research. But don't be paying $50 a trade and up for research and advice. Chances are you are best served just investing in index funds or ETFs anyway.

Use a beginner-friendly broker: There are some brokers that are more geared for frequent traders and professionals, such as Interactive Brokers. There are others that are geared more for beginners, such as TD Ameritrade. For most novice investors, it is much much better to go with beginner-friendly brokers. The brokers geared for professionals offer lower trading fees and some advanced tools, but this will most likely just confuse beginning investors. Investment firms such as TD Ameritrade, Fidelity, etc. are very easy to use, and their trading costs are still relatively low as long as you use internet trades.

While markets are quite efficient and it is difficult to beat them over time, most casual investors seem to have a knack for being able to underperform the stock market. Most do this at least by paying too many fees. Investors put their money in mutual funds with large maintenance fees and bloated asset bases (which makes it more difficult for the mutual fund manager to invest the money). Investors also trade too much, which often costs them dearly in commissions.

But these fees aside, most investors lose money due to their emotions, specifically fear and greed. Many books have been written about how emotional thinking leads to bad investment decisions. This article will focus on the two biggest emotional culprits: fear and greed.

First, leti's talk about greed. The toxic effect greed has on investment results is rather straightforward. When a person sees others do well in an asset class or stock type, he or she decides to jump on the bandwagon and buy some too. This sort of logic has its roots in our cavemen tendencies to do something if others have done it and we deem it safe.

This cavement logic works well if we are deciding whether or not too eat a certain type of berry (if our other cavemen ate them and didn't get sick, it's probably ok to eat the berries), it doesn't work well when investing in stocks. What happens is greedy people end up buying at the top of a bubble. By the time they invest in the stock, the stock's price has ran up so much that it has become overvalued. Of course, the bubble eventually breaks and people that bought at the top lose a lot of money. Investment bubbles have occurred as soon as investment markets were formed, whether it was the Dutch tulip bubble or the tech bubble in the late 90's.

Fear is another toxic emotion for investors. It is also a much more powerful emotion than greed. Researchers have found that humans gain the same emotional satisfaction from earning 2.5 units of currency as their dissatisfaction from losing 1 unit of currency. Essentially, our caveman brain is wired so that earning $25,000 feels about as good as losing $10,000 makes us feel bad. Essentially, the emotion of fear is 2.5 times stronger than the emotion of greed, and we've already seen how greed can negatively affect our investment results!

Investors. fear causes poor investment results in two ways. First, when an investor makes a good stock investment, but for whatever reason, the stock drops significantly temporarily, the investor quickly sells the stock. Though the stock is cheap and the investor should probably be buying more, he ends up 'selling low'.

Furthermore, when stocks are cheap due to poor market conditions, most investors are too afraid to jump in. They generally wait too long and until a bubble forms to start buying stocks.

Together, fear and greed leads most investors to buy high and sell low. Don't let your emotions negatively affect your investment decisions.

A branch of economic thought known as 'efficient market theory' hypothesizes that the stock market is almost perfectly efficient in the sense that asset values are almost perfectly priced when factoring in all known information. Taking this theory to the extreme would mean that a monkey randomly choosing stocks would do no better or worse on average than a wall street guru.

Many people subscribe to this theory. Their main reasoning is that there are so many knowledgeable people that actively invest in stocks (think head fund managers, mutual fund managers, private equity guys, etc.) that all stocks are accurately valued. The only way to make more money in the stock market, or any aasset class for that matter, is to take on more risk. Otherwise, it's futile to attempt to try to pick stocks since you won't find any good deals (other people would have already found them and bid up the stock's price).

People who believe in this theory generally just invest in broad, index funds with low expense fees. They attempt to diversify to mitigate risk (hence the appeal of ETFs or index funds) and also attempt to lower transaction costs (again, the appeal of ETFs). By investing in ETFs and index fund, they also can just park their money in the long-run, which will limit their tax liability.

The market does a pretty good job at accurately pricing stocks, and on the whole, most investors probably can't beat a random monkey choosing stocks. But efficient market theory can't explain why some investors consistently beat the market, such as legendary investors like Warren Buffet and George Soros. It is also stretch to think the daily gyrations of the stock market are completely rational.

It is also difficult to explain the tech boom of 95-99 and subsequent crash in 2000-2002 through efficient market theory, since this was a pretty clear episode of excessive investor exuberance for tech stocks.

Also, while there is a lot of .smart money. in the market, this 'smart money' is often handicapped by large asset bases. Most of the best investors have asset bases of $250 million+ to deal with, so they cannot put much of their funds into the stocks that they necessarily think are the best buys.

For example, if a hedge fund manager who manages $500 million thinks a company with a market capitalization of $500 million is a great buy, he cannot put much of his asset base in their physically. If he invested all of it, he would have bought the company! That, plus with a sizeable infusion of money would have bid the stock.s price up way past its value.

Furthermore, as much smart money is out there, there is also a lot of dumb money too. Plenty of people don't know what they.re doing, and they trade based on emotion, leading to bad investment decisions. It is for these reasons that while efficient market theory has its merits, it's a huge stretch to believe that today's financial markets are almost completely efficient.

One thing newbie investors are often confused about is a stock's market capitalization. A company's market capitalization is simply the value of the company as priced by the stock market. The market capitalization is taken by the price of the stock times the amount of shares outstanding.

For example, if there are 100 million shares of company XYZ and those shares are trading at $35 a share, then company XYZ has a market capitalization of $3.5 billion.

Stocks with a larger market capitalization are generally seen as 'safer' investments, since the company itself is larger. However, large-cap stocks also do not have as much growth potential as small cap stocks. For a $1 billion stock to triple, it just needs to become a $3 billion company. For a $200 billion company to triple, it needs to become a $600 billion company.

Stocks are generally classified as mega-cap, large-cap, mid-cap, small-cap, or micro-cap stock based on their market capitalization. There is no set definition for these terms. What some consider a small-cap others might consider a micro-cap. Nevertheless, here's a general guideline to give you an idea what market capitalizations fit these terms:

Mega Cap: $200 billion or more (very few companies fit this category)

Large Cap: $10 billion to $200 billion

Mid Cap: $2 billion to $10 billion

Small Cap: $250 million to $2 billion

Micro Cap: Less than $250 million

What are investment traps per se? When hearing this term, most people think of investment scams and other illegal acts scammers use to trick investors. Those certainly are traps to look out for. However, in this article, I'm going to describe certain traps regular investors fall into that hurt their returns.

High fees: A common investment trap is simply paying too many fees. These fees may be incurred by investing in a high fee mutual fund (such as a mutual fund with a load) or paying too much in fees to your broker to trade stocks. For example, if you do most of your stock trading over the phone or in-person instead of through the Internet, you are likely paying way too much in fees. Another way people pay unnecessary high fees is buying "investment advice" that they really don't need and likely does not help them.

Fear and greed: Books can be written about how fear and greed destroys investors. Most investors buy high and sell low. They buy after everyone else is buying and sell when things look glim since everyone is selling. This is a natural byproduct of human nature, and unfortunately, the exact wrong way one should invest in the stock market. Most people that actively watch their stocks have much worse returns than people who just leave their money in index funds since the market watchers get consumed by fear and greed and trade too often and at the wrong times.

Infomercials: The epitome of an "investment trap," these "systems" that are advertised on late-night tv are generally at best worthless advice and at worst outright scams. If you see any of these infomercials, go ahead and watch and laugh at them, but certainly do not buy the product.

There are a variety of strategies investors use when analyzing stocks. Here are a few of them:

Value: The classic Warren Buffet strategy seeks to find stocks that are undervalued by the market. Investors who use this strategy seek to find stocks that they believe will earn more than analysts expect or believe the firm has assets that are currently underappreciated by the market.

Growth: Investors looking to find the next Microsoft generally focus on stocks with a high potential for growth. In a similar fashion to the value strategy, these investors seek to find stocks that they believe will grow faster than the market expects.

Technical Analysis: Some people use charts to predict a stock's movement. These traders are known as 'chartists' and this method of trading is known as technical analysis. Technical analysis tends to be used for short-term trades instead of long-term investments.

Newbie investors often make similar mistakes. Below are five of the most common mistakes beginning investors make:

1. Trading too often: Beginner traders often buy/sell their securities too much. They hear a hot tip on TV or a friend and feel they need to sell their current holdings and buy that stock instead. Generally, the only person who gets rich off of this is the investor's broker, who rakes in trading fees. Trading frequently is also tax inefficient, since these investors often end up paying short-term capital gains tax instead of the lower long-term capital gains tax.

2. Panicking: One emotion detrimental to investors is fear. Yes, you should use caution and prudence when making investments. However, panicking whenever the stock market goes down never solves anything. Investors that are quick to panic often end-up buying high and selling low.

3. Being Greedy: Jim Cramer frequently says "bulls make money, bears make money, hogs get slaughtered."

In terms of an asset class, stocks are hard to beat. Over time, they have higher returns than bonds or real estate. There are a few reasons stocks are such a great asset class, but stocks do have a few drawbacks as well:

Benefits of Stocks:

Returns: Over time, stocks outperform bonds, CDs (and other cash investments), and real estate. Stocks on average return about 10% a year, whereas these other investments generally return at about 5-7%.

Taxes: If you hold a stock for more than a year, your profits (when you choose to sell your stock) are taxed at long-term capital gains rate of 15% instead of your standard tax rate. Money you make from interest in a savings account or CD is taxed at your regular tax rate, which can be as high as 35%.

Diversification: Unlike real estate, it is easy to diversify your stocks. In fact, you can buy whole indexes of stocks, such as the S&P 500 or Wilshire 5000, by investing in ETFs that track those indexes. When you buy real estate, your returns are largely the result of how popular that area becomes. If you buy a house in an area that goes downhill, you will lose a lot of money on that house. For stocks, you can own a stock that literally goes to zero, but it's not a big deal provided you invested in a wide variety of stocks.

Disadvantages of Stocks:

Risk: The stock market can vary wildly. If you invest in a stock, your investment can literally go to zero if that company goes out of business. However, if you are properly diversified, the risks associated with the stock market are not that bad. Over the long run, the stock market goes up. Nevertheless, the risks with stocks will always be higher than a guaranteed return with a CD or government treasury.