Covered Call

Long the stock, short a call. The term "buy-write" also is used for this strategy. This has essentially the same payoff as a short put

Covered Call = Long Stock + Short Call

This strategy is best implemented in a bullish to neutral market where a slow rise in the market price of the underlying stock is anticipated. This technique allows traders to handle moderate price declines because the call premium reduces the position's breakeven. Since the profit on a covered call is limited to the premium received, the premium needs to be high enough to balance out the trade's risk. This is good for stock that you like to keep it long term and also get some extra propfit (option premium).

EXAMPLE:

If you believe that Microsoft will be up slowly, you can either buy MSFT stock and sell it's call option. Let's see the example of buying MSFT 100 share and sell

1 contracts (100 share) MSFT October 32.5 call.

1. Buy 100 share MSFT

MSFT current price - $ 30

Commission - $ 10

Total cost - $ 3010 (30*100+10)

2. Sell 1 contracts of Oct. MSFT 35 Call

Premium - $ 1.00/contract * 1 (1.00*100) = $ 100

Commission - $ 20

Total cost - $ 80 (100-20)

Max risk - $ 2930 (3010-80)

Breakeven - $ 29.30 (30.1-.8)

Max profit - unlimited to the upside over breakeven

If CSCO price climb up to 34

Option Profit - 80

Stock Profit - 390 {(34-30.10)*100}

Total - 470

After the call option expire worthless (MSFT price less than 35), you can sell a call option over and over again. Or your option is assigned (MSFT price above 35),

you sell your stock to call option buyer. Now, you can buy the same stock or find other target(stock) and repeat this strategy.

Example of Long Call /Short Call/Long Put/Short Put

Long Call (Buying Call)

A trader who believes that a stock's price will increase might buy the right to purchase the stock call option rather than just buy the stock. He would have no obligation to buy the stock, only the right to do so until the expiry date. If the stock price increases over the exercise price by more than the premium paid, he will profit. If the stock price decreases, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option instead of shares, because for the same amount of money, he can obtain a larger number of options than shares. If the stock rises, he will thus realize a larger gain than if he had purchased shares. This is an example of the principle of leverage.

EXAMPLE:

If you believe that CSCO will be up, you can either buy CSCO stock or buy call option. Let's compare the difference between buy CSCO stock 100 share and buy

5 contracts (500 share) CSCO October 30 call.

1. Buy 5 contracts of Oct. CSCO 30 Call

CSCO current price - $ 28

Premium - $ 1.70/contract * 5 (1.7*500) = $ 850

Commission - $ 20

Total cost - $ 870 (850+20)

Max risk - $ 870 (850+20)

Breakeven - $ 29.74 (28+1.75+20/5)

Max profit - unlimited to the upside over breakeven

Margin - none

If CSCO price climb up to 33

Premium - 3.5/contract

Profit - 860 (3.5*500-870-20)

2. Buy 100 share CSCO

CSCO current price - $ 28

Commission - $ 10

Total cost - $ 2810 (28*100+10)

Max risk - $ 2810

Breakeven - $ 28.10

Max profit - unlimited to the upside over breakeven

If CSCO price climb up to 33

Profit - 480 (3300-2810-10)

Short Call (Naked short call -Sell Call)

A trader who believes that a stock's price will decrease can short sell the stock or instead sell a call. Both tactics are generally considered inappropriate for small investors. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money. Unless a trader already owns the shares which he may be required to provide, the potential loss is unlimited. However, such a trader who sells a call option for those shares he already owns has sold a covered call.

EXAMPLE: (Only for experienced investors who have lots of margin available can take high risk)

If you believe that CSCO will be down, you can either short CSCO stock or sell call option. Let's compare the difference between short CSCO stock 100 share and sell

5 contracts (500 share) CSCO October 30 call.

1. Buy 5 contracts of Oct. CSCO 30 call

CSCO current price - $ 28

Premium - $ 1.50/contract * 5 (1.5*500) = $ 750

Commission - $ 20

Total cost - $ 770 (750+20)

Max risk - unlimited to the upside over breakeven

Breakeven - $ 29.46 (28+1.50-20/5)

Max profit - $ 730 (750-20)

Margin - yes with high margin available

If CSCO price stay below 30

Profit - 730 (750-20)

If CSCO price climb up to 31

Loss - 770 {(31-29.46)*500 +20}

2. Short 100 share CSCO

CSCO current price - $ 28

Commission - $ 10

Total cost - $ 2810

Max risk - unlimited to the upside over breakeven

Breakeven - $ 27.90

Max profit - $ 2780 (2790-10)

Long Put (Buying Put)

A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price. He will be under no obligation to sell the stock, but has the right to do so until the expiry date. If the stock price decreases below the exercise price by more than the premium paid, he will profit. If the stock price increases, he will just let the put contract expire worthless and only lose his premium paid.

EXAMPLE:

If you believe that CSCO will be down, you can either short CSCO stock or buy put option. Let's compare the difference between short CSCO stock 100 share and buy

5 contracts (500 share) CSCO October 25 put.

1. Buy 5 contracts of Oct. CSCO 25 put

CSCO current price - $ 28

Premium - $ 1.50/contract * 5 (1.5*500) = $ 750

Commission - $ 20

Total cost - $ 770 (750+20)

Max risk - $ 770 (750+20)

Breakeven - $ 26.46 (28-1.50-20/5)

Max profit - $ 13230 (26.46*500-20) if CSCO bankrupcy

Margin - none

If CSCO price tumble to 23

Premium - 3.0/contract

Profit - 710 (3.0*500-770-20)

2. Short 100 share CSCO

CSCO current price - $ 28

Commission - $ 10

Total cost - $ 2810

Max risk - unlimited to the upside over breakeven

Breakeven - $ 27.90

Max profit - $ 2780 (2790-10)

If CSCO price tumble to 23

Profit - 480 (2790-2300-10)

Short Put (Naked put - Sell Put)

A trader who believes that a stock's price will increase can sell the right to sell the stock at a fixed price. The trader now has the obligation to purchase the stock at a fixed price. In some exchanges the option contracts are cash settled as well. The trader has sold insurance to the buyer of the put requiring the trader to insure the stockholder below the fixed price. This trade is generally considered inappropriate for a small investor. If the stock price increases, the short put position will make a profit in the amount of the premium. If the stock price decreases below the exercise price by more than the premium, the short position will lose money.

EXAMPLE:

If you believe that CSCO will be up, you can either buy CSCO stock or sell put option. Let's compare the difference between buy CSCO stock 100 share and sell

5 contracts (500 share) CSCO October 30 call.

1. Sell 5 contracts of Oct. CSCO 25 Put

CSCO current price - $ 28

Premium - $ 1.30/contract * 5 (1.3*500) = $ 650

Commission - $ 20

Total cost - $ 20

Max risk - $ 11830 (23.66*500) if CSCO become $ 0 (it's almost impossible)

Breakeven - $ 23.66 (25-1.30-20/5)

Max profit - $ 630 (650-20)

Margin - yes

If CSCO price stay above $ 25

Premium - 1.3/contract

Profit - 630 (1.3*500-20)

If CSCO price tumble to $ 22

Loss - 850 {(23.66-22)*500-20)}

but you can buy 500 share CSCO at $ 25 if you believe it is worthy to keep the stock

2. Buy 100 share CSCO

CSCO current price - $ 28

Commission - $ 10

Total cost - $ 2810 (28*100+10)

Max risk - $ 2810

Breakeven - $ 28.10

Max profit - unlimited to the upside over breakeven

If CSCO price climb up to 33

Profit - 480 (3300-2810-10)

If CSCO price tumble to $ 22

Loss - 610 {(28-22)*100-10)}

Option

Long Call

A trader who believes that a stock's price will increase might buy the right to purchase the stock call option rather than just buy the stock. He would have no obligation to buy the stock, only the right to do so until the expiry date. If the stock price increases over the exercise price by more than the premium paid, he will profit. If the stock price decreases, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option instead of shares, because for the same amount of money, he can obtain a larger number of options than shares. If the stock rises, he will thus realize a larger gain than if he had purchased shares. This is an example of the principle of leverage.

Short Call (Naked short call)

A trader who believes that a stock's price will decrease can short sell the stock or instead sell a call. Both tactics are generally considered inappropriate for small investors. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money. Unless a trader already owns the shares which he may be required to provide, the potential loss is unlimited. However, such a trader who sells a call option for those shares he already owns has sold a covered call.

Long Put

A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price. He will be under no obligation to sell the stock, but has the right to do so until the expiry date. If the stock price decreases below the exercise price by more than the premium paid, he will profit. If the stock price increases, he will just let the put contract expire worthless and only lose his premium paid.

Short Put (Naked put)

A trader who believes that a stock's price will increase can sell the right to sell the stock at a fixed price. The trader now has the obligation to purchase the stock at a fixed price. In some exchanges the option contracts are cash settled as well. The trader has sold insurance to the buyer of the put requiring the trader to insure the stockholder below the fixed price. This trade is generally considered inappropriate for a small investor. If the stock price increases, the short put position will make a profit in the amount of the premium. If the stock price decreases below the exercise price by more than the premium, the short position will lose money.

Option Basic-Short Call

Long Call

A trader who believes that a stock's price will increase might buy the right to purchase the stock call option rather than just buy the stock. He would have no obligation to buy the stock, only the right to do so until the expiry date. If the stock price increases over the exercise price by more than the premium paid, he will profit. If the stock price decreases, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option instead of shares, because for the same amount of money, he can obtain a larger number of options than shares. If the stock rises, he will thus realize a larger gain than if he had purchased shares. This is an example of the principle of leverage.

Short Call (Naked short call)

A trader who believes that a stock's price will decrease can short sell the stock or instead sell a call. Both tactics are generally considered inappropriate for small investors. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money. Unless a trader already owns the shares which he may be required to provide, the potential loss is unlimited. However, such a trader who sells a call option for those shares he already owns has sold a covered call.

Long Put

A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price. He will be under no obligation to sell the stock, but has the right to do so until the expiry date. If the stock price decreases below the exercise price by more than the premium paid, he will profit. If the stock price increases, he will just let the put contract expire worthless and only lose his premium paid.

Short Put (Naked put)

A trader who believes that a stock's price will increase can sell the right to sell the stock at a fixed price. The trader now has the obligation to purchase the stock at a fixed price. In some exchanges the option contracts are cash settled as well. The trader has sold insurance to the buyer of the put requiring the trader to insure the stockholder below the fixed price. This trade is generally considered inappropriate for a small investor. If the stock price increases, the short put position will make a profit in the amount of the premium. If the stock price decreases below the exercise price by more than the premium, the short position will lose money.

Option Valuation

The premium for an option contract is ultimately determined by supply and demand, but is influenced by five principal factors:

• The price of the underlying security in relation to.
  
• The strike price. Options will be in-the-money when there is a positive intrinsic value; when the strike price is above/below (put/call) the security's current price. They will be at-the-money when the strike price equals the security's current price. They will be out-of-the-money when the strike price is below/above (put/call) the security's current price. Options at-the-money or out-of-the-money have an intrinsic value of zero.
  
• The cumulative cost required to hold a position in the security (including interest + dividends).
  
• The time to expiration. The time value decreases to zero at its expiration date. The option style determines when the buyer may exercise the option. Generally the contract will either be
  
  
  
  • American style — which allows exercise up to the expiration date — or
    
  • European style — where exercise is only allowed on the expiration date — or
    
  • Bermudan style — where exercise is allowed on several, specific dates up to the expiration date.

European contracts are easier to value. Due to the "American" style option having the advantage of an early exercise day (i.e. at any time on or before the options expiry date), they are always at least as valuable as the "European" style option (only exercisable at the expiration date).

• The estimate of the future volatility of the security's price. This is perhaps the least-known input into any pricing model for options, therefore traders often look to the marketplace to see what the implied volatility of an option is — meaning that given the price of an option and all the other inputs except volatility you can solve for that value.

Pricing models include the Binomial options pricing model for American options and the Black-Scholes model for European options. Even though there are pricing models, the value of an option is a personal decision, requiring multiple trade offs and depending on the investment objective.

Because options are derivatives, they can be combined with different combinations of

• other options
  
• risk-free T-bills
  
• the underlying security, and
  
• futures contracts on that security

to create a risk neutral portfolio (zero risk, zero cost, zero return). In a liquid market, arbitrageurs ensure that the values of all these assets are 'self-leveling', i.e. they incorporate the same assumptions of risk/reward. In theory traders could buy cheap options and sell expensive options (relative to their theoretical prices), in quantities such that the overall delta is zero, and expect to make a profit. Nevertheless, implementing this in practice may be difficult because of "stale" stock prices, large bid/ask spreads, market closures and other symptoms of stock market illiquidity. If stock market prices do not follow a random walk (due, for example, to insider trading) this delta neutral strategy or other model-based strategies may encounter further difficulties. Even for veteran traders using very sophisticated models, option trading is not an easy game to play.

Option

In finance options are types of derivative contracts, including call options and put options, where the future payoffs to the buyer and seller of the contract are determined by the price of another security, such as a common stock. More specifically, a call option is an agreement in which the buyer has the right (but not the obligation) to exercise by buying an asset at a set price strike price on (for a European style option) or not later than (for an American style option) expiration date; and the seller (writer) has the obligation to honor the terms of the contract. A put option is an agreement in which the buyer has the right (but not the obligation) to exercise by selling an asset at the strike price on or before expiration date; and the seller has the obligation to honor the terms of the contract.

Since the option gives the buyer a right and the writer an obligation, the buyer pays the option premium to the writer. The buyer is considered to have a long position, and the seller a short position. For every open contract there is a buyer and a seller. Traders in exchange-traded options do not usually interact directly, but through a clearing house such as, in the U.S., the Options Clearing Corporation (OCC) or in Germany and Luxemburg Clearstream International. The clearing house guarantees that an assigned writer will fulfill his obligation if the option is exercised. Options/Derivatives are not rated and/or are below investment grade; however the OCC's clearing process is considered AAA rated.

The price of an option is called the premium. An option's premium is determined by a few factors including the current price of the underlying asset, the strike price of the option, the time remaining until expiration, and volatility. An option premium is priced on a per share basis. Each option on a stock (1 contract) corresponds to 100 shares. Therefore, if the premium of an option is priced at 1, the total premium for that option would be $100. Buying an option creates a debit in the amount of the premium to the buyer's trading account. Selling an option creates a credit in the amount of the premium to the seller's trading account

A stock option expires by close of business on the 3rd Friday of the expiration month. All listed options have options available for the current month and the next month as well as specific future months. Each stock has a corresponding cycle of months that they offer options in. There are three fixed expiration cycles available. Each cycle has a four-month interval: 1. January, April, July and October; 2. February, May, August and November; 3. March, June, September and December

There are no margin requirements if you want to purchase an option because your risk is limited to the price of the option. In contrast, option sellers receive a credit in their account for selling an option and earn this amount if the option expires worthless. However, option sellers also have an obligation to buy (put) or sell (call) the underlying instrument if their option is exercised by an assigned option holder. Therefore, selling an option requires a healthy margin.

Value Investing

Value investing has proved to be a successful investment strategy. It is a style of investment strategy; from the so-called "Graham & Dodd" School. Followers of this style, known as value investors, generally buy companies whose shares appear underpriced by some forms of fundamental analysis; these may include shares that are trading at, for example, high dividend yields or low price-to-earning or price-to-cash-flow, or price-to-book ratios. Numerous academics have published studies investigating the effects of buying value stocks. These studies have consistently found that value stocks outperform growth stocks and the market as a whole.

Value investing was established by Benjamin Graham and David Dodd, both professors at Columbia University and teachers of many famous investors. In Graham's book The Intelligent Investor, he advocated the important concept of margin of safety. The main proponents of value investing, such as Benjamin Graham and Warren Buffett, have argued that the essence of value investing is buying stocks at less than their intrinsic value. The discount of the market price to the intrinsic value is what Benjamin Graham called the "margin of safety". The intrinsic value is the discounted value of all future distributions.

Benjamin Graham is regarded by many to be the father of value investing. Graham's most famous student, however, was Warren Buffett, who ran successful investing partnerships before closing them in 1969 to focus on running Berkshire Hathaway. Charlie Munger joined Buffett at Berkshire Hathaway in the 1970s and has since worked as Vice Chairman of the company. Buffett has credited Munger with encouraging him to focus on long-term sustainable growth rather than on simply the valuation of current cash flows or assets.

However, the future distributions and the appropriate discount rate can only be assumptions. Warren Buffett has taken the value investing concept even further as his thinking has evolved to where for the last 25 years or so his focus has been on "finding an outstanding company at a sensible price" rather than generic companies at a bargain price.

Price/Book Value

The Price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company's book value to its current market price. Book value is an accounting term denoting the portion of the company held by the shareholders; in other words, the company's total assets less its total liabilities. The calculation can be performed in two ways but the result should be the same each way. In the first way, the company's market capitalization can be divided by the company's total book value from its balance sheet. The second way, using per-share values, is to divide the company's current share price by the book value per share (i.e. its book value divided by the number of outstanding shares).

As with most ratios, be aware this varies a fair amount by industry. Industries that require higher infrastructure capital (for each dollar of profit) will usually trade at P/B much lower than the P/B of (e.g.) consulting firms. P/B ratios are commonly used for comparison of banks, because most assets and liabilities of banks are constantly valued at market values. P/B ratios do not, however, directly provide any information on the ability of the firm to generate profits or cash for shareholders.

This ratio also gives some idea of whether an investor is paying too much for what would be left if the company went bankrupt immediately. For companies in distress the book value is usually calculated without the intangible assets that would have no resale value. In such cases P/B should also be calculated on a 'diluted' basis, because stock options may well vest on sale of the company or change of control or firing of management.

P/B ratio also known as the "price/equity ratio" (which should not be confused with P/E or price/earnings ratio).Price/book was more popular in the age of smokestacks and steel. That's because it works best with a company that has a lot of hard assets like factories or ore reserves. It is also good at reflecting the value of banks and insurance companies that have a lot of financial assets.

But in today's economy many of the hottest companies rely heavily on intellectual assets that have relatively low book values, which give them artificially high price/book ratios. The other drawback to book value is that it often reflects what an asset was worth when it was bought, not the current market value. So it is an imprecise measure even in the best case.

But the P/B ratio does have its strengths. Like the P/E ratio, it is simple to compute and easy to understand, making it a good way to compare stocks across a broad array of old-line industries. It also gives you a quick look at how the market is valuing assets vs. earnings. Finally, because assets are assets in any country, book-value comparisons work around the world. That's not true of a P/E ratio since earnings are strongly affected by different sets of accounting rules.

PEG Ratio

The PEG ratio is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share, and the company's expected future growth. A lower ratio is "better" (cheaper) and a higher ratio is "worse" (expensive). A PEG ratio that gets close to 2 or higher is generally believed to be expensive, that is, the price paid appears to be too high relative to the estimated future growth in earnings.

It is a generally accepted rule of thumb that a PEG ratio of 1 represents a reasonable trade-off between cost (as expressed by the P/E ratio) and growth: the stock is relatively cheap for the expected growth. If a company is growing at 30% a year, then the stock's P/E could be as high as approximately 30. PEG ratios between 1 and 2 are therefore considered to be in the range of normal values.

When the PEG is quoted in public sources, it is considered preferable to use the expected future growth rate. Investors may prefer the PEG ratio because it explicitly puts a value on the expected growth in earnings of a company. The PEG ratio can offer a suggestion of whether a company's high P/E ratio reflects an excessively high stock price or is a reflection of promising growth prospects for the company.

For example, if HP is trading at a forward P/E of 35 times earnings. After making the comparison and discovering that rivals Dell Computer and Acer are both trading at multiples around 20, you might begin to think HP looks awfully expensive. But then you look at earnings growth. First, you see that HP's earnings are expected to grow at 40% annually over the next three to five years, while analysts are predicting Dell will grow at 15% and Gateway at 20%. That would give HP a PEG of 0.88, while Dell weighs in at 1.33 and Acer at 1. Dell doesn't seem so pricey after all.

Generally you use a forward P/E in the PEG ratio, but a low PEG using a trailing P/E is even more convincing. Anything below 1 is of interest, although there really are no rules of thumb. Like the P/E, different industries regularly trade at different PEGs. It's also true that the PEG works less well for large-cap companies that by nature grow at a slower rate despite strong prospects. As always, the key is to compare a company to its peers.

P/E Ratio

The P/E ratio (price-to-earnings ratio) of a stock (also called its "earnings multiple", or simply "multiple", "P/E", or "PE") is a measure of the price paid for a share relative to the income or profit earned by the firm per share. A higher P/E ratio means that investors are paying more for each unit of income. It is a valuation ratio included in other financial ratios. The reciprocal of the P/E ratio is known as the earnings yield.

If Apple is trading at $90 a share, for instance, and earnings was $3 a share, its P/E would be 30 (90/3). That means investors are paying $30 for every $1 of the company's earnings. If the P/E slips to 27 they're only willing to pay $27 for that same $1 profit. This number is also known as a stock's "multiple," as in Apple is trading at a multiple of 30 times earnings.

The traditional P/E is what's known as a "trailing" P/E. It's for the previous 12 months. Also popular among many investors is the "forward" P/E -- It's for the coming year. Which is better? The trailing P/E has the advantage that it deals in facts -- its denominator is the audited earnings number the company reported to the Security and Exchange Commission. Its disadvantage is that those earnings will almost certainly change -- for better or worse -- in the future. By using an estimate of future earnings, a forward P/E takes expected growth into account. And though the estimate may turn out to be wrong, it at least helps investors anticipate the future the same way the market does when it prices a stock.

The biggest weakness with either type of P/E is that companies sometimes "manage" their earnings. It's also true that earnings estimates can vary widely depending on the company and the Wall Street analysts that follow it. So the P/E ratio should be viewed as a guide to you.

Short Interest Ratio

Selling short - When the investor who do not have stocks but borrows them and sell them in the market. it's becoming increasingly popular among individual investors. Why investor sell short? because the nvestors decides that all signs point to a decline in the stock price rather than an increase. So the investor borrows shares of the stock at that price and immediately sells them. After the stock falls, he buys it back on the open market to repay his debt. But since the price is lower, he pockets the difference.

A higher short interest ratio indicates more pessimism, because a higher proportion of a company's total float has already been sold short. It should always be treated as a red flag. But high short interest doesn't necessarily mean you should avoid the stock. After all, short sellers are very often wrong.

The short ratio (or short interest ratio) is usually the number of shares outstanding of a publicly traded company that is sold short, divided by the average daily trading volume. It can also be the percentage of the free float that is "shorted". The short-interest ratio tells you how many days -- given the stock's average trading volume -- it would take short sellers to cover their positions if good news sent the price higher and ruined their negative bets. The higher the ratio, the longer they would have to buy -- a phenomenon known as a "short squeeze" -- and that can actually buoy a stock. Some people bet on a short squeeze, which is just as risky as shorting the stock in the first place. Our advice is this: Use the short-interest ratio as a barometer for market sentiment only -- particularly when it comes to volatile growth stocks.

The short interest and short ratio can be deceiving, however, when a company has many convertible securities outstanding and is perceived to be at risk, because convertible and options arbitrageurs will often sell the stock short to manage risk with their long positions in these other instruments.

Technicans (Technical Analysts) interpret this ratio contrary to one's initial intuition. Because short sales reflect investors' expectations that stock prices will decline, one would typically expect an increase in the short-interest ratio to be bearish. On the contrary, technicans consider a high short-interest ratio bullish because it indicates potential demand for the stock by those who previously sold short and have not covered the short sale.

A technician would be bullish when the short interest ratio approached 5.0 and bearish if it declined toward 3.0.

Convertible hedgers are usually not hoping the price of shares will fall and, if properly hedged, can cover their short positions with shares embedded in the convertible securities. Thus, a large short interest position for such companies does not necessarily imply a classic short squeeze, and the short interest ratio becomes somewhat meaningless.

There are entire companies devoted to selling stocks short and they make it their job to seek out companies that are in trouble. They pore over financial statements looking for weaknesses. But sometimes they merely think a company is too highly priced for its own good.

Efficiency Ratio

The Return on Assets (ROA) percentage shows how profitable a company's assets are in generating evenue.

ROA can be computed as:

ROA = Net Income / Total Assets = (Net Income / Sales) * (Sales / Assets )

This number tells you "what the company can do with what it's got", i.e. how many dollars of earnings they derive from each dollar of assets they control. It's a useful number for comparing competing companies in the same industry. The number will vary widely across different industries. Return on assets gives an indication of the capital intensity of the company, which will depend on the industry; companies that require large initial investments will generally have lower return on assets.

Return on Equity (ROE, Return on average common equity, return on net worth) measures the rate of return on the ownership interest of the common stock owners. ROE is viewed as one of the most important financial ratios. It measures a firm's efficiency at generating profits from every dollar of net assets, and shows how well a company uses investment dollars to generate earnings growth. ROE is equal to a fiscal year net income(after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares), expressed as a percentage.

ROE = Net Income / Average stockholder's equity

But not all high-ROE companies make good investments. Some industries have high ROE because they require no assets, such as consulting firms. Other industries require large infrastructure builds before they generate a penny of profit, such as oil refiners. You cannot conclude that consulting firms are better investments than refiners just because of their ROE. Generally, capital-intensive businesses have high barriers to entry, which limit competition. But high-ROE firms with small asset bases have lower barriers to entry. Thus, such firms face more business risk because competitors can replicate their success without having to obtain much outside funding. As with many financial ratios, ROE is best used to compare companies in the same industry.

High ROE yields no immediate benefit. Since stock prices are most strongly determined by earnings per share (EPS), you will be paying twice as much (in Price/Book terms) for a 20% ROE company as for a 10% ROE company. The benefit comes from the earnings reinvested in the company at a high ROE rate, which in turn gives the company a high growth rate. ROE is irrelevant if the earnings are not reinvested.

As measures of pure efficiency, these ratios aren't particularly accurate. Because earnings can be manipulated. It's also true that the asset values expressed on balance sheets are not entirely reflective of what a company is really worth. General Eletric or an investment bank like Goldman Sachs rely on thousands of intellectual assets that walk out the front door every day.

But ROE and ROA are still effective tools for comparing stocks. Since all U.S. companies are required to follow the same accounting rules, these ratios do put companies in like industries on a level playing field. They also allow you to see which industries are inherently more profitable than others.

Dividend Yield

The dividend yield on a company stock is the company's annual dividend payments divided by its market cap, or the dividend per share divided by the price per share. It's often expressed as a percentage.

A dividend is a company make a payment to its shareholders from their earnings. It's usually payout as a per-share amount. When you compare companies' dividends, usually we call the "dividend yield" or "yield." That's the dividend amount divided by the stock price. Example: If a stock pays an annual dividend of $4.5 and is trading at $90 a share, it would have a yield of 5%.

Not all stocks pay dividends, nor should they. If a company is growing quickly and can best benefit shareholders by reinvesting its earnings in the business, that's what it should do. Google doesn't pay a dividend, but the company's shareholders aren't complaining. A stock with no dividend or yield isn't necessarily a loser.

When you're searching for stocks with high dividend yields, you should always look at the company's payout ratio. It tells you what percentage of earnings company is paying out to shareholders in the form of dividends. If the number is above 65% consider it a red flag -- it might mean the company is failing to reinvest enough of its profits in the business. A high payout ratio often means the company's earnings are faltering or that it is trying to entice investors who find little else to get excited about.

But don't invest stocks with the highest yield only, it might get you in trouble. When a stock at $100 a share and it has $4 dividend, so it has 4% yield. 4% is well above the market average, which is usually about 1.5 to 2%. But that doesn't mean all is well with the stock. Consider what happens if the company misses a quarterly earnings; and the price falls to $80. That's a 20% drop in value, but it actually raises the yield to 5%. Would you like to invest in a stock that just missed an earnings; Probaly not.

Beta

The Beta coefficient, in terms of finance and investing, is a measure of a stock's volatility in relation to the rest of the market. Beta is calculated for individual companies using regression analysis.

That's worth knowing if you want to avoid being shocked into panic selling after buying it. Some stocks trend upward with all the consistency of a firefly. Others are much more steady. Beta is what academics call the calculation used to quantify that volatility.

The beta figure compares the stock's volatility to that of the S&P 500 index using the returns over the past five years. If a stock has a beta of 1, it means that over the past 5 years its price has gained 10% every time the S&P 500 has moved up 10%. It has also declined 10% on average when the S&P declines the same amount. In other words, the price tends to move in synch with the S&P, and it is considered a relatively steady stock.

The more risky a stock is, the more its beta moves upward. A figure of 2.0 means a gain or loss of 20% every time the S&P gains or loses just 10%. Likewise, a beta of 0.5 means the stock moves just 5% when the index moves in either direction. A low-beta stock will protect you in a general downturn, a high Beta means the potential for big rewards in an upturn.

That's how it is supposed to work. But it is not guarantees about the future. If a company's prospects change for better or worse, then its beta is likely change, too. So use the figure as a guide to a stock's tendencies only.

Stock Market Basic Knowledge

In finance, a margin is collateral that the holder of a position in securities, option, or futures contracts has to deposit to cover the credit risk of his counterparty. This risk can arise if the holder has done any of the following:

• borrowed cash from the conterparty to buy securities or options,
  
• sold securities or options short, or
  
• entered into a futures contract.

The collateral can be in the form of cash or securities, and it is deposited in a margin account. The minimum margin requirement is now the sum of these different types of margin requirements. The margin (collateral) deposited in the margin account has to be at least equal to this minimum. If the investor has many positions with the exchange, these margin requirements can simply be netted.

Example. An investor sells a call option, where the buyer has the right to buy 100 shares in Apple at $120. He receives an option premium of $1.05. The value of the option is $1.05, so this is the premium margin. The exchange has calculated, using historical prices, that the option value won't go above $1.30 the next day, with 99% certainty. Therefore, the additional margin requirement is set at $.25, and the investor has to post at least $1.05 + $.25 = $1.30 in his margin account as collateral.

The Dogs of the Dow

According to The Dogs of the Dow investment strategy popularized by Michael O’Higgins in 1991, an investor should annually select for investment the ten Dow Jones Industrial Average stocks whose dividend is the highest fraction of their price.

Investing in the Dogs of the Dow is relatively simple. After the stock market closes on the last day of the year, of the 30 stocks that make up the Dow Jones Industrial Average, select the ten stocks which have the highest dividend yield. Then simply get in touch with your broker and invest an equal dollar amount in each of these ten high yield stocks. Then hold these ten "Dogs of the Dow" for one year. Repeat these steps each and every year. That's it!

Some of you may be interested in trying to outperform even the traditional Dogs of the Dow. Well, we have a way that historically has done just that. On the last day of any given year, select the ten highest yielding stocks as you normally would. Of these ten Dogs simply select the five Dogs with the lowest stock price and you will have what we call the Small Dogs of the Dow (Sometimes referred to as the Puppies of the Dow or the Flying Five). Then get in touch with your broker and invest an equal dollar amount in each of these 5 high yielding, low priced stocks. Then hold these five "Small Dogs of the Dow" for one year. Investing in the Puppies of the Dow would have resulted in a 20.9% average annual return since 1973! (As reported in U.S. News & World Report, July 8, 1996).

Proponent of the Dogs of the Dow strategy argue that blue chip companies do not alter their dividend to reflect trading conditions and, therefore, the dividend is a measure of the average worth of the company; the stock price, in contrast, fluctuates through the business cycle. This should mean that companies with a high yield, with high dividend relative to price, are near the bottom of their business cycle and are likely to see their stock price increase faster than low yield companies. Under this model, an investor annually reinvesting in high-yield companies should out-perform the overall market. Of course, several assumptions are made in this argument, first, that the dividend price reflects the company size rather than the company business model and second, that companies have a natural, repeating cycle in which good performances are predicted by bad ones.

Growth Stock

Both "Growth" and "Value" are labels put upon a stock or mutual fund by investors.

Usually they represent styles in investing - and not all stocks fit one category or the other, Looking for cheap stocks is value investing. For example, a low P/E ratio often is considered a signal that a stock is "cheap". An investor may buy that stock on just that signal alone. The converse is not necessarily true. A "growth investor" does not usually buy a company simply because it is overpriced, but will usually look at how fast it is growing and what is expected in the future.

The stock of a company that grows its earnings and revenues faster than average is known as a growth stock. These companies usually pay few or no dividends, since they prefer to reinvest their profits in their business.

Investors who focus on growth try to predict which companies will grow faster in the future -- faster than the rest of the stocks in the market, or faster than other stocks in the same industry. If you're successful in buying a company that does grow faster than other companies, then it's likely that the price of that company's stock will increase as well, and you can make a profit.

Momentum Investing

Momentum investing is a system of buying stocks or other equities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period. It has been reported that this strategy yields average returns of 1% per month for the following 3-12 months (Jegadeesh and Titman).

While no consensus exists about the validity of this claim, economists have trouble reconciling this phenomenon using efficient market theory. Two main hypotheses have been submitted to explain the effect in terms of an efficient market. In the first, it is assumed that momentum investors bear significant risk for assuming this strategy, and thus the high returns are compensation for the risk. The second theory assumes that momentum investors are exploiting behavioral shortcomings in other investors, such as investor herding, investor over and underreaction, and confirmation bias.

Seasonal effects may help to explain some of the reason for success in the momentum investing strategy. If a stock has performed poorly for months leading up to the end of the year, investors may decide to sell their holdings for tax purposes. Increased supply of shares in the market drive its price down, causing others to sell. Once the reason for tax selling is eliminated, the stock's price tends to recover.

Some investors may react to the inefficient pricing of a stock caused by momentum investing by using the tool of arbitrage.

It is believed that George Soros(1987) used a variation of momentum investing by bidding the price up of already overvalued equities in the market for conglomorates in the 1960's and Real Estate Investment Trusts in the 1970's. This strategy is termed positive feedback investing.

Richard Driehaus is widely considered the father of momentum investing. This Chicago money manager takes exception with the old stock market adage of buying low and selling high. According to him, "far more money is made buying high and selling at even higher prices."

Technical analysis

Technical analysis is the study of past financial market data, primarily through the use of charts, to forecast price trends and make investment decisions. In its purest form, technical analysis is concerned with the actual price behavior of the market or instrument, based on the premise that price reflects all relevant factors before an investor becomes aware of them through other channels.

Technicians believe that profits can be made by "trend following." So, if a stock price is steadily rising (trending upward), a technician will look for opportunities to buy this stock. This is why technical analysis is concerned more with where prices are moving (the direction or chart pattern). Until the technician is convinced this uptrend has reversed or ended, all else equal, he will continue to own this security. To that end, technical analysts anticipate the various patterns on a price chart and take positions according to the expected pattern.

Technicians apply the tools of technical analysis to decide when the trends and patterns have begun, peaked, reversed, etc. For example, a popular technical analysis tool is a stock price's 200 day moving average. This is the average closing price of a stock over the past 200 trading days (though there are many variations on the moving average used in technical analysis). A stock that has been trending higher will have a history of an increasing daily stock price and an increasing 200 day moving average. Though the daily stock price fluctuates (up 50 cents on day 1, down 20 cents on day 2, up 10 cents on day 3, etc.), the 200 day moving average changes much more slowly and traces a smooth curve that follows the current price on a chart.

When the daily stock price violates the 200 day moving average, a technician sees strong evidence that a price trend has ended and that a new one may have begun to the opposite direction. Suppose IBM's 200 day moving average was 85 and the stock has been trending higher. If IBM closed at 84.50 a technician may sell his IBM shares, and perhaps sell short IBM because the perceived trend is reversing.

The above example also shows that technical analysis data is can be interpreted in several ways. One technical analyst might believe that IBM would need to trade below its moving average for two consecutive days before deciding the trend is over. Another might say one day is adequate. All technicians are likely to think a close below the 200 day moving average is important, but all may not agree on the best way to act. Still, in this example it is safe to assume that most technicians expect to sell IBM.

The problem in this example is: What if in the near term IBM climbs back above its 200 day moving average after the technician sells his stock? If the technical analyst follows his own rules, he may buy the stock back at a higher price than he just sold (plus commissions). This reflects some of the criticisms of technical analysis (see below). Technicians say "false signals" or "whipsaws" are an unavoidable part of using technical analysis, and that the costs of these whipsaws are outweighed by catching a stock early in a long term trend.

If you're a "numbers person," or a heavy-duty computer geek, then you might be interested in a method of picking stocks known as technical analysis. Technical analysis looks at the relationships that exist between a stock's price, its volume (the number of shares that trade hands during a single day), and other factors. By plotting and mathematical analysis, technical analysts hope to be able to predict future changes in the price of a particular stock.

By looking for particular patterns on a price chart of a stock, for instance, technical analysts try to figure out the direction that the stock's price is likely to move in the future. These patterns often have unusual names such as "cup and handle," "head and shoulders," or "double top." If you can identify any of several dozen different established patterns in a stock's price, then you might have a good chance of knowing whether a stock is about to "breakout" (that's technical analysis talk for "rise in price") or "retreat" ("fall in price").

Other information about a stock is often also plotted on a chart along with its price history. A moving average of the stock's price is often included. Each day, the average price of the stock is calculated for the past 90 or 200 days. This moving average is plotted on the chart alongside the price, and can give you an idea of the past trends of stock's price.

Once you've got the basics of technical analysis under your belt, you'll need a couple of things before you start investing -- access to charting software and price data, and plenty of time.

A stock's price chart is the primary tool of technical analysis. There are many technical analysis software programs that you can use if you want to study stocks using these methods. MetaStock, Windows on Wall Street, Omega TradeStation are just a few. You can subscribe to your pick of many services on the Web providing daily price updates that can be imported into these programs.

These programs can be quite expensive, however, so another option might weigh in as the more economical choice for savvy Internet investors. Instead of using a standalone software program, you can take advantage of the free charting programs that are available on the Web.

To use technical analysis successfully, you need to be able to spend time on your portfolio on a regular basis. You need to be able to consistently take the time to analyze charts, and perform the operations necessary to update the indicators you use. And once you've bought a stock, you need to be vigilant in watching that stock's chart in order to know when to sell. There's no time for relaxing if you're a technician.

Opponents of technical analysis point out that there is little likelihood that this method even works. Debate rages about whether it's possible to predict future price movements based on a stock's past performance, or that patterns on a chart are indicative of anything other than pretty designs.

What is IPO?

An initial public offering (IPO) is the first sale of a corporation common share to investors on a public stock exchange. The main purpose of an IPO is to raise capital for the corporation. While IPOs are effective at raising capital, being listed on a stock exchange imposes heavy regulatory compliance and reporting requirements. The term only refers to the first public issuance of a company's shares. If a company later sells newly issued shares (again) to the market, it is called a 'Seasoned Equity Offering'. When a shareholder sells shares it is called a "secondary offering" and the shareholder, not the company who originally issued the shares, retains the proceeds of the offering. These terms are often confused. In distinguishing them, it is important to remember that only a company which issues shares can make a "primary offering". Secondary offerings occur on the "secondary market", where shareholders (not the issuing company) buy and sell shares with each other.

IPOs generally involve one or more investment banks as "underwriters." The company offering its shares, called the "issuer," enters a contract with a lead underwriter to sell its shares to the public. The underwriter then approaches investors with offers to sell these shares.

The sale (that is, the allocation and pricing) of shares in an IPO may take several forms. Common methods include:

• Dutch auction
  
• Firm commitment
  
• Best efforts
  
• Bought deal
  
• Self Distribution of Stock

A large IPO is usually underwritten by a "syndicate" of investment banks led by one or more major investment banks (lead underwriter). Upon selling the shares, the underwriters keep a commission based on a percentage of the value of the shares sold. Usually, the lead underwriters, i.e. the underwriters selling the largest proportions of the IPO, take the highest commissions—up to 8% in some cases.

After the newly public company has its IPO, it enters a "quiet period." During this time, the insiders, and any underwriters involved in the IPO, are restricted from issuing any earnings forecasts or research reports for the company. The quiet period is in effect for 40 calendar days following the first trading day. Regulatory changes by the United States Securities and Exchange Commission, changed the quiet period of 25 days, to 40 days on July 9, 2002. When the quiet period is over, generally the lead underwriters will initiate research coverage on the firm.

How Stock Markets Work?

Stock market is a market for the trading of company stock, and derivatives of same; both of these are securities listed on a stock exchange as well as those only traded privately.

Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere. Their orders usually end up with a professional at a stock exchange, who executes the order. A brokerage firm is a dealer of stocks and other securities that acts as your agent when you want to buy or sell stocks.

Some exchanges are physical locations where transactions are carried out on a trading floor, by a method known as open outcry. This type of auction is used in stock exchanges and commodity exchanges where traders may enter "verbal" bids and offers simultaneously. The other type of exchange is a virtual kind, composed of a network of computers where trades are made electronically via traders at computer terminals.

Most trading of stocks happens on a stock exchange. These are special markets where buyers and sellers are brought together to buy and sell stocks. The best known stock exchanges are the New York Stock Exchange, the American Stock Exchange and NASDAQ. Besides these three national exchanges, there are many smaller regional stock exchanges, such as the Pacific in Los Angeles, the Philadelphia, the Boston, the Cincinnati, and the Chicago. Some small companies are listed only on a regional exchange, while some NYSE and AMEX companies are listed on these smaller exchanges, as well, to help trades happen faster and cheaper for investors.

Actual trades are based on an auction market paradigm where a potential buyer a specific price for a stock and a potential seller a specific price for the stock. (Buying or selling at market means you will accept any bid price or ask price for the stock.) When the bid and ask prices match, a sale takes place on a first come first served basis if there are multiple bidders or askers at a given price.

The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a marketplace(virtual or real). The exchanges provide real-time trading information on the listed securities, facilitating price discovery.

From the perspective of an investor, buying and selling stocks seems pretty simple. If you use a full-service broker, just call her up on the phone and place an order for 100 shares of Apple. Within a few minutes, you'll receive a confirmation that your order has been completed, and you'll be the proud new owner of Apple's stock. Behind the scenes, however, there's a lot of action that takes place between your order and the confirmation.

What is Stock?

In Finance markets, stock is the capital raised by a corporatio through the issuance and distribution of shares. A person or organization which holds at least a partial share of stocks is called a shareholder. The aggregate value of a corporation's issued shares is its market capitalization.

Buy a share of Apple and you acquire a tiny sliver of the eletronic giant, tying your fate to that of Steve Jobs, for better or worse. This is ownership in the most literal sense: You get a piece of every desk, contract and trademark in the place. Better yet, you own a slice of every dollar of profit that comes through the door. The more shares you buy, the bigger your stake becomes.

How is a stock valued?The stock market itself is basically a daily referendum on the value of the companies that trade there. All those guys screaming at each other? Their job is to take in the day's news and distill it down to a single question: Will it help the companies I own make money in the future, or will it prevent them from doing so? If Apple loses a court battle to the Justice Department, look for its shares to fall. But if strong economic numbers come out promising better iPOD sales, traders will buy with a vengeance.

Earnings are the supreme measure of value as far as the market is concerned. Wall Street is obsessed with them. Companies report their profits four times a year and investors pore over these numbers -- expressed as earnings per share -- trying to gauge a company's present health and future potential.

The market rewards both fast earnings growth and stable earnings growth. Stock traders will even pay up for a money-losing company that promises to earn a lot in the future (witness 1998's explosion in Internet stocks). Things the market will not tolerate are declining earnings or unexplained losses. Companies that surprise Wall Street with bad quarterly reports almost always get punished.

What about risk?While history shows that stocks will rise given the fullness of time, there are no guarantees -- especially when it comes to individual stocks. Unlike a bond, which promises a payout at the end of a specified period plus interest along the way, the only assured return from a stock is if it appreciates on the open market. (While many companies pay shareholders dividends out of their earnings, they are under no obligation to do so.) The worst-case scenario is that a company goes bankrupt and the value of your investment evaporates altogether. Happily, that's rare. More often, a company will run into short-term problems that depress the price of its stock for what seems an agonizingly long period of time.

For all the risk, however, there are ways to manage your exposure. The best is to diversify by owning a variety of stocks. That way, no single company can harm you. It's also important to remember that investors are well compensated for rolling the dice with equities. Historically, the long-term return from stocks is about 11% annually, while bonds -- which are less risky -- return just 5.2%. Over time, that spread can make a huge difference in the earning power of your savings.

Along with ownership, a share of stock gives you the right to vote on management issues. Company executives work at the behest of shareholders, who are represented by an elected board of directors. By law, the goal of management is to increase the value of the corporation's equity. To the extent this doesn't happen, shareholders can vote to have management removed.

That's the way it is supposed to work, anyway. As we noted above, one of the grim realities of the stock market is that individual investors rarely amass enough stock to be able to exert any tangible influence over a company -- that's left to big institutional shareholders or groups of company insiders. Consequently, it behooves you to carefully research management's competence before you buy a stock. And the best measure of that may be the company's ability to consistently deliver earnings over time.

Fundamental Analysis

Fundamental analysis of a business involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets

The analysis is performed on historical and present data, but with the goal to make financial projections. There are several possible objectives:

• to calculate a company's credit risk,
  
• to make projection on its business performance,
  
• to evaluate its management and make internal business decisions,
  
• to make the company's stock valuation and predict its probable price evolution.

Two analytical models

When the objective of the analysis is to determine what stock to buy and at what price, there are two basic methodologies.

1. Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprice the security.
   
2. Technical analysis maintains that all information is reflected already in the stock price, so fundamental analysis is a waste of time. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the 'value' of a stock is. Their price predictions are only extrapolations from historical price patterns.

Investors can use both these different but somewhat complementary methods for stock picking. Many fundamental investors use technicals for deciding entry and exit points. Many technical investors use fundamentals to limit their universe of possible stock to 'good' companies.

The choice of stock analysis is determined by the investor's belief in the different paradigms for "how the stock market works".

Investors may use fundamental analysis within different portfolio management styles

Buy and hold investors believe that latching onto good businesses allows the investor's asset to grow with the business. Fundamental analysis lets them find 'good' companies, so they lower their risk and probability of wipe-out.

Managers may use fundamental analysis to correctly value 'good' and 'bad' companies. Even 'bad' company's stock goes up and down, creating opportunities for profits.

Contrarian investors distinguish "in the short run, the market is a voting machine, not a weighing machine". Fundamental analysis allows you to make your own decision on value, and ignore the market.

Value investors restrict their attention to under-valued companies, believing that 'it's hard to fall out of a ditch'. The value comes from fundamental analysis.

Managers may use fundamental analysis to determine future growth rates for buying high priced growth stocks.

Managers may also include fundamental factors along with technical factors into computer models quantitative analysis.

The analysis of a business' health starts with financial statement analysis that includes ratios. It looks at dividends paid, operating cash flow, new equity issues and capital financing. The earnings estimates and growth rate projections published widely by Thomson Financial and others can be considered either 'fundamental' (they are facts) or 'technical' (they are investor sentiment) based on your perception of their validity.

The determined growth rates (of income and cash) and risk levels (to determine the discount rate) are used in various valuation models. The foremost is the discounted cash flow model, which calculates the present value of the future

dividends received by the investor, along with the eventual sale price.;

earnings of the company, or

cash flows of the company.

The simple model commonly used is the Price/Earnings ratio. Implicit in this model of a perpetual annuity (Time value of money) is that the 'flip' of the P/E is the discount rate appropriate to the risk of the business. The multiple accepted is adjusted for expected growth (that is not built into the model).

Growth estimates are incorporated into the PEG ratio but the math does not hold up to analysis. Its validity depends on the length of time you think the growth will continue.

Some of the best-known investors in history have been fundamental analysts, including Peter Lynch, the legendary manager of the Fidelity Magellan mutual fund. Under his management, Magellan was the best performing mutual fund in history. Another famous fundamentalist is Warren Buffet, the brilliant investor behind Berkshire Hathaway. Berkshire Hathaway was once a textile company, but Buffet turned it into a vehicle in which he could invest in other stocks, with phenomenal success. A single share of Berkshire Hathaway now trades for over $100,000!

Most individual investors use fundamental analysis in some way to pick stocks for their portfolios. If you're looking for a way to build a "buy-and-hold" portfolio of stocks, made up of companies that you can purchase and then own for years without losing too much sleep at night, you'll probably use the methods of fundamental analysis.

Investors who use fundamental analysis usually focus on two separate approaches to picking stocks: growth or value (or sometimes a combination of both).