8 posts tagged “corporation”
Yield
There is a widespread belief that a corporation's growth is enhanced by a low dividend payout, based on the logic that the money not paid out in dividends can be reinvested in the corporation thereby facilitating its expansion. This is logical and essentially true, but is not as important as many believe. As we will clearly demonstrate in a later discussion of actual results, the total return (capital appreciation plus dividends) of the stocks on our Master List is about the same irrespective of perceived growth rates.
We like money in any form, and if it happens to come from dividends, that's just fine. In fact, it is so fine that dividend yield can be valid stock selection factor all by itself.
The problem with selecting stock simply on the basis of the highest dividend yield is that dividends (as with earnings) are not constant. A fat dividend yield could suddenly go poof if the dividend is lowered or omitted. This risk is reduced by the construction of the Master List, which attempts to confine interest to issues of demonstrated superior fundamental quality, affording both above average dividend protection and dividend growth.
In employing this method of stock selection, all you need to do is, at the time of a buy indication, review the Master List and select the issues that have the highest dividend yield and that have experienced a price decline over the chosen comparison time period. In the publication of this type of portfolio modeling, the Report uses a four-week price comparison to match that associated with the primary criterion and several of the ancillary criteria. As previously discussed, the actual time periods compared depend on individual preference.
Price
Although most elements of the financial media and analytical community are quick to dream up reasons to justify any price change, the fact is that many price shifts have no fundamental basis and are simply natural imbalances in demand/supply. Since our objective is to buy low and sell high, it seems logical to review the Master List at the time of a buy indication and select the issues that have experienced the sharpest percentage price decline over the chosen comparison period. This percentage price shift is so significant that price change in itself can be considered a valid method of stock selection.
In the published portfolio modeling, again using a four-week comparison period, at the time of a buy indication the issues on the Master List are reviewed to isolate those that have experienced the greatest percentage decline. Those issues that are down the most are chosen for purchase.
Again, the importance of the Master List comes into play. If a corporation turns into garbage, its stock is going to go down. If a corporation reaps fantastic profits, its stock is going to go up. In such instances, the price changes are the result of not a basic demand/supply price dislocation creating over/under valuation; the price shift is based on true underlying fundamentals. The Master List's design is to confine interest only to those issues of demonstrated superior fundamental quality, thereby allowing clearer focus on price changes that are not related by true underlying fundamental change. In other words, the Master List is a conscious attempt to isolate stocks that become more attractive as their prices drop.
Oversimplification?
The initial reaction to determining specific stock selection by these three methods might be that it is too simple to really be valid. No complex mathematical formulas are involved. There is no need for computer assistance. Neither is there a need for a staff of analysts or heeding the predictions of puffed-up gurus. And there is not even any need to pay much attention to the financial media beyond acquiring the necessary data to determine if a buy/sell point has been established as well as the specific stocks involved.
The fact of the matter is that we have found the market to be quite simple. It is often presented, and consequently perceived, as complex, but we have found its core to be nothing other than a straightforward, repetitive, man-made business.
Recognizing this basic, underlying simplicity and comparing it to the rantings of many analysts and media sensationalism, you can gain insight as to why the simplicity is widely overlooked by the majority and always will be. The majority within the analytical community will always attempt to present a reason to justify any price change, after it occurs, in the context of the reasoning being most easily accepted by clientele. Because of the assumed, widespread belief that all price changes are based on fundamental change, the consensus among analysts repeatedly ignores structural and/or psychological pressures that can create prices that are extremely divergent from underlying fundamental norms.
To understand how an erroneous consensus can develop, place yourself in the position of an institutional analyst, keeping in mind that job preservation provides some nice things, such as food and shelter. Now let's say the market makes a significant move because of psychological and/or structural pressures that move prices well away from underlying fundamentals. You are asked to explain why. If you say you don't know, you look stupid to clientele (after all, you are being paid to know everything), and you risk loss of employment. Your image, as well as your future, might very well depend on providing an answer that is most easily accepted by your clientele, which have been conditioned by you and/or other analysts to believe that every price change is justified by a purely fundamental factor. Looking about at what the other analysts say is the cause of the price change, you simply repeat what they are saying and join the consensus. You are one of the group. Even if absolutely wrong, your retaining employment is enhanced because you are in full agreement with your peers (they can't fire everybody).
The sentiment among analysts is reinforced by most elements of the financial media which (in its attempt to generate sales) stresses uncommon events.
The sales structure of the securities industry is also a powerful force that is bolstered by the consensus among analysts and concentrated media attention. It is elementary logic that a sale is made easiest when the customer is predispositioned to making a decision.
The consensus among analysts plus media concentration plus the sales structure of the securities industry combine to create tremendous pressures that can make the exception appear to be the rule. Consequently, chasing price after the fact of price change creates a lure that ignores the market's underlying simplicity. It also ignores the basic logic that profit. ability requires being properly positioned before the fact of price change.
The proponents of LBOs, usually the managements involved and those who are paid fat fees to construct the deals, point out that shareholders benefit by getting to sell their stock at a substantial premium relative to what the stock would be worth if there was not an LBO offer. They also point to somewhat hazy theoretical benefits including (but not limited to) concepts that the nonpublic corporation will be more competitive and thereby benefit the economy as a whole. In addition, they contend that those who provide the financing (usually through junk bonds) are pro. vided higher interest rates than they could otherwise obtain.
Critics of LBOs contend the only true value is to those who construct the deals and the management that takes over the corporation, in that they are provided very large profits with relatively low risk. They maintain that the added debt burden to the corporation detracts from its financial stability, using the high default rate of junk bonds as proof. Their criticism also includes a couple of accusations: For one, the junk bondholders are not properly appraised of the risk involved. Also, when banks are involved in the financing, the taxpayers (because the bank's deposits are insured by the federal government) are subsidizing a process that does nothing except make a select few enormously rich and destabilize the overall economy, as the U.S. savings and loan debacle clearly attests.
Irrespective of the arguments, one aspect is clear. The managements who are buying the stock from stockholders (the owners) are, in effect, competitors thinking they are buying the stock cheap (at least relative to their risk). Otherwise, why would they want the stock all to themselves? Our main point is to demonstrate that the objectives of management and shareholders (for whom management presumably works) can often bedivergent and directly competitive.
Corporate Raiders
Corporate acquisitions can take one of two forms: friendly or hostile. In riendly arrangements, the buyer and the corporation to be acquired agree
on the terms involved and all proceeds (usually) rather smoothly. In hostile situations, the management of the corporation resists the buyer's actions. The buyer in such instances is usually termed a raider.
For a variety of reasons, including the possibility of loss of employment, managements do not like raiders. They want the raider to go away. To entice the raider to leave, they may offer incentives, such as buying the raider's stock in the corporation at a price significantly above the free market price, providing the raider high paying preferred stock/bonds, or any other enticement that leaves the raider with a profit sufficient enough for him to promise not to return. These payments are called Greenmail. In a greenmail arrangement corporate management has paid off the threatening party without the permission of shareholders (or owners). The shareholders have not even been given the choice as to whether they want to take the raider's presumed offer.
Thus, once again, corporate management and shareholder objectives can diverge and, in effect, place management and shareholders in direct competition.
Some raiders have perfected their activities to an art, getting paid off repeatedly without ever really making a serious attempt to takeover the "threatened" corporations. Other raiders have been known to buy stock in a corporation, then announce (or imply) that they might takeover the corporation at a price higher than the current market price. Speculators might rush in and push the stock higher. The raider then "changes his mind" and sells his stock into the buying demand (higher prices) created by the speculation. Such activities turn ethical stomachs. They are mentioned to reinforce the true nature of the market, which includes avoiding the assumption that corporations are automatically investors' friends.
Taking a Corporation Public
In taking a corporation public, instead of management buying stock from the public, it is selling its stock to the public. The sale may take the form of new stock issues, selling stock held previously taken private by means of LBOs, or simply large blocks of stock held by management in corporations already trading publically. Whatever the form, the implication is clear that management is selling because the price of the stock is too high. Again, the managements of corporations so involved have placed themselves in direct competition with other investors.
Avoiding competitive abuses from corporations entirely is not possible. Slimy types have been known to work their way to the top of some of the finest corporations. Once identified as the unethical types that these individuals almost always are, they can be avoided by staying away from the corporations with which they are involved. To reduce the possibility of being victimized by unscrupulous corporate managements, we confine investment interest to the issues that meet the selection criteria where shareholders concern plays an important role.
Stock Splits Versus Stock Dividends
Many texts and financial publications differentiate between stock splits and stock dividends. There is no real difference. Stock dividends are nothing more than small splits. For example, if a corporation has a
3-percent stock dividend, someone with 100 shares would be issued 3 (or 3 percent) new shares.
Almost all articles state the reason for stock splits and stock dividends is so that the stock will be at a lower price level, which makes the stock attractive to a wider range of investors. Because of wider appeal, the assumption is that the stock's price will be more easily supported and consequently will rise more easily. Although this theory might get nods of approval in ivory towers, in the actual market it is not always true. In fact, many stocks literally get smashed after stock splits. This is because of a combination of naive investors bidding up the price too high in anticipation of the split, and professionals shorting in the knowledge that the price is inflated because of irrational buying demand.
The most important realistic aspect of stock splits to corporations is thatthey increase the number of outstanding shares. The more outstanding shares there are, generally the more trading and eventually the moreshareholders. The more shareholders there are, the more difficult their communication with each other and thereby the lower the chance of a concentrated effort by shareholders to oust management. The end result is to make management more secure in its position. This can effectively place the management in a situation of perpetual control, without its ever owning any of the corporation's stock.
Insider Trading and LBOs
New issues and stock splits are the result of overall corporate policy. Competition from corporations can also be from individual officers and directors who have access to information concerning the corporation thathas not been made available to the public—an obvious advantage. Those having such positions within a corporation are called insiders.
The existence of illegal insider trading abuses is obvious, as demonstrated by publicized arrests and indictments. However, the large majority
of corporate insiders (probably) adhere to the law and report their buying and selling to the Securities and Exchange Commission, which is required in an effort to ensure they are not basing their decisions on information not available to the public. These reported trades (often after a significant time lag) are available to the public and provide the basis for a wide range of analytical methods and financial advisory services.
The reasoning behind monitoring reported corporate insider trading is simply that the group's knowledge of corporate events will result in their trading being profitable. Studies indicate that this assumption is basically true. However, the results of these studies of reported insider trading fall well below those considered acceptable by the methods. Insider theories fail to provide acceptable results apparently because the insiders themselves do not understand the market as well as they should. (The topic of corporate insiders is expanded on in Chap. 6.)
The most notorious abuses of insider information (by both corporate managements and others) involves mergers and acquisitions, primarily leveraged buyouts (LBOs). The term leveraged buyout simply means that leverage (or borrowed capital) is used to buy the stock of so many stockholders that the corporation involved is no longer public. Control is transferred to a relatively few individuals who have arranged through borrowing, to purchase the stock. The process is often described as taking the corporation private.
Because of the large amounts of money involved, the fees paid to those who construct the LBOs (although usually a small percentage of the total) can be huge with relatively minor risk. The buyers often include members of corporate management, who also stand to profit dramatically with very little risk. The risk is taken by those who put up the borrowed money to effectuate the purchase of the stock.
To entice shareholders to sell their stock to the LBO group, the buyers will offer a price that is at a significant premium above the usual market price. Those involved in the LBO know that a higher price is going to be offered before there is public announcement. In the United States, trading stock with such insider knowledge is illegal. However, a large number of people are involved. Corporate managements, lawyers, bankers, underwriters and their staffs are aware that a higher price is going to be offered, and the temptation to cheat is obviously great. By buying the stock before the announcement of a higher price is made, huge profits can be obtained with minimal risk. As a long list of arrests and convictions, involving hundreds of millions of dollars in illegal profits (most taken from ethical shareholders), clearly demonstrates that such insider trading can be pervasive.
Corporations Role on Stock Market
Most of the investing public fail to view corporations as direct market participants. They usually assume that the relationship of a corporation to the trading of its stock is an arm's length situation. The corporation, they reason, is consumed by business activities, and the stock exchange is independently judging the relative merits of the corporation's activities.
Yet corporations and the stock market are intertwined on both a theoretical and practical basis. It is widely presumed, and generally true, that the goals of the corporation's management and the stockholders are identical: to maximize the corporation's profitability and consequently to optimize the value of ownership (that is, the common stock). Corporationsare established because of money and the stock market is established because of money.
However, in some instances the objectives of management and stockholders conflict. In these cases, the corporation is both a direct market participant and a direct competitor.
The Dangers of New Issues
Such a conflict is clear, for example, when corporations offer new issues of stock during seller's markets.
The sale of common stock allows access to money without any guarantee it will be returned, and without having to make interest payments. In effect, it is a source of cheap capital. Many corporations, keenly aware of stock market activity, have a genuine desire that their stock command a high market price. The more people are willing to pay for the stock, the higher the (paper) valuation of the entire corporation and the more money available through the sale of new stock.
Thus, when the market is high and a euphoric atmosphere prevails, corporations (both new and established) will come to market to sell new issues of stock. In effect, they are taking advantage of the elevated stock pricing to generate more money through the sale of new stock than would be available if stock prices were lower. In other words, they are selling high—to the corporation's owners!
This type of corporate activity is usually a clear warning signal of impending decline. The corporations, by rushing to sell themselves through new stock issues, are effectively advertising that stock prices are too high. Yet few investors heed the warning. On a more elementary basis, the new corporate stock offerings are increasing the supply of stock and dissipating buying demand over a larger number of shares. Both factors add to a curtailment of price advance and a consequent lessening of buying demand, with the eventual result of supply outweighing demand, causingprices to decline.
Stock Splits
Corporations might also take advantage of high prices with stock splits. The effect of a stock split is simply to expand the number of outstanding shares. Although attractive to naive investors, the effect of a stock split is usually meaningless to the real value of the stock.
For example, let's say a corporation has 1000 shares outstanding and earns $4000. The earnings per share would be: $4 per share.
Now let's say there is a 2-for-1 stock split. The company exchanges two new shares for each old share. The per share earnings change to: $2 per share.
The end result is that the investor has twice as much of what is worth half as much. In other words, if the stock was worth $50 per share before the2-for-1 split, it would be worth $25 per share after the split with twice as much outstanding stock.
In the middle to late 1980s, the restructuring binge financed by junk bonds resulted in many previously superior corporations degenerating to bankruptcy. Despite past records of earnings predictability and growth, we usually delete corporations that have restructured with excessive debt because they are less likely to meet earnings projections.
Inordinately high compensation (in the form of salary or options) to senior management and/or their families and friends is another managerial practice that can disqualify a corporation from our list of issues suitable for investment consideration.
Many corporations have various classes of common stock. The most important differentiations among the classes are usually concerned with rights involving dividends and/or voting. The various classifications are usually distinguished alphabetically—Class A, Class B, and so on. Note that alphabetical positioning is not necessarily indicative of the merit of the class of stock. For example, Class A may be nonvoting and Class B voting.)
Of particular concern is the restriction of the voting right and/or preferential right to dividends to a class that is not available to the public. This characteristic is usually found when a family or other tightly knit group is able to sell the public the lower classes of stock. The public is, in effect, capitalizing the holders of the preferential stock and accepting disproportionate risk. Although such "class" issues are defended rather vigorously, those most vocal in the defense are those holding the preferential stock.
It is a general policy of ours to disqualify such stock issues, but not because of the voting right. As discussed in Chap. 1, the vote is relatively meaningless to the vast majority of stockholders. Our objection is to the basic attitude of the issuing corporation. The motivation demonstrated by any corporation selling "ownership" (via common stock) and then not allowing the stockholder even the gesture of a vote, carries the implication of pomposity at best and hypocrisy at worst. Neither of these traits is desirable in any form and the avoidance of such issues is prudent.
Family-held/publicly-traded situations are similar to those involving stock classes, except that all outstanding stock has voting privileges and equal rights to dividends. The majority of outstanding shares, however, remain under the control of one family. Thus, nonfamily stockholders are effectively as powerless as if their stock has no voting rights.
Such circumstances, although quite common, are not an automatic reason to disqualify the stock issue from investment consideration. Almost all publicly traded corporations will eventually fall under the control of a few individuals whether or not they personally control the majority of outstanding stock.
Family-controlled corporations must, however, be closely monitored to isolate those instances in which management is passing from one generation to the next.
Managerial ability is not a genetic trait. Quite often, when the second and/or successive generations become dominant, the intelligence and drive that initially allowed the corporation to prosper tend to lessen. Another potential problem is sibling rivalry, which can result in effective stagnation of corporate growth.
In summary, the basic intent of our criteria is to select corporations that are stable and predictable. We want to minimize "surprise" from fundamental corporate events. By doing so, the process of actual market participation becomes greatly simplified because attention can be focused on intrinsic market mechanisms (timing and the other aspects of trading that are most affected by internal market structure).
Also important is the fact that our filtering process is a search for the quality of two elements: the corporation's business and its record in conducting that business, as well as the individual managers directing the corporation.
3. Dividend Protection and Growth.
Dividends play a role both in added income and in risk reduction. To maximize these benefits, a corporation's dividend policy must be established and stable. The decision as to what portion of earnings will be paid to shareholders in the form of cashdividends, relative to the amount retained to finance future corporate growth, must be reasonable.
A consistent dividend policy, providing adequate assurance that the dividend will continue to be paid (protection) as well as increase (growth), reduces the possibility of unpleasant "surprises." It also reduces the number of stocks we find suitable for investment consideration.
4. Liquidity.
One of the primary advantages of common stock as an investment type is maneuverability; theinvestor can buy or sell quickly with very low transaction costs. This ease of movement is termed liquidity.
Liquidity involves two elements, which vary as to the characteristics of individual stocks:
- The number of shares a stock trades daily. This is the standard measurement of liquidity. It is only reasonable to confine interest to thoseissues that provide sufficient trading volume so that orders can be accommodated without disrupting price.
- The "mix" of investors in the stock's market. To us, the liquidity factor also involves an aspect largely ignored in conventional analysis. Professional participation mandates the realization that success depends on the actions of other investors. It is only logical, therefore, that the more varied the market participants interested in a particular security, the more areas of potential profit.
We will detail that market participants can be isolated and categorized (public, institutional, market makers, etc.) as to their repetitive behavior, which can provide us opportunity. The more varied and abundant the prey, the easier the task of the predator. Consequently, our liquidity requirements provide a dual function in filtering for both the number of shares traded and the number of different participants. Accordingly, the list of qualifying stocks is decreased.
5. Shareholder Concern.
Unfortunately, a corporation's fundamental (earnings) success does not automatically translate into the success of shareholders. In a variety of ways, management can intervene to block owners (shareholders) from experiencing presumed benefits. Greenmail is the corporate acronym for blackmail. The usual form is a "hostile buyer" (supposedly independent of management) who purchases a relatively small amount of outstanding shares and then threatens to buy controlling interest. The connotation is that with such control it will oust current management and ravage the corporation's assets.
To avoid the greenmailer's threat (and retain their paychecks), a common reaction is for the management to deem it "wise" to buy the green- mailer's stock at a price above "market." That is, "pay off" the greenmailer at prices higher than those available to other owners (shareholders).
Although greenmail could conceivably be justified in some instances, in general we question the credibility of managers that engage in such practices, thereby disqualifying their corporations from investment consideration.
The capitalization structure of corporations (that is, the monies the corporation utilizes to fund its activities) involves two basic sources: equity (monies contributed by and/or earned for stockholders) or borrowings (debt). The capitalization "structure" is simply the ratio of debt versus equity.
To avoid "hostile takeovers," greenmail and other activities that could interfere with management's security, a popular maneuver is to restructure. The general pattern of restructuring is for the corporation to add debt to the point that the new debt load makes the corporation less attractive to potential buyers. The excessive debt has the net effect of reducing the corporation's fundamental quality, with the excessive interest charges detract from earnings and making it more difficult for the corporation to survive adverse economic conditions.
The Right to Earnings
This right is the most important single characteristic of common stock, for it (at least in most theories) is the dominant factor in determining stock price. The corporate earnings (theoretically) belong to the owners (stockholders), who therefore have the potential to realize tremendous profit if the corporation is successful.
One must not blindly assume, however, that if corporate profits rise the stock will also appreciate. The fact is that there is no automatic correlation between corporate profitability and common stock pricing. It often takes more than earnings gains to create an advance in the market price of a stock.
Corporate management has the choice of doing any one (or a combination) of three things with earnings:
- Retain them within the corporation to finance future growth.
- Distribute them to stockholders.
- Steal them.
Most texts on the market ignore theft, considering such nastiness a rare event that it is not important. The general perception of corporate theft is that of a slimy little over-the-counter stock sold to the public at a ridiculous price by management or a seedy embezzler packing misappropriated cash in a suitcase and running to Brazil. Theft at the expense of shareholders can take many forms and can occur in dramatic amounts in the largest corporations. There are two basic types of theft:
- That in direct violation of law. All you need to do is look at the paper to see the Mr. Boesky types being taken away for stealing millions, or the billions in fraud that contributed in making the insurance protection for the entire savings and loan industry of the United States insolvent. Such behavior cannot be shrugged off or considered a laughing matter because of the light penalties; remember whose pockets—stockholders' and taxpayers'—were fleeced.
- That not in direct violation of law. This includes management's paying itself exorbitant salaries, perks, options, and other compensation without merit. It also includes such practices as putting friends and relatives on the payroll at inflated costs or making corporate contracts at a price above real market value because of personal interest. In the most abrasive form, management sells corporate assets (or the entire corporation) to itself or "others," where management has an interest at a significant discount. In effect, any managerial "decision" that unethically takes from the rightful owners (stockholders) is stealing. Such activities are common and easily identified, but, since they fall into the classification of "business judgment," they are beyond statutory prosecution.
The point: There are very nice people and very nasty people involved in both the structure of securities trading and in the corporations represented by that trading.
As we will discuss in Chap. 2, there are methods to significantly reduce the chance of becoming victimized by scoundrels, but the reality of the market must include clear, ongoing recognition that the environment involves some unsavory characters. To repeat, it is not a team sport.
Setting thievery aside for the moment, can concentrate on whether corporate earnings should be retained to fund future growth or distributed to stockholders via dividends.
The generally "taught" academic approach is that the corporation (extrapolated to read "stockholders") is most benefited by applying earnings to future growth; consequently, a low dividend policy expands futurepotential.
From the perspective of professional investing, however, an exceptionally low (or inconsistent) dividend policy is a weak point. There is a real correlation between the degree of potential price decline and the dividend when the stock price descends to the point where the dividend payment is offering an exceptionally high yield in relation to the market price of the stock. In other words, people will buy the stock simply because of the dividend. This buying can help support the market price of the stock and minimize risk. It should be noted that, although the dividend yield may help soften the decline of a stock, there is no significant evidence that a high dividend in itself will help the price of a stock to advance.
We have found the three basic stockholder rights to be shallow at best, with only the right to earnings providing a general benefit. Even this right, stolen or not, provides no guarantee that the market price will appreciate.
As an investor, your primary concern is optimal utilization of common stock in your own capital growth. In this context, stockholder rights in themselves do not warrant any emotional attachment. The advantage of the stock market is liquidity. That is, you can easily move in and out of the stock market as well as within the market. By being long (buying) in anticipation of rising prices, or by going short (selling) in anticipation of lower prices you can benefit either way, as long as you correctly anticipate the direction, with very low transaction costs. It is a function of easy maneuverability to whatever area is providing the most opportunity at any given time.
To identify yourself with an individual stock issue is effectively to identify with the "rights." The rights are often illusion and in any form do not guarantee success. Emotional attachment to the rights only encourages relatively poor performance because it does not allow either objective reasoning or full utilization of the liquidity factor.
Face it. As a holder of common stock from a professional trading perspective, you are involved for the price ride. And, like it or not, to maximize profit, the ride has to be for a limited duration. No matter what the stock, the time will come to get out of the market entirely or obtain a position in another stock for another ride. To function as a professional, you must accept in fact that stock is a piece of paper to be utilized as a medium of exchange in acquiring the monies of others.
Having refused to be intimidated and consciously aware that our purpose is to take money, we can now step into the market. Looking about, we can see that the gist is the redistribution of wealth via the trading back and forth of common stock.
Common stock is nothing more than a piece of paper stating the proportionate ownership of the corporation that issues the stock. For example, at the time of this writing, American Telephone and Telegraphhad 1,335,609,000 outstanding shares of common stock. Therefore, if you own 100 shares of AT&T, your shares represent 1/13,365,090 of thecorporation.
This example helps you put into proper perspective the absurdity ofdeveloping an emotional attachment to an individual corporation. For the vast majority of investors, their proportionate share of ownership is insignificant. The "piece of paper" does not care who owns it or why. Those who transpose ownership into a symbol of status or ego support are both wasting their time and making themselves more susceptible to a variety of common errors.
We all remember Dear Old Uncle Charlie. Right before he choked to death on his gruel, he said, "If anything ever happens to me, don't sell National Zipper. I bought the stock in 1920 for $10 a share and now it's $200. It has been good to us. Hold on!"
Uncle Charlie was emotionally locked into National Zipper by the common lure of witnessing paper profitability without a true understanding of the value of compounding. No matter that Uncle Charlie was eating lumpy gruel because he refused to cash in on National Zipper. No matter that, if National Zipper had managed to grow at only 10 percent a year, the stock would be worth $7000! Uncle Charlie was simply in love with a piece of paper.
Over the years, National Zipper (as the name implies) fluctuated in price. Profit maximization, as well as risk minimization, required getting in when Zipper was down and getting out when Zipper was up. The fact that, no matter how much Uncle Charlie loved National Zipper, the National Zipper stock cared nothing about him.
One-sided love affairs are tragic, as are the results of those who indulge in stock marriage. For those so affected, the divorce can be made painless by means of a realistic understanding of the true nature of common stock.
There are intrinsic merits to common stock ownership because the holders of the stock are entitled to certain privileges or rights. These major rights can be divided into three categories:
- The right to information
- The right to vote
- The right to corporate earnings
The use, or misuse, of these rights can influence stock price. A basic understanding of these rights is necessary to prevent one from being misled by the volumes of literature that portray stock ownership in an unrealistic context.
The Right to Information
Each stockholder is provided with quarterly and annual reports concerning various aspects of corporate activity.
These reports contain financial information as well as a discussion of current corporate highlights and future prospects. The discussion generally begins in the form of a message from the corporate president, who is usually making a case for his retention: taking credit if the company is doing well and blaming others if it is doing poorly. After all, it is his message. For practical purposes, this discussion is of little concern because there is little the individual stockholder can do even if the management is incompetent.
The financial data presented in the reports is also of little benefit to the average investor. The accountant's statement will usually state that the accounting was conducted using "generally accepted accounting principles." All this means is that there is a great deal of variance in the methods of accounting allowed. Since things can be accounted for differently, the earnings of a corporation can vary with the type of accounting utilized. In many cases, the published financial data is quite misleading and is presented in such a way that it results in confusion rather than an understanding of the corporation's actual financial condition.
Many analysts who thrive on dissecting financial data pay little attention to the annual report provided to shareholders, preferring the much more detailed information in corporation's 10K filings with the Securities and Exchange Commission, which is available to the public.
The most important things to remember are that the information is provided to the general public as well as to the shareholders and that it is always presented after the fact of recorded corporate events. Stock prices related to this information have therefore almost always occurred by the time the stockholder or anyone else receives the information through corporate printing.
In its proper context from the perspective of stock trading, the stockholders' right to information is relatively meaningless since the information is usually late and is available to all.
