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The question in the title is misleading. Most individuals have no choice whether to use a broker, since they’re not members of an exchange. Those members (their employees, really) are the only ones who can actually execute a trade and they don’t take calls from individual investors.

They’re called Floor brokers and they’re the one’s who actually buy and sell securities on the floor of a securities exchange. You can watch them on TV waving their hands vigorously and yelling at one another.

So the question really should be: “What Kind of Broker Do You Need?”

Prior to 1975, Full-Service brokers were about the only choice. Then the world gave birth to discount brokers and life changed. In the 1990s, it changed again with the beginnings of Internet trading for average investors. Note that trading over networks had already been going on between large investors for decades.

Along with the changes in technology, making trades as easy as a few mouse clicks, came changes in the kind, amount and availability of research. Now any investor could, sometimes for free but rarely for more than a modest fee, get up-to-the-minute information about a company’s earnings per share, historical profits and dividends, along with a bewildering array of more technical data.

Those two facts – technology and research – are the basis for deciding what kind of broker you need.

Some are comfortable with executing trades by making those few mouse clicks, others want some human contact – even if nothing more than an efficient-sounding voice – before plunking down a few thousand.

Full-Service brokers, if you find not only the right company but that special individual, can provide you with more than an efficient-sounding voice. Good brokers, and they do exist, offer their clients sound advice based on good research.

No one can predict with certainty any particular price for any stock five hours from now, nor five years from now. But massive statistical studies are undertaken and research analysts do conduct and study them then pass on their recommendations to brokers.

When those brokers are astute they can make reasonable judgments about the likelihood that long rock-solid Acme, Inc will fold in three months, or that newcomer Whizzard Techno-Babble is about to skyrocket.

If that kind of advice and ‘partnering’ is worth the commissions you’ll pay, then a Full-Service broker is for you – especially if you have neither the time nor the temperament to undertake that research yourself.

Others, with more time or analytical interests – or perhaps, just more chutzpah – may find it not only financially worthwhile, but intellectually and emotionally satisfying to take the reins themselves. This is especially true for short-term traders, day traders even more so.

To these types, research isn’t a burden or a bafflement it’s an adventure. And the deep discount brokers, or pure Internet trading accounts, are the perfect fit for them. Reports, some free others available at varying cost, can be had in greater abundance than even they have time or desire to study.

So, along with determining how much money can be saved by using the broker behind Door #1 vs Door #2, study yourself and decide which kind of trader you are. That’s the best way to choose which kind of broker you need.

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‘SOFT’ FACTORS

The first thing to consider about investing isn’t technical at all. EPS, P/E, P/S, MA and EMA, RSI and dozens of other indicators are all important. But start at the beginning by looking not outside, but in.

What kind of investor are you? Young with a little capital to risk but a large earnings potential over several decades? Retired, or near it, with a healthy savings but living on limited income?

And, more psychologically, what’s your temperament for research and your tolerance for risk? Are you comfortable with statistics or intuitive? Are you detail oriented, or tend to look at the big picture? Not mutually exclusive categories, to be sure.

All these factors will influence your investment strategy. You do have a strategy, right? If not, go back to square one and develop that first.

‘HARD’ FACTORS

PEG – Projected Earnings Growth

Traditionally, Price to Earnings (P/E) ratio was a helpful indicator of value. Low price, relative to large earnings (per share) suggested a company’s share price would likely rise in the future. But that was before thousands of new companies entered the public markets and when investing meant buying Coca-Cola stock.

But P/E isn’t entirely useless, even today. Just supplement it with a little more information to calculate the PEG – Projected Earnings Growth.

Calculate PEG by taking the P/E and dividing it by the projected growth in earnings. For example, a stock with a P/E of 20 and projected earning growth next year of 10% would have a PEG of 2 (20/10 = 2). The lower the number the less you’re paying for a unit of future earnings growth. Therefore, a company with a high P/E may still be a value if it has a high projected earnings.

Of course, the key is getting accurate projections. While no one can predict with certainty, many Internet sites provide those numbers and over time, with diligence, you can find one you trust.

Just as deciding to buy is, in small part, finding a large PEG stock, electing a time to sell means estimating when PEG is likely to take a turn downward. So, tracking PEG over time in the form of a simple chart should be a weekly (or more often) task on your research list.

ROE – Return On Equity

Some companies can make silk purses out of pigs ears, others couldn’t make a profit if they were given Apple’s engineering and marketing teams for free. Return on Equity is one measure of how well a company uses its assets to produce earnings. (By the way, silk comes from worms, not pigs.)

Easy to calculate, simply divide Net Income by Book Value (assets minus liabilities). Both numbers needed are easy to obtain from Internet sites. Three percent is low, 15% is healthy – but be sure to compare to other companies in the same economic sector, and track the number over the long term.

Obviously, when projected ROE is high (based on historical trend) you want to buy. Timing the sell is a matter of estimating when ROE is trending downward.

Some factors to consider for the latter involve major mergers which look to be unwise (HP acquiring Compaq is one example), major technology or management changes (this can be positive or negative), lawsuits initiated or settled, and general economic factors influencing that company more than others.

Continually add to your database and your toolkit. Track the numbers and add new numbers to track. MA – moving averages and RSI – Relative Strength Indicator are two of the more common technical indicators used, for example. After you’re comfortable with those, seek out some of the methods of quantifying risk.

And don’t forget to develop that strategy. Tools are useless if you don’t know what you want to do with them.

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As with gamblers in Las Vegas so it is with stock investments, ‘everybody’s got a system’. The goal of research, however, is to make the activity a lot less like gambling and a lot more like investment.

For those without the time or temperament to carry out research themselves, there are full time research services available – for a fee, of course. Full-Service brokerages, such as Merrill Lynch and other large, well-established firms offer research as part of their value to clients.

But there are firms, both traditional and the newer online variety, that offer research without the advice available from the broker. Whether the research (and the advice) are worth what it costs is an ongoing debate.

For those who see research not as a necessary evil or time-consuming burden, but as part of the process or even an adventure, there are now more sources than could be used in a lifetime.

Starting with the source of data is always a safe bet, since it’s the most unbiased, thoroughly audited information around. That source is the legally required filings of individual publicly traded companies.

In the U.S. those are 10-K’s – more or less equivalent to lengthy annual reports – which can be viewed or downloaded from the SEC’s website (www.sec.gov). (10-Q’s are filed quarterly, 8-K’s for significant financial changes in between.) Other countries have their equivalents, such as the Hong Kong Securities Regulatory Commission (HKSRC).

In those reports you’ll find recent (as of the filing date) financial data about income, expectations, competition and lines of business, current senior management listings and other information useful to those inclined toward Fundamental Analysis. 

Quarterly reports and annual reports are sent automatically to share holders, even those with only one share (though they’re usually traded in lots of 100 or more.) But, they’re often available free by calling or emailing the Investment Relations department; after all, companies want you to buy their stock. They contain the same factual data as 10-K’s and 10-Q’s but occasionally wording differs, for those interested in subtle details.

For a modest annual or one-time fee, a blizzard of chart data is available that matches any produced by the in-house research departments of the large brokerages. (Sometimes they’re produced by the same people.)

Newsletters are another potentially good source of information, though opinions about the market vary so widely that researching whom to believe takes as much time and care as researching individual stocks. Sometimes they’re a few dollars per year, sometimes many hundreds – and price is no indicator of quality here.

One direct source of one kind of information are the in-person, on TV, or on the Internet interviews of company senior managers, usually by one or a panel of analysts.

CEOs, CFOs, and others often talk to the financial press and brokerage share analysts to give their views on where their company stands, what challenges they face, and where they expect to be in the near to long-term future. Often they’re asked about specific pending lawsuits or legislation and to assess its potential impact.

Of course, executives have an interest in painting a rosy picture, but analysts have often heard it all and are very adept at keeping the ’spin factor’ to a minimum. If nothing else, it tells you what the executives want you to believe, which in itself is useful.

Even armed with nothing more than an inexpensive online trading account, the average investor has access to charts of historical and current data, future expectations, and a wide variety of statistical information which would keep even the most technically inclined busy for quite some time.

Be sure to use it all, or as much as you can absorb in the time available, when formulating a trading strategy. And remember, opinions ‘on the street’ are a dime a dozen – including mine.

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Stock picking is akin to weather prediction – no one can predict with certainty five hours from now if the price will rise or fall, much less five years from now.

Nevertheless, there are indicators that help to reduce the risk and increase the odds of profiting over the long term. After all, historically stocks have returned over 10%, as measured by the growth of the S&P 500.

The first step is to get educated. Learn not only about dividends yields and earnings per share, but also some basic accounting. Reported figures have an air of authority but the sad fact remains that those numbers are arrived at, in part, by accounting methods which are not cut and dried. 

The Enron case (case in which the executives of Enron manipulated their earnings figures to appear to be much more
successful than they were) is extreme, but even ordinary procedures involve judgment calls on the part of financial officers and auditors.

Next, commit to continuing research about stocks both inside and outside your intended portfolio, and update it as you buy and sell. There’s a broad spectrum between exact prediction and throwing darts blindly. In the long run, those who do their homework do far better and almost all day traders lose money.

Research both prospective buys and intended sells. Many investors put considerable time and effort into analyzing a buy, but then only watch for some price to be reached in order to sell. Knowing when to sell is just as important, and a target should be selected before the stock is bought.

RESEARCHING BUYS

Obtain the latest, and some historical, financial statements. The SEC provides these free (www.sec.gov) in their EDGAR database, but other exchanges have similar arrangements.

Analyze the quarterly statements covering two to three years, looking for EPS (earnings per share) and revenue trends. Calculate dividend yields, if the company pays dividends.

Compare the company’s P/E (Price to Earnings) ratio to others in the same economic sector. Look at P/S (Price to Sales) ratios, too. Sales growth is easier to predict than earnings and less volatile than P/E ratios. 

Examine general economic factors. Interest rates affect stock prices as well as bonds (though less directly), since almost every company borrows money. Even when they don’t, their competitors, suppliers, and customers do. Interest charges reduce profits for all but the lenders, for whom it’s income. 

Even when researching a bank, though, high interest rates increase short-term profits, but can reduce the number of loans and cause certain current ones to be repaid early. High interest rates aren’t necessarily good for banks either, therefore.

Use some of the more common technical indicators, such as MA (moving averages) and RSI (Relative Strength Index, which compares the number of days a stock finishes up versus down). An RSI of 70, or above, for example, does tend to indicate a stock which is overbought and due for a fall in price.

RESEARCHING SELLS

Pick a target price, which amounts to deciding how much profit (in dollars or percentage terms) you seek then sell at that price, unless your continuing research has turned up significant new information.

Consider selling if the price has dropped substantially or remained unchanged for several months. Losses are hard to bear, but consider that you can’t always pick winners and while you’re invested in one stock, you’re forgoing potential profit from another. That profit could help reduce or more than make up for the loss from the sale.

Continue to monitor the company’s fundamentals by obtaining updated filings. Re-evaluate them by updating earnings trend calculations, significant management or general economic changes.

You can ease the difficulty of performing calculations (which is a useful exercise at least once) by finding Internet sites that provide objective data and go easy on the “here’s how to pick winners” sales talk.

And remember, ‘on the street’ opinions are a dime a dozen – including mine.

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One of the alluring myths that surrounds the stock market is the prospect that a certain share may split, giving stock holders twice as many shares as before. What is poorly understood by the outsider, though, is that although the investor has more stock after a split, the value of each share is reduced. For example, if a corporation decides to split its stock 2-for-1, it issues one new share for each outstanding one. At the same time, the value of each share is cut in half. So the stock holders now hold twice as many shares but the total value is the same as before the split. A stock split is like receiving 2 five-dollar bills for a single ten-dollar bill.  Same value – twice as much paper.

Why would a company do this?

A lot of it has to do with investor psychology. The price-per-share of a share may be so high that the average investor feels it is out of his reach. A stock split reduces the price so that it may be more affordable to smaller investors. In reality, the small investor could have bought a smaller number of pre-split shares for the same price, but the appeal of buying a $20 stock as opposed to a $60 may be strong for some investors.

Stocks can be split by a number of ratios but the most common are 2-for-1, 3-for-2, and 3-for-1.  stocks can also be reverse-split – the company reduces the number of outstanding shares so that each stock holder has fewer shares than before. Reverse share splits are less common, but can be used for several reasons: the price per share may be so low that it appears as a poor investment; the company may be attempting to stave off possible de-listment on the stock exchange; to push out minority shareholders; or as a way to go private.

Advantages

Lower prices per share can result in greater liquidity – stocks are easier to sell at lower prices and there is less of a bid/ask spread. This is especially true for shares that are priced in the hundreds of dollars – small investors view them as out of their budget and the high bid/ask spreads (the difference between buying and selling prices) can put off bigger investors.

Other advantages have to do with investor psychology. A split is usually seen as a bullish indicator – share prices are increasing and the company is doing well financially. There is usually a short-term rally around a stock which splits, but the market tends to normalize after a short period.

On the downside, a split may cause investors to expect more about how the company performs. If these expectations are not met investor confidence may be shaken and the result could be a drop in share prices.

The bottom line is a share split does nothing to affect the worth or performance of a company. It may be nice to own more shares, but in the end your 2 five-dollar bills are still worth the same as your ten-dollar bill.

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Probably you know by now that the big boys don’t play nice. In the stock market, institutional and other investors with large sums have much more influence on events than the average trader. One way they do that is through the use of something called ‘program trading’, the purchase (or sale) of a group of stocks, usually by automated buy/sell orders.

Originally the term had little to do with ‘computer program’. Program Trading got its name when index funds and other institutional investors embarked on large-scale trading to replicate a stock index. Before long, clever statistical analysts joined hands with even more clever arbitrageurs to try to ‘beat’ the market through the use of sophisticated trading algorithms, assisted by (then) new, high-speed computer programs.

Fundamental analysis met technical analysis and introduced themselves to software. The rest is rather bumpy history. In one famous case, though some studies deny this, it may have contributed heavily to the well-known Black Monday of October 1987 when the market dropped by over 20% in one day.

While not the largest drop in history (a larger percent decline occurred in 1914 and later a larger point drop, in 2001), nevertheless within one day, 500 billion dollars evaporated from the Dow Jones index. And, the event continued in markets around the world. Hong Kong shares fell over 45% (some say this happened before the U.S. decline – accounts differ) and London over 26%.

Out of favor for, oh say maybe a day, program trading continued – albeit after a few software tweaks. New SEC rules were devised and major market players altered thresholds to slow or halt trading when certain percentage declines are reached.

While the NYSE defines a program trade as a basket of 15 stocks or having a total value of $1M (or more), trades can be executed in small lots (100-300 shares, for example). In theory, this allows orders to be completed before other investors get wise, and helps avoid large price movements before positions are solidified or liquidated.

As finance professors and large-firm specialists develop ever more sophisticated methods of taking advantage of small price discrepancies across global markets, program trading becomes ever more complex. In many cases, the individuals involved don’t themselves understand well the consequences of implementing a particular strategy.

Program trading now comprises over 50% of NYSE volume on average and it can introduce large swings in a few stocks or large portions of the market. Clearly, the big boys wouldn’t bother unless they believed – backed now by decades of studies – that there was an advantage in using the technique.

But whether villain or savior, it’s here to stay. Over 50% of the volume on one exchange that trades over 1.6 billion shares a day is a huge amount of arbitrage activity. That effect can work against the average investor or for him, but only if included in a trading strategy that pays attention to where those trades are going.

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Once upon a time there was no Internet. OK, now take a deep breath. It’s alright because there is one now. For several decades (roughly from 1960 to 1990), large companies such as Merrill Lynch and Morgan Stanley were able to trade among themselves electronically, but these trades took place over private networks.

In 1978, the Intermarket Trading System (ITS) opened for business, providing an electronic link between the NYSE and competing exchanges, enabling brokers to access several markets. But still, only for the ‘in-crowd’.

Then in 1994, Aufhauser Securities (now owned by Ameritrade) created the first Internet trading system. As Internet trading grew dramatically, companies developed systems allowing individual investors to not only trade, but access information once available only to those large companies.

The world has never been the same since.

Trading commissions fell to negligible territory. Twenty years ago, it was common to pay $100 or more on a $1000 trade; online trading fees are less than $10 today. Yet, despite the considerable drop in prices, brokerages are making enormous profits, thanks to the increase in trading volume.

Peak volume in 1824 on the NYSE was 380,000 shares, though less than 10,000 was the norm in 1835. Unfair comparison, too far back? Fine. In 1992 average daily volume was 200 million shares. Today, it’s over 1.6 Billion. Peaks as high as 3 billion have been seen.

Along with lower prices and increased volume, trading times have shortened from an hour or half a day, to a few seconds. And you wonder why the floor brokers are always yelling at one another on the share exchange.

Research, once available only to specialized analysts in large brokerage firms, is now accessible to the average investor with an online trading account – often for free. And the research itself has grown from simple Earnings Per Share and Dividend Yield data to a bewildering array of Relative Strength Indexes (RSI), Moving Average Convergence Divergence (MACD), Bollinger Bands and others even more arcane.

Networked trading, along with other computer technology, has made exchanges international and in some cases global. Only a few years ago the Amsterdam, Brussels, Lisbon and Paris exchanges merged into Euronext – a single trading exchange for countries with widely differing backgrounds. Efforts continue to bring the London stock Exchange into partnership with Euronext or FWB (Frankfurter Wertpapierbörse, the major German exchange), or both.

As a consequence of the emergence of merging exchanges, trading has improved not only for members but the individual investor as well. It isn’t just citizens of the countries involved in Euronext who can trade there. Exchanges the world over are now open to almost any investor anywhere. Now anyone, not just London’s professional traders, can enjoy the effects of sleep deprivation monitoring and trading on exchanges that cross every time zone on the globe.

All this change, while difficult to absorb, has one overriding goal and result – you can now make (or lose) a lot more money a lot faster, in a lot more places, than your father. That ought to produce at least a few interesting family dinner conversations.

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Although the raw data of the Financial Statement has some useful information, much more can be understood about the value of a stock by applying a variety of tools to the financial data.

Earnings per Share
The overall earnings of a company is not in itself a useful indicator of a stock’s worth. Low earnings coupled with low outstanding shares can be more valuable than high earnings with a high number of outstanding shares. Earnings per share is much more useful information than earnings by itself. Earnings per share (EPS) is calculated by dividing the net earnings by the number of outstanding shares. For example: ABC company had net earnings of $1 million and 100,000 outstanding shares for an EPS of 10 (1,000,000 / 100,000 = 10). This information is useful for comparing two companies in a certain industry but should not be the deciding factor when choosing shares.

Price to Earning Ratio
The Price to Earning Ratio (P/E) shows the relationship between stock price and company earnings. It is calculated by dividing the share price by the Earnings per Share. In our example above of ABC company the EPS is 10 so if it has a price per share of $50 the P/E is 5 (50 / 10 = 5). The P/E tells you how much investors are willing to pay for that particular company’s earnings. P/E’s can be read in a variety of ways. A high P/E could mean that the company is overpriced or it could mean that investors expect the company to continue to grow and generate profits. A low P/E could mean that investors are wary of the company or it could indicate a company that most investors have overlooked.

Either way, further analysis is needed to determine the true value of a particular stock.

Price to Sales Ratio
When a company has no earnings, there are other tools available to help investors judge its worth. New companies in particular often have no earnings, but that does not mean they are bad investments. The Price to Sales ratio (P/S) is a useful tool for judging new companies. It is calculated by dividing the market cap (stock price times number of outstanding shares) by total revenues. An alternate method is to divide current share price by sales per share. P/S indicates the value the market places on sales. The lower the P/S the better the value.  

Price to Book Ratio
Book value is determined by subtracting liabilities from assets. The value of a growing company will always be more than book value because of the potential for future revenue. The price to book ratio (P/B) is the value the market places on the book value of the company. It is calculated by dividing the current price per share by the book value per share (book value / number of outstanding shares). Companies with a low P/B are good value and are often sought after by long term investors who see the potential of such companies.

Dividend Yield
Some investors are looking for stocks that can maximize dividend income. Dividend yield is useful for determining the percentage return a company pays in the form of dividends. It is calculated by dividing the annual dividend per share by the stock’s price per share. Usually it is the older, well-established companies that pay a higher percentage, and these companies also usually have a more consistent dividend history than younger companies.

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The stock market moves up and down every day, but when movements continue downwards for a period of time the market is referred to as a ‘bear market’. Upward moving markets are ‘bull markets’. If a particular stock is doing well, it is said to be bullish. If it is losing value it is bearish. 

Bull and Bear are the terms to describe the general conditions of the stock market. These do not refer to short term fluctuations – a bear market is commonly understood as one where prices of key stocks have fallen in price by 20% or more over a period of at least 2 months. Even during a bear market, however, prices may increase temporarily. Bull markets are the opposite of bear markets – they are indicated by a rise in prices of key stocks over a certain period of time.

Usually stock market conditions reflect the state of the economy. During bull markets the economy is doing well, unemployment is low and interest rates are reasonable. Bear markets usually occur during times of economic slowdown.  Investors lose confidence and companies may begin laying off workers. At the extremes, an exaggerated bear market can lead to a crash brought on by panic selling. An exaggerated bull market can be caused by over-enthusiasm of investors.  It leads to a market ‘bubble’ that will eventually burst.

Although most money can be made during bull markets, there are also opportunities during bear markets. Knowing the characteristics of each type of market allows investors to profit from them. As would be expected, when the market is bullish investors wish to buy up share. The economy is doing well and people have extra money which they wish to invest in shares. This creates a situation of short supply which drives up prices even higher. During bear markets, on the other hand, prices are falling so investors wish to unload their stocks and put their money in fixed-return instruments such as bonds. As money is withdrawn from the stock market, supply exceeds demand which drives prices down even further.

It is easiest to make money during a bull market. Getting in right at the beginning will allow you to make the most profits. During a bull market any dips in the market are temporary and should soon be corrected. The upward rising prices can’t go on forever, though, so the investor needs to be able to gauge when the market reaches its peak and sell at that time.  

Bear markets represent opportunities to pick up shares at bargain prices. Getting in near the end of a bear market offers the greatest chance for profit. The prices will most likely fall before they recover, so the investor should be prepared for some short term loss. Short-selling is also an investment strategy during bear markets. Short selling involves selling stock that you do not own in the anticipation of further price drops, so that when it comes time to deliver you can buy the stock for less than you sold it.

Fixed return investments such as CAs and bonds can be used to generate income during a bear market. So called ‘defensive stocks’ are also safe to buy at any time. These include government owned utilities that provide necessities no matter what state the economy is in.

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The investor has many tools at hand when making decisions about which stocks to buy. One of the most useful of these is fundamental analysis – examining key ratios which show the worth of a stock and how a company is performing.

The goal of fundamental analysis is to determine how much money a company is making and what kind of earnings can be expected in the future. Although future earnings are always subject to interpretation, a good earning history creates confidence among investors. stock prices increase and dividends may also be paid out.  

Companies are required to report earnings on a regular basis and stock market analysts examine these figures to determine if a company is meeting its expected growth. If not, there is usually a downturn in the stock’s price.  

There are many tools available to help determine a company’s earnings and its value on the stock market. Most of them rely on the financial statements provided by the company. Further fundamental analysis can be done to reveal details about the value of a company including its competitive advantages and the ratio of ownership between management and outside investors.

Financial Statements
Every publicly traded company must publish regular financial statements. These statements are available in printed form or on the Internet. All statements must include an income statement, a balance sheet, an auditor’s report, a statement of cash flow, a description of the business activities and the expected revenue for the coming year.

Auditor’s Report
The auditor’s report is one of the most important sections of the financial statement. The auditor is an independent Certified Public Accountant firm which examines the company’s financial activities to determine if the financial statement is an accurate description of the earnings. The auditor’s report contains the opinion of the auditor concerning the accuracy of the financial statement. A financial statement without an independent auditor’s report is essentially worthless because it could contain misleading or inaccurate information. An auditor’s report, although not a guarantee of accuracy, at least provides credibility to the financial statement.

Balance Sheet
Another important section of the financial statement is the balance sheet. This is a ’snapshot’ as it were, of the financial condition of the company at a single point in time. The balance sheet shows the relationship between assets (cash, property and equipment), liabilities (debt) and equity (retained earnings and share).

Income Statement
The income statement shows information about the revenue, net income, and earnings per share over a period of time. The top line of the income statement shows the amount of income generated by sales, underneath which the costs incurred in doing business are deducted. The bottom line show the net income (or loss) and the income per share.

Cash Flow
The statement of cash flow is similar to the income statement – it provides a picture of a company’s performance over time. The cash flow statement, however, does not use accounting procedures such as depreciation – it is simply an indicator of how a company handles income and expenses. A statement of cash flow shows incoming and outgoing cash from sales, investments, and financing. It is a good indicator about how the company is run on a day-to-day basis, how it handles creditors and from where it receives growth capital.

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