This tow-priced Bantam Book
hiu been completely reset m a type face
from new plates. It contains the complete
text of the origncu hard-cover edition.

NOT ONK WORD HAB BEKM OMITTM*.
BOW TO BUT STOCKS

ABoftfamBoofc / published by arrangement with
Little Brown 6- Company

FHOTTING HISTORY
Orignal Lfttte, Brou>n edition / April 1953
ix printing* through June 1956
Lfttte, Brown rooifd edition / May 1957 
Little, Brown third revised edition f January 1961*
Little, Brown /oxrth wiwd edition / February 1967
Littte. Brown fifth wised edition I September 1971
Little, Brown sixth reviled edition I October 1976
Little, Brown seventh wised edition / January 1983
Bantom oOfon / February 1995
7 printing* through September 1956
Bantam reiriwd edition / June 1957

8 printeifi* through May 1962
Bantam third revised edition I January 1963

7 printing* through September 1966
Bantam fourth revised edition I July 1967

9 printings through April 1970
Bantam fifth revised edition / February 1972

10 printing* through April 1976
Bantam tilth revised edition I July 1977

i printftw through September 1982
Bantam sevenA revised edition I August 1983

AS rights reserved.

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Cover art copyright  1983 bf Bantam Boob, Inc.
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Acknowledgments

SUCH is the process of learning that it is never possible for
anyone to say exactly how he acquired any given body of
knowledge. And that circumstance I now find somewhat con-
soling, because in a very real sense this book is not my book.
but it is the product o( hundreds of different people who over
the years have taught me what I have written down here.

Obviously, I cannot acknowledge my indebtedness to all
these people and so I must necessarily limit my thanks to
those who helped me directly in the preparation and checking
of the material in this book through all its seven versions
from 1952 to 1982. Some are no longer associated with the
institutions whose names are used to identify them here.
Some are no longer even alive. But all of them are people to
whom I owe a debt beyond repayment.

These include AIger B. Chapman, Jr., Cecil MacCoy, Wil-
lard K. Vanderbeck, Stanley West, F. W. Reiniger, Richard I.
Callanan, Afleen Lyons, Thomas T. Murphy, Charles Storer,
and George Christopoulos, all of,the New York Stock Ex-
change; John W. Sheehan and Victoria Kelly of the Ameri-
can Stock Exchange; James H. Lorie and Lawrence Fisher of
the University of Chicago; John McKenzie, Russell Mom-
son, George Oken, and Donald A. Moser of Standard &
Poor's Corporation; Max Fromkin of Fromkin & Fromkin;

J. Scott Rattray and Hundy W. F. McKay of the Toronto
Stock Exchange; Leah Cartabruno, Joseph H. Cooper, and
Eno Hobbing of the National Association of Securities Dealers;

and a score of individuals actively engaged in the securities
business: Kenneth R. Williams, Robert L. Stott, Victor B.
Cook, Edward A. Pierce, Milija Rubezanin, James E. Thom-
son, Donald T. Regan, Howard T. Sprow, Peter F. McCourt,
James Albee. Cecil C. Burgin, John J. Cahill, Rudolph J.
Chval. James D. Corbett, Dwight H. Emanuelson, John F.
Ferguson, John A. Fitzgerald, Richard P. Gulette, Calvin
Gogolin, Allan D. Gulliver, Gilbert Hammer, Stephen B.
Kagan, Arthur L. Kerrigan, George T. Lee, George J. Leness,
Josiah 0. Low, GiUette K. Martin, Michael W. McCarthy,

VI ACKNOWLEDGMENTS

Anthony G. Meyer, Harvey L. Miller, John H. Moller, Sam-
uel Mothner, Joseph C. Quinn, Walter A. Scholl, Julius H.
Sedlmayr, Thomas B. Shearman, George L. Shinn, John W.
Adams, Jr., David Western, Jay Robinson-Duff, Wallace
Sellers, John Anderson, Thomas J. Christie, Robert E.
Cleary, Francis J. Ripepi, Robert Rittereiser, Martin Portnoy,
Nancy K. Hartley, Thomas E. Engel, and  most important
Robert L. Tebeau, Frederick P. Groll, and Robert C.
Kavee.

Last, but certainly not least, let me list Muriel D. Nutzel,
Ann Scourby, Loretta A. Gigante, Elizabeth J. Gibson.
Loretta D. Hamey, Zita Millet, Agnes Rother, Janet K. Low.
Lorraine M. Hanley, Gloria Duck, Barbara Lee, Gloria
Wiener, Jane Keen, and Glea Humez.

And, of course, my long-suffering editor, Richard P. Mc-
Donough of Little, Brown and Company.

Foreword to the Original Edition

THIS book is based on a very simple premise: that the stock
market is going up.

Tomorrow? Next month? Next year?

Maybe yes. maybe no. Maybe the market will be a lot
lower than it is today.

But over any long period of time  10 years, 20 years, 50
years  his book assumes that the market is bound to go
up.

Why?

Because it always has.

Because the market is a measure of the vigor of American
business, and unless something drastic happens to America,
business is going to go on growing.

Because prices of food and clothing and almost everything
else in this country  including stocks  have steadily gone
up as the buying power of the dollar has gone down. That's a
trend that isn't likely to be reversed^

And so these are the reasons why the author is sold on the
value of investing, of buying stocks for the long pull  and
not for a quick profit tomorrow.

There's nothing hidden about this prejudice. You'll see it
when you read the book. And you will find other prejudices,
otiher opinions, despite an earnest effort to focus this book
strictly on factsthe facts about investing that have been
obscured all too long by double talk, by financial jargon, and
by unnecessary mystery.

Of course it can be said that there are no facts when you
get beyond the simple business of adding one and one. That's
true. So let's say that here are the facts as the author sees
them  and as plainly as he can state them.

He has only one hope: that they will add up to good
common sense in your own mind.

Louis ENGEL

Introduction to the Seventh Edition

TWENTY years ago I worked in a bookstore in Boston. We
sold hundreds of copies of How to Buy Stocks every year.

A few years later, after opening my first brokerage ac-
count, I had a chance to read Mr. Engel's incisive primer and
discover for myself the reason for its continued popularity.

I have since reread it on several occasions, never failing to
marvel at the logic and clarity with which it makes seemingly
forbidding investment procedures seem like the common,
everyday undertakings they, in fact, can, and should, be.

But all too often are not.

Several months ago I was browsing through another Bos-
ton bookstore when a clerk asked me to recommend a book
that would explain the intricacies of investing to him in the
most comprehensive and least painful manner. My eyes
scanned the hundreds of screaming titles; How to Make a
Million Dollars in Twenty Minutes-'with This Theory, How to
Avoid the Coming Cataclysm with That Theory. Then my
eyes settled serenely on How to Buy Stocks. I handed it to the
clerk without a word. Just as I would have twenty years
ago.

Every investment book needs to be revised periodically to
keep pace with changing market conditions. How to Buy
Stocks is one of the handful of investment books that require,
during this revision process, incidental updating rather than
fundamental change. This is the mark of a true classic.

In undertaking this seventh revision, therefore, I have
made it my primary objective to retain the full thrust of Mr.
Engel's basic ideas. I have updated the main body of the text
to conform to current regulatory conditions and shifting
market moods. I have added new chapters on computerized
stock selection, related stock market reading, and the many
alternative investment vehicles that have emerged in the past
Sve years. Otherwise I have sought neither to tinker with Mr.
Engel's thesis nor to intrude on his methods of explication.

X  INTRODUCTION TO THE SEVENTH EDITION

The extent to which I have succeeded in revising How to
Buy Stocks, then, is the extent to which I have stayed out of
its way in updating it

I am grateful for the opportunity of ushering this indis-
pensable volume into its fourth decade.

BBENDAN BOYD
May, 1982

A Note on the Gender of Pronouns

WHEN the Srst edition of How to Buy Stocks was published
in 1953, there were very few women actively engaged in trad-
ing stocks, either as customers, brokers, or employees of the
various exchanges. In the intervening 29 years most of the
ludricrous prejudices that caused these exclusionary conditions
have disappeared. As a result, women have finally begun to
take their rightful places in the world of American finance.
Whenever possible, therefore, we have replaced the masculine
pronouns used exclusively in the earlier editions of this book
to refer to both brokers and customers with more specific and
appropriate words. We have retained the use of the masculine
pronoun only when the clarity of the text absolutely neces-
sitated it.

Acknowledgments

Foreword to the Original Edition
Introduction to the Seventh Edition
A Note on the Gender of Pronouns
A Note on How to Read This Book

i- What Investment Means to You

a. What You Should Know about Common Stocks

3. How and Why New Stock IsJiold

4. What You Should Know about Preferred Stocks

5. What You Should Know about Bonds and
Investment Banking

6. How New Issues Are Regulated

7. What You Should Know about Government and
Municipal Bonds

8. How Stocks Are Bought and Sold

9. What It Costs to Buy Stocks

10. How the Stock Exchange Works

11. How a Market Is Made

12. How Large Blocks of Stock Are Handled
13. How Small Orders Are Handled

riv CONTENTS

14. Monthly and Other Accumulation Plans

15. Other Exchanges  Here and in Canada

16. How the Over-the-Counter Market Works

17. Investing  or What's a Broker For?

18. How You Do Business with a Broker

19. How You Open an Account

20. What It Means to Speculate

21. How You Buy Stocks on Margin

22. What It Means to Sell Short

23. Options  Plain and Fancy

24. How to Tell What the Market Is Doing

25. How to Read the Financial News

26. Financial Advice  at a Price

27. How Your Broker Can Help You

28. Can You "Beat the Market"?

29. Should You Buy a Mutual Fund?

30. Why You Should InvestIf You Can

31. How Good Are Common Stocks?

32. How You Should Invest  If You Can

33. When Is the Time to SeD?

34. The Folklore of the Market

35. Who Owns Stock?

36. Stock Screens

37. The New Investment Areas

38. Further Reading
 Index

100
io6

ii3
124
129

i35
146

154
i6i

169
178
189
198

212
223
232

247

252
264

7S

282

287

293
300

3i8
325

A Note on How to Read This Book

MANY people are afraid to buy stocks because they think
investing is a complicated business.

If it were really complicated, more than 32.6 million
Americans (14.4% of the country's population) wouldn't
own stocks, as they did at the beginning of 1982.

Actually, investing only sounds complicated, and that is
because it uses a lot of unfamiliar words. The words them-
selves stand for very simple things.

Winston Churchill once said, "Old words are best, and old
words when short are best of all." This book tries to use old,
short words instead of Wall Street jargon. It seeks to explain
the technical words of the securities business by explaining
the things they stand for. In other words, each term is ex-
plained in context as the story of investing unfolds. You
won't find a glossary or any long list of definitions anywhere
in this book.

In telling the investment story, the book begins with the
common words in the business '-stock, share, capital  and
just to be sure that the reader realizes he has encountered a
technical term, possibly new to him, the word is italicized the
first time it is used. And to be further sure there is no mis-
understanding or confusion, no technical term is used until
the reader comes logically upon it in the development of the
whole thesis.

If the reader has by any chance forgotten the meaning of a
particular word, all he has to do is refer to the index and look
back in the book to that page on which the word is first
used.

Here, then, is the story of investing told in terms that the
author believes everyone can understand  himself included.

1

CHAPTER

What Investment Means to You

THIS is a book about how to make your money cam more
money for you by investing it.

It is not a book about how to make a million in the stock
market. If Acre were any certain way to do that, all the
brokers in the world, the men who are supposed to know
more than most people about the market, would be mil-
lionaires. Needless to say, they're not

This is a book about investing. Specifically, it's a book
about investing in stocks and bonds, which is one way ox
putting your extra money to work so that in the long run it
will earn a good return for you' either in the form of a
regular income from dividends or in the form of a profit
resulting from growth in value or a combination of both.

Most people, if they have anything left at all after paying
their bills, will think first of putting that extra money into a
savings bank or into life insurance. Nobody could possibly
quarrel with such a prudent course. These forms of saving are
essential if people are going to protect themselves properly
against the always unpredictable emergencies of life.

But today millions of people have come to regard securities
 stocks and bonds in all their varied forms  as an equally
good form of investment.

Of course, there's a risk in buying stocks and bonds  and
for most people it's a far bigger risk than it needs to be,
because they've never taken the time to study securities or
find out how to invest in them wisely.

But it should never be forgotten that there's some risk in
any form of investment. There's a risk in iust having money.
Actually, having money is a double-barreled risk. The one
riskthe risk that you might lose some of your money
regardless of what you do with it  is always evident. The
other risk is never so apparent. And that's the risk that the
money you save today may not buy as much at some future

3 HOW TO BUY STOCKS

time if prices of food and clothing and almost everything else
continue to go up, as indeed they have, more or less steadily,
since this country began. The person who simply hoards extra
dollars  puts diem in a vault or buries them in the ground
 may avoid that first evident risk, the risk of losing any of
them. But such a person can never sidestep the unseen risk.
the risk of inflation.

So every decision you make about what to do with your
extra money should take into consideration those two kinds
of risk; the evident and the unseen.

Naturally, you must also consider the return you hope to
realize on your money. In most forms of investment the
greater the return you try to get, the greater the risk, the
evident risk, you must be prepared to take.

If you put your money in a savings account, it's almost
impossible to lose any of it because your savings are insured
by the Federal Deposit Insurance Corporation for up to
$100,000 in one bank. But you have to be willing to accept a
return of only 5%% a year and you have to realize that a
savings account provides no protection against the unseen
risk of inflation. Your money, or capital, won't grow except
by the redeposit of the interest you get, and then only slowly.

You can also put your money in various bank time de-
posits that offer markedly higher rates of interest than simple
savings accounts (ranging up to 20% p.d, for $100,000 for
30 days during the credit squeeze of 1981, for example).
Rates earned on these certiScates depend on the amount of
money you deposit and the length of time you agree to leave
it with the bank. But even with these more generous yields
you are still earning on your invested capital a return that
barely keeps you even with the spiralling inflation rate and
that remains largely exposed to the crippling taxing powers of
federal, state, and local governments. Additionally, these
types of deposit come equipped with another subtle draw-
back. They tie your money up completely for the length of
time specified in the deposit contract, tie it up where you
can't get at it, either for emergencies or to take advantage of
other developing investment opportunities, without running
the risk of incurring the "loss of interest" penalties that most
of these time deposits stipulate for premature withdrawal.

Investing your spare cash in one of the new, and enor-
mously popular, money market funds allows you to enjoy

WHAT INVESTMENT MEANS TO YOU 3

yields equal to, or slightly greater than, those available on
time deposits of similar amounts. These funds are nothing
more than a pooling of enormous amounts of money from
thousands of individual investors for investing in a wide
range of short-term money market instruments with various
maturity dates. Thus, there is always a steady stream of cash
flowing into, and back through, these funds to guarantee that
individual investors can get any or all of their money out
anytime they want to. Still, most money market fund yields
are subject to the same rigors of taxation as bank interest
(although there are money market funds that invest in muni-
cipal securities, and are therefore tax-exempt). The 15% they
generated in 1981-1982 looks like a lot less when stacked
against the double-digit rises in die cost-of-living index this
country has been experiencing each of the past several years.
Fifteen percent in. And then 15% back out almost before
you can count it.

Life insurance is also virtually 100% safe. thanks to state
and federal laws. But there's more sense in buying a standard
life insurance policy to protect your family than there is in
buying it as an investment. Over a long period of years, the
usual life insurance policy may yield a return somewhat bet-
ter than that of a savings account. But it too fails to protect
you against the unseen risk of inflation. The money you
may get on such a policy when you retire is not likely to buy
as much as you could have bought with all the money you
paid out in premiums over the years.

What else might you do with your money? Well, you might
put it into a savings and loan association, which makes a
business of lending money on home mortgages. Thanks again
to government supervision, this kind of investment will be
relatively safe as far as the evident risk is concerned. But it
will pay you very little more interest than you would get on a
savings account And it will not protect you against the un-
seen risk of inflation.

You can invest in real estate. And as a general rule real
estate prices are likely to rise if the prices of other things do.
So there, you say, you can find protection against that un-
wen risk. Yes, there you can  provided you buy the right
piece of property at the right time and at the right price, and
provided you're just as lucky when you sell it Provided, too,
that all Ac taxes you pay while you own the property don't

4 HOW TO BUY STOCKS

eat up your potential profit. And provided you cope with all
the unpredictable actions of local zoning and assessment
boards. Here the evident risks are so great, even for those
who worfc full time at buying, developing, managing and
selling properties, that real estate must be classified not as an
investment, but as a speculation for the average man with
only a little extra money.                              ,

Then too you can invest in some of the "hard asset" areas
that recently have become so popular as inflation hedges.
You can buy gold or silver. But they, and all other invest-
ment metals, strategic and nonstrategic, are very expensive to
store and earn no dividends at all to help pay for their keep.
You could buy gems or coins or stamps. But they require a
great deal of expertise to traffic in and are characterized by
exorbitant retail markups, which discount a significant per-
centage of their potential appreciation right off the bat You
could buy art or antiques. But they're not the most portable
of assets for apocalypse-minded investors. And they're very
difficult to liquidate in times of down markets.

Finally, you can invest in stocks and bonds. That's what
banks do with at least part of the money you deposit with
them, in order to earn the interest they pay you and to earn a
profit for themselves. The same thing is true of insurance
companies. Both kinds of institution have always invested
heavily in bonds. But today they are buying more and more
stocks, even to the limits permitted by the various state laws.
Furthermore, commercial banks and trust companies, which
are responsible for funds left with them to invest for various
beneficiaries, are putting a greater proportion of those funds
into stocks.

Why?

Because over the years, the record shows that the average
stock has paid a better return and provided a better balance
of protection against the evident and unseen financial risk
than any other form of investment.

The stockholders of America are the people who own
much of America's business  virtually all its more impor-
tant business. As that business has grown, stockowners have
prospered. As it continues to grow, they will continue to
prosper.

Not all of them have prospered all the time. Of course not
But most of them have prospered most of the time. Some

WHAT INVESTMENT MEANS TO YOU 5

^httve made millions, and some have gone broke. Just as some
^companies have succeeded and some have failed. But over the

years, the average investor has generally earned a significant
V return on his money. Most important of all, he has seen his
'v, ttockholdings go up in value as prices generally have risen.
\: He has been able most times to sell his stocks at a profit,
^eipecially if he has held them a long time. And he has thus
"^ protected his money against the unseen risk of inflation.

w~ A study completed in early 1982 by Computer Directions
^Advisors of Sflver Spring, Maryland, showed that over the
^.entire gG-year period from 1926 to 1982, total returns on
^icommon stocks exceeded the rise in the consumer price index
i^-by a ratio of three to one. And during the 47 possible ten-
,^; year holding periods over those 56 years, common shares
^Outpaced consumer prices in 41 of the 47.

^- These are the reasons why more people are buying stocks
^i- today who never gave them a thought until a few years ago.

S'^And all of these people are finding that it pays to know
,,; aomething about the fundamentals of the business. So ...

,'a'.'
'M:..

t

2

CHAPTER

What You Should Know
about Common Stocks

THERE'S nothing commonplace about common stock. It's
the number one security in our system, basic to all corporate
business and to our whole free enterprise system. If you own
a share of stock in a company, you own part of that com-
pany. You and the other shareholders own the company in
common.

How does common stock come into being?

Assume for the moment that you've invented a fine new
collapsible metal fishing rod. You've got your patents, and
you're convinced there is a splendid market for your pocket
fishing pole.

You're all ready to begin production, except for that one
essential: capital. You haven't got the money to rent a small
factory, buy the necessary machinery, and hire labor and
salesmen. You could get your business under way for
$20,000, but you haven't got $20,000. The bank won't lend ft
to you simply on the strength of your patents, and you can't
find an "angel" with that kind of cash to put in your business.

So you decide to form a company and sell shares in the
venture. You file the necessary incorporation papers as re-
quired by your state law. and the Pocket Pole Company,
Incorporated, comes into being.

In setting up that company, you might find twenty people,
each of whom was willing to put up an even $1,000 of
venture capital. In that case, you'd have to issue and sell only
twenty shares of stock at $1,000 apiece. Then every person
who bought such a share would own 1/20 of the company.

But one person might be willing to put $2,000 into your
Pocket Pole Company, while another person could only
afford to invest $200. So instead of issuing twenty shares of
stock at $1,000 each, you decide it's better to put a lower

WHAT YOU SHOULD KNOW ABOUT COMMON STOCKS 7

price on every share of stock and sell more shares. Such a
plan would be more attractive to the people who might be
interested in buying the stock, because if they ever had to sell
it, they would probably find it easier to dispose of lower-
priced shares. After all, more people can spare $10 or $100
than can afford to invest in $1,000 units.

So you finally decide to issue 2,000 shares at $10 apiece.
Taken collectively, those shares would represent the common
stock issue of the Pocket Pole Company. The $10 price you
place on it would represent its par value.

You sell the 2,000 shares at $10 apiece, and by this means
you raise the $20,000 capital you need. The Pocket Pole Com-
pany is in business. Actually, of course, you might well think
of Pocket Pole as your business. So that when the company
was set up, you might bargain with the other stockholders so
you could acquire a stock interest in the company at little or
no cost to yourself. But for purposes of simplicity it can be
assumed here that you simply buy your stock like any other
stockholder.

Every person who owns a share of Pocket Pole stock is a
stockholder in the company. They are shareowners, part
owners. How big a part of the company they own depends on
how many shares they buy in relation to the 2,000 that are
sold, or outstanding. If they buy one share, they own %ooo
of the company. If they buy twenty shares, they own %oo, or
1%, of the company. As evidence of their ownership, a stock
certificate is issued to each stockholder showing the number
of shares he owns.

When the stock is all sold, let's assume the company finds
that it has 50 stockholders on its books. Now, it would be
difficult to operate Pocket Pole if all 50 of them had to be
consulted about every major decisionwhether to buy this
lathe or that one, whether to price the product at $40 or
$50.

So the stockholders elect a board of directors to oversee the
operations of the company. How is the board picked? By the
stockholders on the basis of the number of shares of stock
each one owns. If there are five shareholders to be elected to
the board, each for a set term, the one who owns one share of
stock will, as a matter of general practice, be allowed one
vote for each of the five vacancies, and the one who owns ten
shares will have ten votes for each vacancy.

8 HOW TO BUY STOCKS

This five-member board of directors elects its own chair-
man, and, once organized, is responsible for managing the
affairs of the Pocket Pole Company. Since in most instances
the board members can't give their full time to the job of
running the company, they pick a president to be the actual
operating head. They also name the other major officers.
Such officers may or may not be members of the board.'But
they are responsible to the full board, and periodically
perhaps once a month or once a quarter  the officers report
to the board on the progress of the company and their con-
duct of its affairs.

Then once a year the Pocket Pole Company board of di-
rectors will conduct a meeting open to all the stockholders: at
this meeting the management makes its annual report to the
owners. Furthermore, the board supplies all stockholders,
those present and those absent, with a copy of the report.

If any stockholder is dissatisfied with the way things are
going for the company, he can speak his mind at the meeting.
He may even make a motion that the board adopt some
policy or procedure that he thinks is an improvement on
present practice. If the motion is in order, it will be submitted
to the stockholders for a vote. In most instances, such issues
are decided by simple majority vote, with each stockholder
being allowed as many votes as he has shares.

If an action that requires a vote of the shareowners is
scheduled to come before a meeting, such as the election of
new directors, each stockholder is notified. If he cannot at-
tend the annual meeting and vote, he is usually asked to sign a
paper that authorizes one or more of the officers or directors
to act as his proxy, or representative, and vote for him. That's
why these papers are called proxies. Sometimes when new
directors are to be elected, a dissident group of stockholders
will propose a rival slate in opposition to those picked by the
management. In such a fight, each side will try to get signed
proxies from the stockholders favoring its slate. This is called
a proxy fight.

In addition to the regular meetings of the board or the
annual meeting of the stockholders, special meetings of either
group may be called to deal with special problems.

Why should people invest money in the Pocket Pole Com-
pany? Because they think it has a good product and one that

UHAT YOU SHOULD KNOW ABOUT COMMON STOCKS 9

is likely to make money. If it does, they as part owners
stand to make money. This can happen in two ways: first,
through the payment of dividends, and second, through an
increase in the value of Pocket Pole stock.

Let's look at the dividend picture first. Suppose in the first
year, after paying all bills and taxes, the company has earn-
ings, or profits, of $2,000, or 10%, on its $20,000 capitaliza-
tion, the money that it raised by selling 2,000 shares of
common stock. That would be a handsome profit for a new
company, but not impossible.

It would then be up to the board of directors to decide
what to do with that profit. It could pay it all out to the stock-
holders in dividends. Or it could vote to keep every penny of
it in the company treasury and use it to buy more machinery
to make more pocket poles and earn more profits die follow-
ing year. Since all stockholders like dividends and all boards
of directors know that. Pocket Pole's board might very prop-
erly decide on a middle course. It might vote to pay out
$1,000 in dividends and plow the other $1,000 back into the
business as retained earnings.

Now if the board has $1,000 for dividends and 2,000
shares of stock outstanding, the dividend per share is going to
be $0.50. That's what the shareholder with one share of stock
gets, while the shareholder with ten shares gets $5, and the
shareholder with 100 shares gets $50. For all of them this
would represent a 5% return on their investment, regardless
of the number of shares they own, since they each paid $10 a
share.

But there's another intangible return that they would get
on their money. Presumably that $1,000, which the board
decided to retain and plow back into the business, will serve
to increase the value of every person's share in the company
 their equity in the company, as it's called.

If an original share of stock in Pocket Pole was fairly
valued at $10, each of the 2,000 shares might now be consid-
ered to be worth $10.50, since the company now has an extra
$1,000 in the business besides the original capital of $20,000.

Already that par value figure of $10 has been made slightly
fictitious. As the years roll by, it will have less and less
relation to the value of the stock, especially if the company
continues to earn good money and if the directors continue,

10 HOW TO BUY STOCKS

year after year, to put a portion of those earnings back into
the company. In comparatively few years, the total assets of
the companyeverything it owns: its plant, machinery, and
inventory of products  might well have doubled without a
corresponding increase in its liabilities: the sum total of what
the company owes. In that case. the book value of each share
of stock  assets, less liabilities, divided by the number of
shares outstanding  would be increased.

Par value is a term so generally misunderstood and so
completely without significance that many companies today
either do not set any value on their stock, in which case it is
known as no-par stock, or they fix the value at $1 or $5, a
figure so low that it could not possibly be misinterpreted as
an index of its real value.

Even book value is a term with little real meaning today,
although it had a real significance in the last century when
watered stock was all too often sold to an unsuspecting pub-
lic, That graphic expression, watered stock, is supposed to
have had its origin in the practice of feeding cattle large
quantities of salt on their way to market and then giving them
a big drink of water just before they went on the weighing

scales.

As applied to securities, the phrase describes the kind of
company stock that was issued with an inflated value- For
instance, an unscrupulous operator might pay only half a
million dollars for some company, then issue a million dol-
lars' worth of stock in it. He might sell all that stock to others
and pocket a half-million dollars' profit. Or, after he sold halt
the stock and got his cost back, he might keep the remaining
shares and thus own a half-interest in the company at no cost
to himself. Such stock issues are now virtually nonexistent,
thanks to improved government regulation.

Most stockholders have come to realize that book value
frequently doesn't mean very much. What really counts is the
earning power of a company and its growth prospects, not
the total value of its plants and machinery. Frequently, the
stocks of many big companies sell at a price considerably
more than their book value  sometimes double or triple the
book value. In contrast, other stocks, like those of the rail-
roads, which have gigantic investments in equipment, sell for
much less than book value. Book value is frequently thought

WHAT YOU SHOULD KNOW ABOUT COMMON STOCKS  11

of as representing what the owner of a share of stock could
expect to get if the company were liquidated  if it went out
of business and sold off all its property. This is often a mis-
conception, because when a company is in liquidation it can
rarely get full value for the property it must dispose of.

So how do you know what a share of stock is really worth
 Pocket Pole stock or any other?

There's only one answer to that. Bluntly, a share of stock is
worth only what somebody else is willing to pay for it when
you want to sell it.

If the product isn't popular and sales suffer, if the cost of
wages and raw materials is too high, if the management is
inefficient. Pocket Pole or any other company can fail. And if
it goes into bankruptcy, your stock can become worthless.

That's the black side of the picture. That's what can hap-
pen if the risk you assumed in buying a stock proves to be a
bad one.

But if Pocket Pole proves to be a successful company, if it
has a consistent record of good earnings, if part of those
earnings is paid out regularly in dividends and another part of
them wisely used to expand the company  then your stock
is likely to be worth more than the $10 you paid for it.
Perhaps a good deal more.

And that is the second way in which a stockholder expects
to make money on an investment. First, through dividends.
Second, through an increase in the value of the stock  or,
rather, an increase in the price that somebody else will pay
for it. This is known as price appreciation.

The price of a stock, like the price of almost everything
else in this world, is determined by supply and demand: what
one person is willing to pay for a stock and what another one
is willing to sell it for, what one person bids and another asks.
That's why stocks always have a bid and an asked price. And
don't forget that that price is not necessarily a reliable guide
to good investing. Some people think that a low-priced stock
is a good buy because it is cheap, and they shy away from a
high-priced stock because they think it is expensive. That just
isn't so. The stock of one company may sell at a low price
simply because it has a large number of shares outstanding 
because the whole pie has been cut up into lots and lots of
little pieces  while the stock of another equally good com-

12 HOW TO BUY STOCKS

pany may sell at a high price because it hasn't been cut up
into so many pieces and there are relatively fewer shares
outstanding. The price of a stock takes on meaning only as
you consider it in relation to earnings and dividends per
share.

Here, in brief, is the story of common stock  what it is,
how it comes into being, what it means to own it.        ,

American Telephone & Telegraph. General Motors, and
U.S. Steel may have millions of shares of stock outstanding,
and they may even count their shareholders in the millions.
But in these giant corporations, each share of stock plays
precisely the same role as a share of stock in our Pocket Pole
Company. And each stockholder has the same rights, privi-
leges, and responsibilities.

There is only one significant difference between buying a
share of Pocket Pole and investing in a share of American
Telephone & Telegraph, General Motors, or U.S. Steel. These
big companies have been in business for many years. You
know something about them and the reputations they enJoy.
You know how good their products or services are. You can
examine their financial history, see for yourself how the
prices of their stocks have moved over the years and what
kind of record they have made as far as earnings and divi-
dends are concerned. And on the basis of such information
you can form a more reliable judgment about whether the
stocks of these companies are overpriced or underpriced.

In contrast, the person who buys stock in our Pocket Pole
Company has nothing to go on other than his own estimate
of how good a product the company has and how big its sales
are likely to be. There are no benchmarks to guide him, no
past records on which to base an appraisal of the future.

As a matter of literal truth, the Pocket Pole stockholder
cannot properly be called an investor. Most times, when a
person buys a stock in a brand-new company, he isn't invest-
ing in it; he's speculating in it. An investor is a person who is
willing to take a moderate risk with his money for the sake of
earning a moderate return. A speculator is a person who
takes a big risk in the hope of making a big profit as a result
of an increase in the price of a stock. An investor usually has
an eye on long-term values to be realized over a period of
years. A speculator usually hopes to make a big profit in a
relatively short period of time.

WHAT YOU SHOULD KNOW ABOUT COMMON STOCKS 13

American business needs both kinds of risk takers. Without
the speculator, new business wouldn't be born, nor would
many an old business be tided over a rough spot. Without the
investor, a company would not have the capital to carry on,
much less grow and expand.

3

CHAPTER

How and Why New Stock Is Sqld

LET'S assume that the years are good to our Pocket Pole
Company. It continues to grow. The original collapsible fish-
ing pole has proved a best-seller, and the company now has a
full line of models. Good earnings year after year have en-
abled the management to put the stock on a regular annual
dividend basis. It now pays $1 a year per share$0.25 a
quarterand in several good years the directors even de-
clared extra dividends, one of $0.25 and two of $0,50 a

share,

Now the company feels that the time has come for it to
expand. It could sell twice as many pocket poles, make twice
as much profit, if only it had a bigger factory. So the board
of directors decides to expand the plant. That means it will
need more machinery, a larger workforce, and, above au,
more money a lot more money than it has in the company
treasury. Problem: how to get $40,000.

A bank might advance the money. Maybe two or three
banks would each put up part of the loan. But some of
Pocket Pole's directors don't like the idea of being in hock
to the banks. They worry not only about paying interest on
the loan every year, but also about paying the money back in
installments. That kind of steady long-term drain on the
company treasury could eat into earnings and result in few, if
any, dividends. Furthermore, banks don't usually like to
make such long-term loans, and even if they are willing to,
they might  to protect their loans  insist on having their
representatives sit on me board of directors. That is a pros-
pect some of Pocket Pole's directors don't relish.

Isn't there some other way to raise the money?

Yes, there is.

Maybe the present stockholders would like to put more
money into the company. Maybe there are other people who

14

HOW AND WHY NEW STOCK IS SOLD  15

would like to invest in a nice thriving little business like
Pocket Pole. There's an idea.

And so the board of directors proposes to the stockholders
that they authorize the company to issue 3,000 additional
shares of stock  2,000 shares to be sold at once, and the
remaining 1,000 to be held against the day when the com-
pany may want to raise more money by selling more stock.
Each of the new shares of stock will carry with it the same
rights and privileges as an original share.

This proposal is approved by a substantial majority of the
stockholders, but nut without &ome disagreement. One stock-
holder objected to the plan She thought the company should
have two classes of common stock: a Class A stock, which
would consist of the original issue, enjoying full rights and
privileges, and a new Class B stock, on which the same divi-
dends would be paid but which would not carry any voting
privileges. In other words, she wanted control of the company
kept in the hands of the original stockholders.

The board chairman replied to this suggestion by pointing
out that such classified-stock setups, A stock and B stock, are
no longer popular with investors. True, some companies still
have two issues of common stock outstanding, but few com-
",   panics have followed such a practice in recent years.

Furthermore, the chairman explained, the old stockholders
4  would properly still retain about the same measure of control,
since they could be expected to buy most of the new issue
anyway. This appeared likely, because it would be offered to
^   them first and on especially favorable terms. This is the usual
procedure for companies that have a new issue of stock to sell.

In this instance, the board recommended that old stock-
holders be permitted to buy the new stock at $20 a share  a
figure about $2 less than the price at which the original stock
was then being bought or sold  while others who might buy
any of the new issue that was left over would have to pay
whatever the going price might be at the time.

After the stockholders approved the plan, each was given
rights that entitled them to buy new shares in the company at
a discount from the market price. This right was clearly set
forth on a certificate mailed to each shareholder. Everyone
who owned one of the 2,000 original shares was permitted to
buy one of the 2,000 new shares at $20. And the owner of



l6 HOW TO BUY STOCKS

ten old shares could buy ten new ones if he chose to exercise
his rights. But such rights had to be exercised within two
weeks  for rights are relatively short-lived. If the right was
good for a long time, perhaps for years or even perpetually, it
would be called not a right but a warrant: a certificate that
gives the holder the right to buy a speciBc number of shares
of a company's stock at a stipulated price within a certain
time limit or, in some cases, perpetually.

Some Pocket Pole shareholders, unable or unwilling to
purchase additional stock, sold their rights. Often the market
in such rights is a brisk one, even when they entitle the holder
to buy only a part of a share  a tenth, a fifth, or a quarter
of a share of new stock tor each old share that he owns.

In the case of Pocket Pole each right was worth $1. Here is
the way the value would have been arrived at; if you owned
one share of Pocket Pole worth $22 and you exercised your
right to buy an additional share at $ao, you would then own
two shares at an average of $21 apiece, or just $1 less than
the going price per share. Hence, the right could be figured to
have a value of just $1. Actually, some stockholders might
sell their rights for a fraction of that, while others might get
more than $1 apiece, if the price of Pocket Pole advanced
while the rights were still on the market. And, of course,
some careless stockholders would ignore their rights, forget-
ting either to sell or to exercise them, in which case the rights
would become worthless after the expiration date.

The standard formula for figuring the value of rights works
this way: first, take the prevailing market price of the stock
(in this case $22), then subtract the subscription price (here
$20); divide this difference ($a) by the number of old shares
it is necessary to own in order to buy one new share (i) plus
an additional one (i plus i is 2, and $2 divided by 2 is $1).

When the rights expired. Pocket Pole discovered that all of
them had been exercised except for 50 shares of the new
issue. These were readily sold at a price of $22. The company
had raised $40,100 of new capital and had 4,000 shares of
common stock outstanding.

Pocket Pole's plan for expanding the plant was put into
effect. But because of delays in getting the machinery needed,
it was two years before the new factory was in full operation.
That situation raised for the board the awkward problem of
how to continue paying dividends to the stockholders. In the

HOW AND WHY NEW STOCK IS SOLD I/

first year of the transition period, the board felt obligated to
continue paying the customary $1 dividend. But that put a
serious dent in the company treasury. The second year, the
directors decided it would be foolhardy to do that again.
They concluded that the only prudent thing they could do
was to pass the dividend and keep the full year's earnings in
the treasury until the new plant was operating efficiently.

But if the company paid no dividend, what would the
stockholders say? Omission of the dividend would certainly
mean that the price of the stock would go down. It would be
interpreted as a sign of trouble by those who might be inter-
ested in buying the stock.

The board found an answer to that problem in the 1,000
shares of new stock that had been authorized but not issued.
With the approval of the stockholders, it took those 1,000
shares and distributed them without any charge among the
owners of the 4,000 outstanding shares on the basis of one
quarter of a share of free stock for every single share that a
stockholder owned.

Actually, this stock dividend, did nothing to improve the lot
of any individual stockholders. They were not one penny
richer, nor did they actually own any greater proportion of
the company. The stockholder who. had one share before the
stock dividend owned 1/4000 of the company. Now with 1%,
shares out of the 5,000 outstanding, that stockholder still
owns exactly 1/4000.

Yet in terms of future prospects, that extra quarter of a
share had real potential value. When the company got rolling
again, that extra quarter share could represent a real profit 
and extra dividends, too.

That, happily, is exactly what happened. Pocket Pole
prospered. The next year it earned $2 a share. And the di-
rectors felt they could prudently restore the old $1 dividend
on each share. To the stockholder who held iV* shares, that
meant a return of $1.25.

4

CHAPTER

What You Should Know
about Preferred Stocks

WITH its new plant and its new machinery, the Pocket Pole
Company forged rapidly ahead. Earnings doubled. Then they
doubled again. And most of those earnings, by decision of the
directors, were reinvested in the business to expand produc-
tion and improve operations. Dividends were modest. But the
company was growing. Now its assets totaled almost
$200,000.

Then another problem  and another opportunity 
presented itself. The Rapid Reel Company, a well-known
competitor owned and operated by a single family, could be
acquired for $75,000. It was, the Pocket Pole directors
agreed, a good buy at that price. But where could they get the
$75,000?

Negotiations with the president of Rapid Reel revealed
that he was anxious to retire from business. He planned to
invest whatever he got from the sale of the company so that it
would yield him and his family a safe, reasonable income.
Further, it was evident that he had a high regard for the
management of Pocket Pole and was favorably impressed
with the company's prospects. Here was the basis of a deal.

So the directors of Pocket Pole proposed that they take
over Rapid Reel as a going concern and merge it into their
company- How would they pay for it? By issuing preferred
stock in the Pocket Pole Company  an issue of 750 shares
with a par value of $100 per shareand giving it to the
owners of Rapid Reel in exchange for their company.

Like most preferred stock, this issue would assure the
owners a first claim on the assets of Pocket Pole, after all
debts had been taken care of, should it ever be necessary to
liquidate the company. Further, it was provided that this

28

WHAT YOU SHOULD KNOW ABOUT PREFERRED STOCKS  1Q

particular preferred stock would carry a specific dividend
payable every year on every share before any dividends could
be paid to common-stock holders. To make the deal as attrac-
tive as possible for the owners of Rapid Reel, the company
was willing to pay a good dividend  $10 on every share, or
10%.

Sometimes such a preferred dividend is not paid in a given
year because the company did not earn enough that year to
cover it. But the most common type of preferred stock is
cumulative preferred. That is the kind Pocket Pole issued to
the owners of Rapid Reel. Pocket Pole's cumulative preferred
stock provided that if Pocket Pole could not pay the $10
dividend in any year, the amount due for that year would
accrue to the preferred-stock holders and would be paid the
following year or whenever the company had sufficient earn-
ings to pay it. If the company could not make the payments
on the preferred for a period of years, the payments would
continue to accrue during all that time and would have to be
paid in full before the common-stock holders got as much as
a dime in dividend payments.

On the other hand, it was agreed that this would not be an
issue of participating preferred. This meant that the holders
of the preferred would not participate, beyond the stipulated
dividend payment, in any of the extra profits the company
might earn in good years. Even if earnings were so good
that dividends on the common stock doubled or trebled, the
holders of the preferred would still get just their $10 a share
and no more. Furthermore, they would have no participation
in company affairs and no voting rights except on matters
that might adversely affect die rights guaranteed them as pre-
ferred-stock holders. They were also guaranteed the right to
elect two directors to the board if the company should ever
pass, or fail to pay, the preferred dividend for eight consecu-
tive quarters.

Although the terms of this issue might be regarded as fairly
typical, there is no such thing as a standard preferred stock.
About the only common denominator of all such issues is the
guarantee that the owner will be accorded a preferential
treatment, ahead of the common-stock holder, in the pay-
ment of dividends and in the distribution of any assets that
might remain if the company was liquidated. That's why it is

30 HOW TO BUY STOCKS

called preferred stock. And that's why its price usually
doesn't fluctuate, either up or down, as much as the price of
the company's common stock.

Besides their preferential status, speciBcations for preferred
stocks vary widely. Most preferreds have a $100 par value.
But some are no-par stocks. Dividends vary according to
interest rate conditions at the time. Most preferreds are npn-
participating. But there are many exceptions.

Many preferreds are issued, as in the case of Pocket Pole,
to acquire another company. But most are issued simply to
acquire more capital for expansion or improvements at a time
when the company's circumstances are such that its stock-
holders and the public at large might not be willing to invest
in more of its common stock.

Cumulative preferreds are by all odds the most common.
But there are some noncumulatwe issues on the market as
wellprincipally those of railroads. Occasionally, in the
case of cumulative preferreds, accrued dividends pile up in
bad years to a point where it becomes impossible for a com-
pany to pay them. In such a situation the company may
attempt to negotiate a settlement with the preferred holders
on the basis of a partial payment. However, some companies
have paid off more than $100 a share in accumulated back
dividends due on a given preferred stock issue that cost the
owners just $100 a share, originally.

Another kind of preferred stock that has become increas-
ingly popular in recent years is the convertible preferred.
Such a stock carries a provision permitting the owner to
convert it into a specified number of shares of common stock
at a specified time. Suppose, for instance, that a company sold
a new issue of convertible preferred at a time when its com-
mon stock was quoted at $17 or $18 a share. In such a
situation, the conversion clause might provide that every
share of the new $100 preferred could be exchanged for five
shares of the company's common stock at any time during
the next five years. Obviously, there would be no advantage
to the preferred-stock holders making such a swap unless the
common stock advanced in price to more than $20 a share.

The price of a convertible is apt to fluctuate more than
the price of other preferreds because a convertible is always
tied to the price of the common stock of the company. This
has its good and bad points. If the company is successful and

WHAT YOU SHOULD ENOW ABOUT PBEFERBED STOCKS 21

the price of its common stock rises, the holder of a con-
vertible preferred will find that the stock has had a cor-
responding increase in value, since it can be exchanged for
the common. On the other hand, if the price of the common
declines, the convertible preferred is apt to suffer too. This is
because one of the features that was counted on to make it
attractive has suddenly lost something of its value, and the
other features of the issue, such as its dividend rate. may not
prove as attractive or substantial as those of orthodox pre-
ferreds. Convertibles are always especially popular when
stock prices are rising generally.

Most preferreds carry a provision that permits the com-
pany to call in the issue and pay it off at full value, plus a
premium of perhaps 5%. A company will usually exercise
this right to call in its preferred stock if it thinks it can
replace the outstanding issue with one that carries a lower
dividend rate.

From the point of view of the owners of Rapid Reel, the
plan which Pocket Pole proposed looked attractive. So they
accepted it  after the common-stock holders of Pocket Pole
had approved the plan and authorized issuance of 750 shares
of 10% cumulative preferred stock with 100% par value in
exchange for the Rapid Reel Company.

With this acquisition. Pocket Pole was on its way to be-
coming a big business. And in the next ten years, with boom-
ing sales, it strode forward along that path with seven-league
boots.

It bought the little Nylon Une Company for cash.

It acquired the Fishing Supplies Corporation with another
issue of preferred stock. This issue it called seconds-preferred,
because it had to recognize the prior claim to assets and
earnings that had been granted the owners of Rapid Reel. To
make this issue more attractive to the owners of Fishing
Supplies, a conversion privilege was included in it. In other
words, it was a convertible preferred.

It bought the Sure-Fire Rifle Company by authorizing an
additional issue of common stock and arranging to trade the
Sure-Fire stockowners one share of Pocket Pole for every
three shares of Sure-Fire that they owned.

Finally, it acquired control of Camping Supplies, Incor-
porated, on a similar stock-swapping basis.
g11     Now, with a full, well-rounded line of fishing, hunting, and

32 HOW TO BUY STOCKS

camping supplies, backed by an aggressive advertising and
merchandising campaign, the company decided to experiment
with its own retail outlets. In a few years, these grew into a
small chain of 30 sporting-goods stores, known as the Rod &
Reel Centers.

Sales multiplied, and so did earningsup to $10 and $12
a share. Dividends were boosted correspondingly, and with
the adoption of a regular $6 annual dividend. Pocket Pole
stock was frequently quoted at $120 a share and higher.
Stockholders complained that it was too high-priced, that it
couldn't be sold easily if they wanted to dispose of their
holdings.

So the company decided to split the stock on a tcn-for-one
basis and simultaneously to change its corporate name to Rod
& Reel, Incorporated  a much more appropriate name,
since most fishermen consider the fishing "pole" passe.
Hence, it issued new certificates for ten shares of Rod & Reel
common stock for every single share of the old Pocket Pole
stock. Theoretically, each of the new shares should have been
worth about $12.. But since stock splits frequently excite un-
usual investor interest, it wasn't long before the new shares
were being bought and sold at prices a dollar or two higher,
even though there had been substantially no change in the
outlook for the company-
In companies with larger numbers of shares of stock out-
standing than Rod and Reel, such a split can often have a
negative effect on the stock's price. Increasing the number
of shares outstanding by 500%, a larger company runs the
risk of creating such an oversupply of stock in the market-
place that it requires substantial buying demand from the
public to drive its price up.

Along its road to success. Rod & Reel encountered only
one misadventure. Eyeing its growth, its sales and earnings
record, and its general financial strength, the Double-X Sport-
ing Goods Company proposed to Rod & Reel that they merge
their two businesses. After many joint meetings and careful
examination of the pluses and minuses of the proposal, the
directors of Rod & Reel decided that the interests of their
stockholders would best be served if the company continued
to row its own boat, and so it declined the offer to merge.

But Double-X wasn't prepared to take no for an answer. It
wanted Rod & Reel and its successful retail outlets. And so

WHAT YOU SHOULD KNOW ABOUT PREFERRED STOCKS 33

Double-X made a tender offer to each Rod & Reel stock-
holder. They agreed to buy the stockholders' shares on a set
date at a set price almost 10% above its prevailing market
price, provided enough other stockholders surrendered their
shares so that Double-X could obtain control of Bod & Reel.
If Rod & Reel stockholders signed the form agreeing to sell,
they would have to tender their stock to Double-X on de-
mand at the set price and on the given date.

Bod & Reel fought the tender offer and urged its stock-
holders not to sign up. In the end Rod & Reel won out. So
few stockholders were willing to sell, even at the higher price,
that Double-X realized it could not gain control of Rod &
Reel. So it was forced to withdraw its tender offer.

During the late seventies and early eighties, as ballooning
start-up costs and rising interest rates made it more economi-
cal to buy existing businesses than to begin one from scratch,
large cash-rich corporations waged increasingly heated bid-
ding wars among themselves to acquire smaller established
companies. Frequently these bidding wars drove the price of
the merger target's stock up two- or threefold in a matter of
weeks. Soon, ferreting out which smaller companies were the
most likely candidates for a lucrative tender offer  by virtue
of their assets, growth potential, and the undervaluation of
their stock  had become one of Wall Street's more popular
guessing games. Rod & Reel was one of the very few of these
heavily romanced takeover candidates to escape assimilation
by an acquisitive suitor during the heyday of merger fever.

This is the story of Rod & Reel, Incorporated, formerly
Pocket Pole Company, Incorporated. It is a success story, as
it was meant to be, to show the various kinds of stock opera-
tion that may mark a company's growth. But for that matter,
it is no more a success story than the real-life stories of
General Motors or International Business Machines, Xerox
or Polaroid, or any of hundreds of other companies in which
the original investors (or speculators) have seen the value of
their stockholdings multiplied 10, 20, even 100 times over.

5

CHAPTER

What You Should Know
about Bonds and Investment Banking

DO you have a lot of money to investsay, $20,000,
(50,000, or more? Or is there some reason why you should
be particularly conservative in your investments?

If either is so, then you ought to know about corporate
bonds, the kind of bond issued by companies like Bod & Reel,
Incorporated, and bought principally by institutional in-
vestors: banks, insurance companies, pension funds, colleges
and universities, and charitable foundations.

If you don't have substantial sums to invest or some good
reason for being especially conservative, chances are that
there are better investments for you than corporate bonds.

But who can tell when you might get a lot of money? And
anyway, every intelligent investor should know something
about bonds just so hell have a grasp of the whole securities
business.

The easiest way to understand bonds is to consider the
plight of Rod & Reel's treasurer at a time when the company
needed $1 million of new capital  a much greater sum than
it had ever had to raise before.

It needed that money because over the years it had grown
rather haphazardly, acquiring a manufacturing plant here and
another one there, a warehouse here and some retail stores
there.

Now the whole operation had to be pulled together, made
to function efficiently. An independent firm of engineers had
figured out just what economies Rod & Reel could effect by
centralizing most of its manufacturing operations in one big
new plant and by modernizing its equipment. In the long run,
the $i million would unquestionably prove to be money well
spent.

But how to get the money?

24

WHAT YOU SHOULD KNOW ABOUT BONDS 25

As company treasurer, you might first discuss the matter
with the officers of your regular bank. They are perfectly
willing to supply you from month to month with the credit
you need for raw materials. But a million-dollar loan to con-
struct a new plant  well, that is too much of an undertaking
for them. What you need in die present situation, they sug-
gest, is help from a very special kind of banker, an invest-
ment banker.

Investment bankers specialize in raising the kind of money
that business needs for long-term use, usually in amounts
considerably greater than the million Rod & Reel wanted.

Most times when a company wants money, it would like to
get it without obligating itself to pay any set return on the
money. In short, it wants equity capital, the kind of money it
can get only by selling common stock.

If the company's condition is sound, if its prospects are
good, and if the stock market is then very active and healthy,
an investment banker may agree to underwrite such an issue
of common stock. That means he will buy aB the new stock
himself from the company, then resell it at a set price per
share to individual buyers. As a general rule, this is the only
time in the entire life of a stock issue that its price will be
fixed  at the time when it is originally issued, either to start
a new company or to raise new capital. Once the stock is in
public hands, its price will be determined solely by how much
buyers wiB pay and how much the sellers want for the stock
they own  the law of supply and demand.

For the risk that the investment banker assumes in under-
writing an issue of common stock, the risk that he may not
be able to resell the entire issue that be has bought, he ex-
pects to make a profit on each share of the issue.

On small issues, involving only (i million or $2 million, he
may be able and willing to carry the whole risk himself. But
on most issues he shares the risk with other investment bank-
ers, who join with him in forming an underwriting group or
syndicate under his management.

When it comes time to sell the issue to the public, the
underwriters usually invite other security dealers to join with
them in a selling group.

The costs of underwriting and selling an issue of stock
depend primarily on how salable the underwriting group
thinks the issue wiB be when it is put on the market. Those

26 HOW TO BUT STOCKS

costs might nm anywhere from 3% to 10% of the final
selling price, and they are wholly paid by the seller. The
buyers get such stock at the announced price, free of aH
commission cost or other charges. On some issues, such as
cheap mining or oil stocks offered at a dollar or two a share,
charges might even run as high as 20%. That's because these
penny stocks can usually be sold only by a costly merchandis-
ing effort. A third to a half of the total commission on any
new issue might go to those who underwrite it, with the
manager of the group getting an extra fee for his services,
and the balance going to those who sell it. But if the issue
looks as though it might be hard to sell, the selling commis-
sion is likely to be increased and the underwriting commis-
sion reduced correspondingly.

When a company wants to raise capital by selling a new
securities issue, it usually shops around to see which invest-
ment banker will offer the best, terms and handle the new
issue at the lowest total cost. Once an underwriter is selected,
the relationship between the company and the underwriter
is apt to develop naturally into a dose one. If the company
needs to raise additional capital at some future time, it will
usually expect to get help again from the same underwriter.
When an underwriting is arranged in this fashion, it is de-
scribed as a negotiated deal, as distinct from a deal that is
arrived at through competitive bidding by various investment
bankers interested in obtaining the business.

While most companies might prefer to raise new capital by
selling stock, this is not the kind of securities issue that an
investment banker is likely to sanction, especially in the case
of a comparatively small company like Rod & Reel. He is far
more apt to suggest an issue of bonds rather than an issue of
stock. In normal years, the aggregate value of new bond
issues may be five or ten times greater than the value of new
stock issues. As a matter of fact, in the modern era, Ameri-
can business has raised little more than 5% of the money it
has needed through the sale of stock. It has raised most of
the balance by selling bonds. That is why the bond market is
many times bigger than the stock market.

Bonds always represent borrowed money, which the com-
pany that issues them is obligated to repay. That's why they
are called obligations. They are a kind of promissory note.
When a company sells bonds, it borrows the money from the

WHAT YOU SHOULD KNOW ABOUT BONDS B/

investors who buy the bonds, and the bonds stand as a formal
evidence of that debt. Each bond is an agreement on the part
of the company to repay the face value of the bond 
usually $1,000  at a specified time and in most cases to pay
a set annual rate of interest from the day the bond is issued to
the day it is redeemed.

The person who buys stock in a company actually buys a
part of that company. The person who buys a company's
bonds simply lends money to the company.

The stockholder expects to collect dividends on that stock
and thus share in the company's profits. The bondholder ex-
pects only to earn a fixed return on that investment in the
form of interest payments.

There's one other important difference between stocks and
bonds. If a company is successful, the stockholder can hope
to make a substantial profit because the price of the stock
should go up. The bondholder enjoys no such extravagant
hope. Market-price appreciation for a company's bonds is
usually limited, regardless of how successful the company
may be, although price changes sparked by interest rate
fluctuations have often been quite dramatic, and in the late
seventies and early eighties have frequently equaled, and
sometimes even surpassed, similar price changes for common
stocks.

On the other hand, if the bondholder can't expect to gain
as much on invested capital, neither does he run the risk of
losing as much. The investment is much better protected,
thanks to the fact that bonds do represent debt. If the com-
pany is dissolved, the debt it owes its bondholders, like any
Other debt it owes for labor and materials, must be paid
before the stockholders, either common or preferred, can get
a nickel out of what's left of the company. The claims of
bondholders come first, then the preferred-stock holders 
and last, the common-stock holders.

It is because the element of risk in bonds has historically
been so comparatively slight that they have usually been such
a popular form of investment with institutional investors.
This is the market the investment banker has his eye on when
he underwrites a bond issue. Very often, an issuer may suc-
ceed in selling an entire bond issue to just one or two large
' iistitutional customers  a bank, an insurance company, or
:' a pension fund. This is known as a private placement.




aB HOW TO BUY STOCKS

Because the institutional market for bonds has over time
been such a good market, underwriting and selling commis-
sions are usually much lower on an issue of bonds than on an
issue of stock. Otherwise, the two kinds of securities are
issued and sold in much the same way.

From the point of view of any company treasurer, a stock
issue has obvious advantages over a bond issue. The interest
that must be paid on bonds represents a fixed charge that has
to be met in bad times as well as good times. And bonds must
be paid off when they come due. The stockholder has to be
paid dividends only if the company makes money  and
even that is not a binding obligation.

If the company is successful, it can afford to pay interest
on money borrowed from bondholders, provided it can
make a substantially greater profit on the extra capital that
it raises by the bond issue. Again, bond interest payments
are an expense item deducted from a company's earnings
before it pays its federal income tax on those earnings.
In contrast, dividends are paid out of what is left after a
company has paid the tax on its earnings. Thus, it actually
costs a company less to pay a given amount of money to
bondholders than it does to pay the same amount of money
to stockholders.

For the company issuing the bonds the situation is not
much different from what it would be if you as an individual
sought to get a loan from a bank. If the banker knew you and
knew that you would be able to repay the money, he might
lend it to you without asking you to put up any collateral,
such as your life insurance policies or other property, to
guarantee the loan. But if he didn't know you or if it was a
sizable loan, he might insist that you give him some col-
lateral, such as a mortgage on your home.

It's much the same way with companies when they issue
bonds. They would prefer to get the money without posting
their property as a guarantee that the contract set in the bond
will be fulfilled. That, as a matter of fact, is precisely the way
the Rod & Reel treasurer felt when the investment banker
told him the company would have to foot a bond issue, not a
stock issue.

As long as it had to be bonds, the treasurer proposed that
the company issue $1 million of debentures.

A debenture is a bond that is backed only by the general

WHAT YOU SHOULD KNOW ABOUT BONOfi 29

credit of the corporation. No specific real estate or property
stands as security behind it. It is, in effect, a giant-sized
LO.U. Debentures are the most common type of bond issued
by big, well-established industrial companies today. But in the
case of Rod & Reel, the investment banker was not disposed
to feel that such an issue would be in order, because the
company, though successful, was still relatively small and not
too well known. He was afraid the debentures wouldn't sen.

The treasurer then asked if a debenture might not be made
more attractive by including a convertible provision on it.
There are many convertible bonds on the market, and their
terms vary widely. But like convertible preferred stocks, all
convertible bonds offer the owners the privilege of converting
their bonds into a specified number of shares of common
stock.

Such a provision may add a certain speculative appeal to
tfie bondthe chance to make an extra profit if the com-
mon stock rises. But the typical bond buyer may look ask-
ance at such a "sweetener." He knows better than most
security buyers that you don't get something for nothing in
a security, any more than you do in any other kind of
merchandise. A convertible bond may offer the possibility of
price appreciation, but its guarantee of safety is not as sub-
stantial. Such issues are considered to be subordinate to other
bonds.

In Rod & Reel's case, the investment banker did not feel
that a convertible was feasible. In light of this attitude, the
treasurer did not even raise the question of whether the com-
pany could issue some kind of income or adjustment bond.

These bonds are a kind of hybrid security, something like a
noncumulative preferred stock, since they provide that the
interest is to be paid on the bond only as it is earned. It
earnings are sufficient to pay only a part of the interest on
such bonds, the company must make whatever payment it
can to the nearest % of 1%. Thus on a 5% bond a company
; might pay only s^t or 3% or 3%$, depending on its
r earnings. Hence, most income bonds have a very low quality
rating.

There is stifl another kind of bond, the collateral-trust
bond, which, like the income bond, used to be more popular
' than it is today. But Rod & Reel's circumstances were such
; that this type of security was obviously not suited to them.

30 HOW TO BUY STOCKS

When a company Issues a collateral-trust bond, it deposits
securities with a trustee as a guarantee that the bonds will be
redeemed and interest paid on diem. UsuaDy the securities on
deposit are worth at least 25% more than the total value of
the bond issue. And they are frequently the securities of sub-
sidiary companies.

As the discussions progressed, it became apparent that the
investment banker felt there was only one kind of industrial
bond that Rod & Reel could offer. That was a first-mortgage
bond  the kind of bond that is secured by a mortgage on all
of a company's property: not only on its existing property but
sometimes even on all property that it might later acquire.

Industrial bonds of this type are considered to be among
the highest-grade security investments. They offer the investor
an undisputed first claim on company earnings and the great-
est possible safety. The claims of the holder of such a first
mortgage take absolute precedence over the claims of au
other owners of the company's securities, including the hold-
ers of debentures, adjustment bonds, or secondary-mortgage
bonds that may be issued after a first mortgage has been
made-
Having resigned himself to the fact that Rod & Reel would
have to mortgage its property, including Ac new plant that it
expected to build, in order to float a $x million bond issue,
the company treasurer next took up with the banker the
question of what rate of interest the company might have to
pay. Here the banker was in no position to supply an answer,
because the rate a company has to pay always depends pri-
marily on its credit standing and its earning capacity. And
these were the crucial factors on which the banker could not
commit himself without a thorough, painstaking investigation
of all aspects of the company  the same kind of survey that
every investment banker must make, with the help of outside
accountants, engineers, and/or other needed specialists, be-
fore underwriting any new issue of securities for a company.

Bond interest rates vary not only with the health of the
company but also with the bond's quality and with general
business conditions. Whenever a new bond issue is floated,
Moody's Investors Service and Standard & Poor's Corpora-
tion, America's two outstanding organizations in the field of
securities research and statistics, assign it a quality rating.

WHAT YOU SHOULD KNOW ABOUT BONDS 31

Most times the two companies agree on the ratings. But they
don't quite agree on the form of the designation. Thus,
Moody's grades bonds (downward in quality) as Aaa, Aa, A,
Baa, Ba, et cetera, while Standard & Poor's prefers capital
letters, using AAA, AA, et cetera, and also assigns plus and
minus ratings to most major quality groups.

hi 1920, Aaa or AAA bonds paid over 6%, while in 1945
they were paying only a%%. In the early sixties, Aaa bonds
were paying 4^2% to 5%  a range that bond dealers con-
sider fairly typical over a long period of years. By the end of
Ae sixties, however, the return on such bonds had increased
to 8*6, then to 10% in 1974, and finally, by 1981, to as
much as 14% as inflation soared to double-digit figures.

When money is "tight," as it was during the late seventies
and early eighties, banks increase the rates they charge on
mortgages and loans, and they pay higher interest rates on
deposits. At such a time bond interest rates usually go up, too.
If this happens at a time when stock dividends, expressed as a
percentage of the price, have been going down, a situation
develops where the investor can get a better return from
bonds than he can from stocks. Thus, he is frequently
tempted to shift to the "safer" investment.

This is why it is a mistake to think that bond prices never
fluctuate. When new bonds are issued with interest rates of
13% or 14%, the prices of outstanding bonds, offered origi-
nally at 4% or 5%, are bound to decline. No one is going to
pay face value for an old bond with an interest rate of 4% if
he can buy a new bond of equal quality with an interest rate
of 14%. The only way the old 4% bond could compete
with the new 14% bond on even terms would be for the 4%
bond to sell in the market at much less than one third of its
original price. So, when interest rates rise, older bonds with
low interest rates have a tendency to fall proportionately in
price.

During the late seventies and early eighties, as the prime
interest rate, the rate banks charge their most creditworthy
customers, rose above the unprecedented 20% level, the
prices of old bonds issued at substantially lower rates of
interest fell precipitously. Thus, the once staid bond market,
long treasured by conservative individual and institutional
investors for the stability of its prices and the predictability of

32 HOW TO BUY STOCKS

its return on capital, became the scene of frequent price
swings as wide as any witnessed during the most dramatic of
stock market fluctuations.

The interest rate of a bond is frequently referred to as the
coupon rate, because traditionally bonds have appended to
them a number of detachable coupons, one for each six
months of the bond's life. The owner clips each coupon as it
comes due and presents it to the company's paying agent for
payment. Coupons were used at first because bonds were not
registered on the company's books in the owner's name, as
stock certificates are. Instead, they were the property of the
bearer  whoever had them at a given time  and hence
were called bearer bonds.

Today, there has been a departure from this practice.
Nearly all companies now issue bonds that are registered in
each owner's name, just like stocks. On some registered
bonds, coupons are still used tor the payment of interest. But
on others the bondholder gets a check automatically from the
company. This practice has become increasingly popular. In
time, the phrase "coupon-clipper" to denote a wealthy indi-
vidual who lives off the proceeds of bond interest may vanish
from the language entirely.

Just as crucial as the interest rate of any company issuing
bonds is the question of maturity  how long a life the
bonds will have, how soon the company wiU have to redeem
them, or pay them off. In general, the stronger the company,
the longer the maturities. For a company like Rod & Reel, ten
years might be considered the maximum time limit. Further-
more, the company would probably be required to establish a
sinking fund and put enough into it every year to provide for
an annual repayment of a portion of the issue, just as one
pays off part of the principal on a mortgage each year. In
view of its building and reorganizations plans. Rod & Reel
would probably be allowed a breathing spell of two or three
years before it had to start putting money into the sinking
fund.

Like preferreds, most bonds have call provisions, which
permit a company to redeem them before maturity if it has
the money.

There is a wide variation in how long bond issues run, but
a period of 20 or 30 years is about as common as any.
Curiously, the railroads have issued bonds with the longest

WHAT YOU SHOULD KNOW ABOUT BONDS 33

life on record, and they also have some with about as short a
life as any. Many old rail bonds run for 100 years, and some
have no maturity date. They were issued in perpetuity
a (rank recognition of the fact that no one expects the rail-
roads ever to pay all their debts.

At the other end of the time scale are equipment trust
obligations, which mature in only one to fifteen years. These
serial maturity bonds enable a railroad to buy freight cars,
passenger cars, locomotives, and other such equipment virtu-
ally on the installment plan. Some have carried interest rates
under 1^*6. On this kind of bond, the equipment itself
stands as the guarantee of repayment.

The maturity of a bond can affect the return you realize on
it You can buy a bond with a 656 coupon rate, but it may
yield you something less  or something more  than 6%,
depending on how much you pay tor the bond and what its
maturity is. If you pay exactly $1,000 for a bond and get $60
interest on it every year. you do realize a 6% yield. But if
you pay $1,050 for the bond, the $60 annual interest pay-
ment obviously represents less than a 6% return on the
money you've invested. Furthermore, if you hold the bond
until it matures, you will get only $1,000 for it on redemp-
tion, a loss of $50. H the bond has a twenty-year maturity,
that $50 loss would represent, in effect, a reduction of $2.50
a year in your interest payment. Furthermore, over the full
twenty years you would have lost the amount of interest that
you might have earned on that $50.

The net of it all is that if you pay $1,050 for a 6% oo-year
bond, you will realize a yield to maturity of just 5.58%, but
only if all coupons when paid are reinvested (interest on
interest) at the yield they would provide if held to maturity.
Of course, if you buy the bond at a discount instead of a
premiumfor $950 instead of $1,050, for exampleyou
will earn more than 6% on it.

It was the yield to maturity that made many old bonds
issued at 4% or 5% in earlier years especially attractive in
19811982. In eariy 1982, for instance, it was possible to
buy a top-quality bond, such as American Telephone & Tele-
graph's 3% bonds, due in 1990, at around $53. As the price of
the old bond was forced down, its yield was increased so that
it was able to compete in the marketplace with new bonds
issued at 9% or 10%. The A.T.&T. bondscheduled to be

34 BOW TO BUY STOCKS

paid off in eight years at a full par  would have to gain 47
points before 1990, when it would be redeemable at full
value. That built-in gain gave the bond ? yield to maturity of
over 19%. The capital gain portion of this 19% yield would
be taxable like all capital gains, thus affording the investor a
distinct tax advantage.

When a company like Rod & Reel floats a stock or bond
issue to raise new capital, such an issue represents new fi-
nancing. But very often preferred stocks or bonds are issued
as part of a refinancing operation. Thus, when a company
refinances, it may seek to substitute some new bond issue for
an outstanding one that it issued many years ago  a process
known as refunding.

Why should such a substitution be made? Because as busi-
ness and investment conditions change, it is frequently
worthwhile for a company to call an outstanding issue of
bonds or preferred stock on which it may be paying a high
rate of interest. Such an issue can then be paid off out of
funds raised by the sale of a new issue carrying a lower
rate.

When a company has a substantial amount of bonds or
preferred stock outstanding in relation to the amount of its
common stock, the common stock is said to have high lever-
age. This phrase is used because the price of such a stock is
likely to be disproportionately Influenced by any increase or
decrease in the company's earnings. Here's why: suppose a
company is obligated to pay $500,000 in bond interest and
preferred dividends every year. If the company has earnings
of $l million before paying such fixed charges, it has only
$500,000 left for the common-stock holders. But if the com-
pany has earnings of $3 million, it will have $2,500,000
available for the benefit of the common-stock holders, in the
form either of dividends or of reinvested capital. This would
serve to increase the value of the company and its stock. In
this situation, a threefold increase in the company's earnings
would have meant a fivefold increase in the amount of earn-
ings available to the common-stock holders. This is because
the holders of the bonds and preferred stock would still have
received only the prescribed $500,000.

Of course, if the company's earnings decreased from $1
million to $500,000. there would be no earnings at all avail-
able to the common-stock holders. Because fluctuations in

WHAT YOU SHOULD IMOW ABOUT BONDS 35

earnings can have such magnified effects on earnings avail-
able to the common-stock holders, high-leveraged stocks are
likely to fluctuate more drastically in price than the stocks of
companies that have relatively small amounts of outstanding
bonds or preferred stocks.

6

CHAPTER

How New Issues Are Regulated

WHENEVER a company like Rod & Reel wants to raise
capital by floating a new issue of stocks or bonds, it must
comply with the federal law that governs the sale of any such
issue offered to the public.

In the boom days of the twenties, many a new stock was
sold with few facts and lots of glittering promises. In 1933,
Congress changed all that. It enacted a new law, widely
known as the Truth in Securities Act. Then in 1934, it passed
the Securities Exchange Act, and, the same year. set up the
Securities and Exchange Commission to administer both laws.

The S.E.C. requires fvQ disclosure of all the pertinent facts
about any company before it makes a puMic offering of new
stocks or bonds. The company must file a lengthy registration
statement with the S.E.C. in which it sets forth all the perti-
nent data concerning its financial condition: its assets and its
liabilities, what it owns and what it owes. It must also furnish
its profit and loss record for the past several years. It must
describe all outstanding issues of its securities and their
terms, list all its officers, and directors, together with the
salaries of the top five who make over $50,000 as the cumula-
tive salaries of all, and reveal the identity of anyone who
holds more than 5$ of any of its securities issues. Finally, it
must provide a description of its operations.

If Ac data appear to be complete and honest, the S.E.C.
gives a green light to the new issue. But this does not mean
that it passes any judgment whatsoever on the quality of the
securities, how good or bad they may be for any investor.

The Securities and Exchange Commission also sees that the
information that is filed with it is made available to any
possible buyer of the new issue. A company is required to put
all the essential facts into a printed prospectus. Every securi-
ties dealer who offers the new stock or bond for sale must
give a copy of that prospectus to everyone who buys the

36

HOW NEW ISSUES ARE REGULATED 37

new issue and also to anyone who might request a copy.
These prospectus regulations are generally binding on all pub-
licly owned companies for 40 days after the new issue is
offered for sale. If a company is offering its securities to the
public for the first time, these prospectus regulations are bind-
ing for 90 days.

Before the price is set on a new issue, a preliminary draft
of the prospectus is usually printed up. Such drafts, not yet
reviewed by the S.E.C.. are known as red herrings, because in
the early days of its regulatory work, the S.E.C. often found
them to be little more than outright sales promotion, designed
not so much to divulge information as to distract the reader
from facts about the new issue that the S.E.C. might regard
critically. A red herring is usually distributed only to mem-
bers of the underwriting and selling groups, but because some
copies may reach the public, a red herring must carry on its
face a warning printed in red ink to the effect that the pros-
pectus has not yet been reviewed by the S.E.C.

The prospectus is usually about 20 to 30 pages long, some-
times even longer. But some well-established companies,
notably utilities, that can meet certain high standards of
financial responsibility have for years been permitted by the
Securities and Exchange Commission to use a short-form
prospectus on bond issues. In 1970 the S.E.C. relaxed its
rules and extended the short-form privilege to stock issues of
companies that had a strong financial position and a record of
consistent earnings over a period of years.

During the period when a new issue is under prospectus
regulation, no broker or dealer can provide the public with
any additional information or opinion about that new issue or
any outstanding issue related to it. If he wants he can publish
the prospectus or a detailed summary of it as an advertise-
ment. But apart from that the only other kind of advertising
he can use for the issue is the so-called tombstone announce-
ment. This is an advertisement in which no information is
provided beyond the name of the issue, its price, its size, and
the names of the underwriters and dealers who have it for
sale. And above even this austere announcement the under-
writers usually insert a precautionary note to the effect that
the advertisement is not to be interpreted as an offer to buy or
sell the security, since the offer is made only through the
prospectus.

38 HOW TO BVY STOCKS

Sometimes you may see in the Wall Street Journal or one
of the large metropolitan newspapers a tombstone ad an-
nouncing a new issue and stating that the issue has already
been completely sold. You may well wonder why such an ad
appears. The answer is simple. Underwriting houses are
proud of their Bnancing activities, and when they have ar-
ranged to sell all of a given issue  usually to big investors
 even before it is scheduled for public offering, they go
ahead and publish the new-issue advertisement as a matter of
prestige. It is also a good piece of public relations for both
the underwriter and the company whose offering has been
sold.

Even if a company satisBes all the requirements of the
Securities and Exchange Commission on a new issue, its
troubles may not necessarily end there. Most of the individual
states also have laws governing the registration and sale of
new securities. While the requirements of these so-called blue
sky laws are much like those of the S.E.C.. they are suffi-
ciently varied to cause a company a lot of trouble and a good
deal of extra legal and administrative expense in filing the
necessary forms to comply with the various state laws.

All told, preparing a new issue for sale can be a very
expensive undertaking. The bfll for preparing the necessary
forms and printing a prospectus can run into the hundreds of
thousands of dollars. This is the case when a large company
brings out a new stock issue and has to offer rights to all its
stockholders. Each of them must be supplied with a pro-
spectus. Fees for lawyers and accountants can add a lot more
to this bill.

However, the federal law, as well as most state laws, pro-
vides an "out" for little companies like Rod & Reel. For
instance, if the new issue has a value of not more than
$1,500,000, the company need file only a short registration
form with the S.E.C. This is known as a Regulation A filing.
Companies using it can satisfy the requirements of the law by
distributing an offering circular, as it is called. On issues of
less than $^100,000 it isn't even necessary to prepare a circu-
lar. Again, if the new issue can be classified as a private
placement  usually one that will be purchased by no more
than 35 persons  rather than as a public offering, it doesn't
even have to be registered with the S.E.C.

HOW NEW ISSUES ARE REGULATED  39

In the case of a small company like Rod & Reel, the
investment banker would try to qualify any new issue as a
private placement by lining up one or two institutional buy-
ers, perhaps an insurance company or a charitable founda-
tion, before the deal was finally set. If he succeeds in doing
so, he would insist that the issue be of topflight quality, for
such customers are only interested in high-grade securities. In
Rod & Reel's case this would mean a first-mortgage bond.

While the Securities and Exchange Commission's "full dis-
closure" rules have undoubtedly done much to protect the
investor, it is frequently argued that they are more exacting
than they have to be, and that this may deter some
companies from trying to raise new money for expansion.
Again, tile prohibition on disseminating any information
about a company while its new issue is under prospectus
regulation can deprive investors who own existing securities
issued by that company of essential information about the
company during the period of the prospectus blackout The
intent of the rule  to prohibit promotion of the new issue
 is good. But the application sometimes works hardships on
investors.

Furthermore, it has been argued that the individual in-
vestor doesn't really benefit as he should from the protection
that the prospectus regulations provide. Individuals who buy
a new issue  and their number is few compared with those
who buy securities already on the market  rarely examine
tfae prospectus, or don't understand it if they do. As a matter
of fact, if the buyer knows that the Securities and Exchange
Commission cleared the issue, he is apt to believe that the
commission has endorsed it  and anything that is good
enough for the S.E.C. is good enough for him.

Nothing, of course, could be further from the truth. Full
disclosure can protect against fraud. It can't guarantee a
profit or protect against loss. Caveat emptw ("Let the buyer
beware") is still the rule of the market. And it applies with
particular force to new, unseasoned issues. This is especially
true, for example, with respect to the low-priced oil and
uranium shares that were unloaded on the public a few years
ago. Many of these stocks were not worth the paper they
were printed on. But the S.E.C. often lacked the necessary
power to deal with the promoters behind them. Needless to

40 HOW TO BUY STOCKS

say, many new issues of these worthless penny stocks avail
themselves of the "small-issue" or Regulation A exemption so
that they won't have to "tell all" in a full prospectus.

In times of general business uncertainty the number of
companies with securities issues already outstanding that at-
tempt to offer new stocks or bonds to the public diminishes
markedly. Understandably, the number of new issues lessens
proportionately. But in times of general business prosperity
the number of little companies with big plans and lots of
stock to sell increases with the optimism of the moment. And
if the times are good enough, and the little companies' big
plans are appealing enough, then demand for their offerings
can be so great that it drives up the stock's first official traded
price significantly from its initial offering price. Thus in the
past fifteen years, during the increasingly frequent outbreaks
of "new issue fever" that have periodically afflicted the mar-
ket, it has not been at all unusual for the initial stock offering
of a small computer company sold at $10 a share through the
underwriting group to be resold on the first day of trading in
the open market at $25 or $30 a share. Demand for such
"hot" new issues can be so great, in fact, that broker partici-
pants in the offering may be forced to parcel out their alloca-
tions of stock in ten- or fifteen-share allotments. Some
prospective buyers may not be able to obtain any stock at the
offering price at all, and must buy it in the aftermarket at the
substantially higher prices resulting from the heavy buying
pressure on the stock when it enters the open market.

During periods of intense speculation in new issues it has
become common for companies with no earnings, or even no
product, to "go public" with an initial stock offering. Many
of these companies never make a profit and are eventually
forced into bankruptcy. During the late sixties, for example,
scores of nursing home operators and fast-food franchisers
sold their first batch of stock to a gullible public and were
never heard from again. During the late seventies and eariy
eighties the process repeated itself with the initial stock offer-
ings of marginal energy exploration and biotechnological
companies. At the same time, scores of other companies in
these and similarly promising areas were going public for the
first time and rewarding their charter investors with signifi-
cant profits on their purchase of stock at the offering price.

There are both greater risks and rewards in buying new

HOW NEW ISSUES ARK MECTLATED 41

issues than in any other area of stock investing. The risk is
great because the companies going public for die first time
generally have limited track records. The rewards are poten-
tially great because this factor is reflected in the compara-
tively low offering price of the stock.

What follows is a record of price fluctuations for a cross-
section of new issues that went public from 1978 through
1981.



New	luue	Offering	BidPtice	Percentsgn
luue	Dote	MwW	i/ss W	Clmss(%)
Advanced Semiconductor	5/12/81	15	8.50	-42
Avantek	11/16/78	1.87	1650	+789
Bioroecbcal Ref Labc	5/4/79	6	20	+238
Bne	5/4/79	19	7.78	-59
Brodc Hotel	6/18/80	4.06	13.87	+240
Cetus	3/6/81	23	13	-43
Chem-Tniaia	1/29/81	H.50	6^0	-53
Dinus	3/13/80	6.75	2.75	-57
Dreco Energy	12/3/80	17.50	8.75	-SO
Evnr & Sutheriaod	8/7/78	3.33	2S.25	r JWMt TUUU
Fafco	6/23/81	9	3.75	-57
Iidotron	3/S6/81	25-50	13.25	-47
1S.C. Systems	9/16/80	" 4.87	14.75	+208
K-Troo IntL	12/3/80	16	7-17	-54
MfpnuoD Computer	6/25/80	20	435	-78
Monolithic Mouorid	8/6/80	21	11.75	-43
N.B.I.	12/12/79	6.97	29	+337
Netwodc Sytenr	11/3/80	9	18	+100
Odette	7/14/81	18	9.50	-46
Petroleum Equipment	12/13/78	8	23.75	+200
Smdea Technology	7/17/79	9	2	-75
SctTex	5/21/80	5-50	15	+177
Sftec	3/11/80	20	8	-59
Spedndyne	9/17/79	4.89	12.37	+158
Stiyter	S/2/T&	9.33	20-50	+122
Tech America	8/6/81	13	6.12	-53
Untt Drilling	4/6/79	7	16	+129
VenMttm	2/15/79	17	37.50	+121
Wribtt	8/7/79	IS	33.50	+123
Xldex	10/26/78	10	27.50	+178

7

CHAPTER

What You Should Know about
Government and Municipal Bonds

THE government bond poses an interesting paradox. Here is
the security about which more people know something than
about any other. Yet here too is the security that is fuUy
understood by fewer people than is any other.

An estimated 85,000,000 Americans learned what it
meant to lend their money on a bond, with the promise of
repayment and the assurance of interest, during World War
H when they bought the famous Series E government bonds.
Millions of other Americans have initiated their investment
education by buying these savings bonds since the war.

But only the big institutional buyers of government bonds,
plus a comparative handful of dealers who regularly buy and
sell hundreds of millions of these securities for a proBt mea-
sured in fractions of 1%, really understand the government
bond market and know how it can be affected by subtle shifts
in the credit and money policies of our own government or
other governments half the world away.

There are scores of different government issues, carrying
different coupon rates, different maturities, different call pro-
visions. Some are issued for very short periods of time.
These are Treasury btUs with maturities as short as 91 days,
and notes that may run up to ten years. On the short-term
issues, interest rates have ranged from 3% to 3%, a level that
was once considered fairiy standard, to the high of 16.75%
on May 22, 1982 for the gi-day Treasury bill. During World
War II, the government pegged interest rates on bills at an all-
time low of % of i%. This practice was terminated in March
^Si by an agreement between the Treasury and the Federal
Reserve Board,

Long-term issues of Treasury bonds, usually called Trea-
suries, have maturities ranging from ten to thirty years.

42

GOVERNMENT AND MUNCIPAL BONDS  43

In periods of tight money. Treasuries usually sell in the
open market at a discount, and the investor who buys a bond
at less than par may well realize a yield in excess of its
coupon rate if he holds it to maturity.

Thus, when interest rates are high, a bond yielding only
4^i% would be so unattractive to investors that its price
might drop 60%, and a $1,000 bond would be worth only
$400. If you bought the bond at that price, you would still be
collecting $42.50 a year in interest. That return on a $400
investment would mean that you would be earning an effec-
tive rate of 10.62%.

No matter how cheaply you buy a government bond, you
can count on getting the full face value of the bond, the full
$1,000, if you hold it till its maturity date. And all that time
you would be collecting a higher effective rate of interest,
based on the low purchasing price.

While Treasuries may sell at a discount in the open market
when competitive interest rates are high, it is equally true that
they are apt to sell at a premium  a price above par  and
return a lower current yield than the coupon rate when inter-
est rates are generally low.

Treasury bonds, representing the great bulk of the federal
debt, are always freely traded in the market at prices that
change only slightly from day to day.

Regularly traded by the same dealers and on much the
same basis as government bonds are those bonds issued by
various government agencies, such as the Federal Home Loan
Banks and die Federal Land Banks.

And there are other government bonds that are not traded
in any market, bonds that can be bought only from the gov-
ernment and sold back to the government at set prices, bonds
that never suffer any fluctuations in market price. These are
Ac savings bondsSeries EE and Series HH (formerly
Series E and Series H). They can be bought at virtually any
bank. No commission is charged. They are handled free as
a patriotic service.

When savings bonds were first introduced during World
War II, the maximum yield you could get on them was 2.9%.
You paid $75 for an E bond; ten years later you could cash it
in for $ 100, thus realizing an average annual return of 2-9%.
If you cashed it in earlier, you got less on your investment.

As interest rates increased in later years, the government

44 HOW TO Bin STOCKS

was forced to liberalize the return on its savings bonds. It
accomplished this objective by shortening the maturity. Step
by step, the length of time you had to hold an E bond before
cashing it in at face value was cut from ten years down to
five years and ten months in 1969. With this shortened ma-
turity, the yield was boosted from 2.9% to 5%. A year later
the Treasury added a bonus of ^ of 1% to encourage salfis.
By 1981, through the combination of shortened maturities
and increased interest, an EE bond was yielding 9% for a five-
year maturity. Additionally the Treasury now has the au-
thority to adjust yields upward or downward 1% every six
months.

All along the line, the Treasury also made similar changes
in its Series HH bonds. Unlike EE bonds, which are sold at a
discount ($75 for a $100 bond, for instance), HH bonds
are sold at their full face value. The government sends the
buyer an interest payment every half-year, smaller payments
in the early years, larger payments as the bonds approach
maturity. In early 1982 HH bonds were yielding 8.5% over
their full term. Whereas EE bonds come in denominations as
small as $50, the smallest HH bond is $500.

Despite all the differences among various issues, govern-
ment bonds have one common characteristic: they are re-
garded as the safest investments in the worfd.

What security lies behind them? The pledged word of the
government of the United States. Just that. Nothing else. As
long as that word is believed and accepted  as it must be by
all Americans, since we are the government, in the last      ^
analysis  government bonds, if held to maturity, offer the
best protection you can find against the risk of losing any of
your capital,

But because their prices do not rise with inflation, govern-
ment bonds offer poor protection against the risk that your      ^
dollars will lose something of their purchasing power if prices     H
generally go up. Thus, if you had paid $75 for an E bond in      |
June 1964 and held it, that bond would have been worth      \
$123 to you in June 1975. But the goods that you could buy      ^
with that amount of money would have cost you only     s(y
$72.78 in June 1964. You would actually have lost $2.22 in      ^
buying power on the deal, thanks to the tremendous increase      ^
in the cost of living.                                           |C

GOVERNMENT AND MUNdPAL BONDS 45

With the persistent double-digit inflation of the late seven-
ties and eariy eighties, the buying power of savings bond
yields has deteriorated even further, making these safest of
all investments the least rewarding for the average investor.

Like the federal government, states, cities, and other units
of local government, such as school districts and housing
authorities, need capital  to build schools, roads, hospitals,
and sewers and to carry on the many other public projects
that are their responsibility- So they too issue bonds. These
are called municipal bonds.

Unlike the federal government, which underwrites its own
bonds, these local units of government go to the investment
bankers for their money, just as a corporation does. Bankers
underwrite municipal bond issues in very much the way that
they underwrite corporate bonds.

The growth of municipal bond issues since the end of
World War II has been littfe short of fantastic. In the early
1940s, when new municipal bonds were being issued at the
rate of only about $1 billion a year, the total value of afl
outstanding issues was just short of $20 billion. By the end of
1981, thanks to our expanding economy and public demand
for all kinds of new municipal facilities, that figure had
grown to nearly $360 billion.

With approximately one million'municipal bond issues on
the market, the investor is confronted with a wide range of
maturities, quality ratings, and yields. For many years, inter-
est rates on municipal bonds ranged in the neighborhood of
3% to 4%, occasionally as high as 5%. But when interest rates
surged to all-time highs in 1980-1981, municipals sold at
prices that yielded returns of 12%, 13%, even 14%.

And what made those rates especially attractive was that
the interest collected on a municipal bond is totally exempt
from federal income tax. Thus an investor in the 50% tax
bracket who got a return of 10% in dividends on common
stock or in interest on corporate bonds would be able to
retain only half the income. But if he got 10% on a munici-
pal bond he would be able to keep all of it, free of federal
income tax.

Not only that, but in many states if he bought a municipal
bond issued by a city or town or other taxing authority within
the state, the interest collected on that bond would also be

46 HOW TO BUY STOCKS

exempt from state taxes. That might mean another 5% or
6% of tax-free income. In short, individuals with incomes in
the $100,000 range might realize more "take home" income
from municipal bonds than they would get from an invest-
ment that yielded a taxable return of 25%.

Is it any wonder then that municipal bonds have proved
increasingly attractive to investors in the upper income
brackets? So much so, in fact, that Congress has been repeat-
edly tempted to revoke their exemption from federal income
taxes. On such occasions, however, cities, towns, and other
local taxing authorities have complained so loudly that Con-
gress has always backed down.

No one but an expert can hope to know all about the
different characteristics, the different qualities, of municipal
bonds. But in the main they offer the investor a good degree
of safety, plus the assurance that he can always sell his bond
in the open market if he doesn't want to hold it to maturity.
Consequently, municipal bond prices are usually more stable
than those of stocks, although in the 1980-1981 slump
prices did fall precipitously, and it was this drop that resulted
in the spectacular increase in yields, up to levels approaching
14%.

As far as the ultimate payoff on maturity is concerned,
municipal bonds can be considered "safe" because the word
of any unit of government, like the word of the federal gov-
ernment, can generally be believed and accepted.

There are six generally recognized types of municipal
bond. General obligation bonds, which constitute by far the
largest category of municipals, are generally considered the
blue chips of the business. With rare exceptions they are
backed by the full faith, credit, and taxing power of the state
or municipality that issues them. Both the principal and in-
terest on such bonds are virtually guaranteed by the ability of
the state or city to tap tax revenues as necessary to pay off its
obligations. In contrast, special tax bonds are payable only
from the proceeds of a particular tax or some other particular
source of revenue and do not carry a "full faith and credit"
guarantee.

Revenue bonds are issued to finance specific projects 
toll roads, bridges, power projects, hospitals, various utilities,
and (he like. The principal and interest on such bonds are
payable solely from the revenues collected on such projects.

GOVERNMENT AND MUNCIPAL BONDS 47

In some cases a state will back a toll road project with its
own credit But this is not usual. Turnpike bonds are also
known as doUar bonds because they are quoted on a price
basis rather than in terms of their yields, as most municipals
are quoted. Again, unlike most municipals, dollar bonds usu-
ally mature on a single date rather than over a period of
time.

Housing Authority bonds are issued to finance low-rent
housing projects. They are backed by the Federal Housing
Assistance Agency. This guarantee gives them a top-quality
rating, since the full faith and credit of the United States
stands behind them.

Industrial revenue bonds are issues to finance Ac building
of industrial plants, which will attract industry to a com-
munity and expand the local tax base. These bonds are se-
cured by the lease payments that the issuing authority collects
from the corporate tenants. Their popularity was such that
$1.6 billion of these bonds were issued in 1968. But toward
the end of the year Congress raised the question of whether
such developments were entitled to tax exemptions and im-
posed legislative restrictions of such stringency that new is-
sues were sharply curtailed.

There are no restrictions, however, on certain types of
industrial revenue bonds, such as those issued to build air-
ports, pollution control facilities, or hospitals. Hospital bonds
have been especially popular in the past few years, because of
a growing reliance on Blue Cross, Blue Shield, and other
programs, which pay about 90% of all hospital bills. Refund^
ing bonds are issued to replace an outstanding issue that is
being recalled, usually because interest rates have become
more favorable.

Most municipal bonds are bearer bonds. They mature
serially  that is, a certain number of bonds in each issue
mature in each year over a period ranging up to 50 years.
Quality ratings are provided on municipal bonds (Aaa, Aa,
A, Baa, et cetera) just as they are on corporate bonds.

Municipal bonds are bought principally by banks, fire and
casualty insurance companies, and estates. But the wealthy
individual constitutes a steadily growing market because of
that all-important tax exemption feature.

The table on page 49 shows just what return an individual
at various income levels would have to earn on stocks or

I I'll: 3
is-1 

("l^
gSr

g&gs
gj4

aa &?

B-ff

The Advantage of Owning Tax-free Municipal Bonds

Comparative after-tax yields from taxable and tax-exempt securities based on federal tax rates as of January
1982. At the various income levels shown in the column at the left, you can realize as great a return from munici-
pal bonds with yields shown on the top line as you can from taxable dividends or interest shown in the corre-
sponding line below.

1982 Taxable Income
Joint Return   Single Return



Tax						
Bracket	7%	8.4%	9.8%	11.0%	12.6%	24%
29%	9.86	11.83	13.80	15.77	17.75	19.72
31%	10,14	12.17	14.20	16.23	18.26	20.29
33%	, 10.45	12.54	14.63	16.72	18.81	20.90
35%	10.77	12.92	15.08	17.23	19.38	21.54
39%	11.48	13.77	16.07	18.36	20.66	22.95
40%	11.67	14.00	16.33	18.67	21.00	23.33
44%	12.50	15.00	17.50	20.00	22.50	25.00
49%	13.73	16.47	19.22	21.96	24.71	27.45
50%	14.00	16.80	19.60	22.40	25.20	28.00

24,601-29.900

18,201-23.500
29.901-35.200

23,501-28,800
35,201-45,800

28,801-34.100
45,801-60,000/34,101-41,500
60.001-85,600
Over 85,600/Over  41,500

8

CHAPTER

How Stocks Are Bought and Sold

THE stocks of the biggest and best-known corporations in
America are bought and sold on the New York Stock Ex-
change. In World War II days, the average daily trading
volume was less than a million shares. But with increased
interest in share ownership, trading volume has expanded
almost steadily so that even in a market slump like that of
1973-1974, the daily volume averaged 15 million shares, and
when the bull market really took hold at the beginning of
1976, the turnover rose to 30 million shares or more a day.
During the early eighties, trading had risen to a daily average
of 46 million shares a day. The all-time trading record was
broken on January 7, 1981, with 92.88 million shares.
Prospects were that even that record wouldn't last long.

A 40 million-share day is likely to represent about $3 bil-
lion worth of stock. That much money has a lot of glamour
about it. It builds its own folklore. As a consequence, the
New York Stock Exchange has become one of the most
publicized institutions in the world, the very symbol of Amer-
ican capitalism.

But somehow that publicity has got in the way of public
understanding, so much so that the stock exchange could
almost be described as the business nobody knows  but
everybody talks about.

A lot of people think the stock exchange sells stock. It
doesn't. It doesn't own any, doesn't sell any, doesn't buy any.
If stocks sold on the exchange lose or gain $100 million in
the aggregate on a given day, the exchange itself neither loses
nor gains a nickel. It is simply a marketplace where thou-
sands of people buy and sell stocks every day through their
agents, the brokers.

Nor does the stock exchange have anything to do with
fixing the price at which any of those stocks is bought and
sold. The prices are arrived at in a two-way auction system.

50

HOW STOCKS ABE BOUGHT AND SOLD 51

The buyer competes with other buyers for the lowest price,
and the seller competes with other sellers for the highest
price. Hence, (he stock exchange can boast that it's the freest
free market in the world, the one in which there is the least
impediment to the free interplay of supply and demand.

When the buyer with the highest bid and the seller wiflTthe
lowest offering price conclude a transaction, each can know
that he got the best price he could at that moment. As buyer
or seller, you may not be wholly satisfied. But you can't
blame the stock exchange any more than you can blame the
weatherman if it's too hot or too cold for you.

Stock prices can and do fluctuate sharply  they dropped
36% in 1969-1970 and 45% in 1973-1974. But these price
movements simply reflect the optimism or pessimism of share-
owners about business prospects at that time.

Perhaps you've heard that the stock market is "rigged,"
that big operators drive prices up or hammer them down to
suit themselves and make a profit at the little fellow's ex-
pense. Yes, that did happen  as recently as the igaos. Big
market operators resorted to all kinds of questionable devices
then to manipulate stock prices to their own advantage.

But today there are laws, stringent laws, to prevent price
manipulation. And they are vigorously enforced by the Se-
curities and Exchange Commission. The abuses of the twen-
ties. which were blamed in part for the great market crash of
1929-193^, when prices fell 89%, brought the Securities and
Exchange Commission into being in 1934. Thirty years later,
after an exhaustive study of the securities business, the com-
mission got from Congress a substantial grant of additional
power to help it in its work of policing the markets. This was
the Securities Acts Amendment of 1964.

The Securities Reform Act of 1975 not only augmented
that power by revising certain old regulations and introducing
new ones, but it also gave the S.E-C. additional funds to
increase its staff. This enabled the S.E.C. to supervise the
markets more closely and to enforce its rules and regulations
more rigorously.

Actually, the commission leaves much of the regulatory
work in the hands of Ac exchange, which, in turn, clamps
down on its members' firms. The N.Y.S.E. rules are generally
designed to prevent unfair trading practices and protect the
individual investor. They were tightened when the exchange

52 HOW TO BUY STOCKS

was reorganized in the thirties- And they were tightened again
in many areas as a result of the enactment of the 1964
amendment. But these reforms were as nothing compared to
that imposed on Wall Street by the Reform Act of 1975.
Repercussions to that reform will be felt right down the line
for a long time to come  from top management right down
to the "runners," or messengers, who make daily deliveries
and pickups all over the financial district.

Today, there is probably no business in the world that
operates under more stringent regulation or with a stricter
self-imposed code of ethics than the New York Stock Ex-
change.

For instance, tine exchange has a computerized stock-
watching service that keeps under constant surveillance the
price and volume movements of all stocks traded on the
exchange. The computer is programmed to flag automatically
any unusual movements in a stock. These indications are
followed up by investigators. Sometimes a rumor can make a
stock "act up." Is there anything to it? If not, the exchange
takes immediate steps to scotch the rumor. Sometimes it asks
the company itself to clarify the facts in the situation and
announce them to the public. And if the computer ever turns
up evidence of illegal manipulation, the exchange turns those
facts over to the S.E.C. for action.

When the original securities law was Brst enacted in 1934,
Congress even undertook to protect the buyer of securities
(and the seller too) against himself  against his own greed
and rashness. Before 1934, you could buy securities with only
a small down payment, or margin. Typically it was 20%.
Often it was less. And an occasional customer even "bought"
securities 100% on creditwithout putting up a dime.
That's how a few people made a fortune on a shoestring.
But it's also how more of them brought disaster on them-
selves and thousands of others in the 1929 crash.

When stocks bought on zero to 20% margin began declin-
ing in the fall of 1929, brokerage houses began sending out
calls for more cash from the stocks owners in order to protect
their own precarious position as lenders on an asset whose
value was rapidly deteriorating. If, for an example, a stock
cost $20 a share, and the broker had lent his customer $16 of
that cost in order to generate a commission and make a profit

HOW STOCKS ARE BOUGHT AND SOLD 53

on interest charges, and that stock had declined to $14, not
only had the customer's entire $4 equity in the stock been
wiped out, but the broker now had a $2 loss on his loan. He
needed more cash to keep operating. But frequently the cus-
tomers either did not have the cash necessary to prop up the
sagging stock, or did not want to throw good money after bad
in the interest of protecting their position in a declining in-
vestment. So the brokers were forced to sell the customer out,
to dump the stock into a declining market in order to raise
cash. This wholesale dumping drove stock prices down still
further, which led to more margin calls, which led to more
selling, and so on and on in a snowballing decline, which
quickly turned into the greatest investment market debacle of
all time.

Nowadays, the Federal Reserve Board decides what the
minimum down payment shall be, and its decision is binding
on everybody. The board changes the figure from time to
time; depending on how much restraint it thinks it should
apply to the market. Since 1934, it has ranged from as low as
40% of the purchase price up to 100%. When the 100% rule
prevailed, that meant there was no credit at all; the buyer had
to pay in full for his stocks.

This power alone  the power of the Reserve Board to say
what the minimum margin shall 6e  guarantees that there
will never be another market crash quite like the one in 1929,
Stock prices are bound to go down from time to time, and
down sharply. Indeed, in 1937-1938, despite die regulatory
powers of the federal government, they dropped about 50%
in just twelve months. There have been many other drops of
25% or more since then. But it can still be said that the
market can never crash as spectacularly as it did in 1929.

That can't happen again because under the Reserve Board's
margin regulation prices can never be as overinflated as they
1  were when people bought hundreds of millions of dollars'
worth of stocks by putting up only a small fraction of that
amount in cash.

One noteworthy result of all the regulations that have been
'" imposed on the market has been a change in the character of
^ the market itself. It has become more of an investor's market,
';'.' less of a speculator's market. Of course, speculators still buy
and sell stocks in the hope of making a profit. This function

54 HOW TO BUY STOCKS

is not only legitimate but useful and desirable in the main,
because it helps provide a continuous and liquid market. It
also helps stabilize prices, thus permitting the investor to buy
and sell more readily and at fairer prices.

Nevertheless, more of the people who buy stocks today are
doing so for the sake of earning a good return on their money
over the long pull. They are not "in-and-outers," people trad-
ing for a small profit on every market move. Generally, Uiey
hold their stocks for years and years. They're investors 
people who want to be part owners of those biggest and best-
known corporations.

All told, on the New York Stock Exchange, the stocks of
over 1,500 of these companies were listed as of January 31,
1982. Collectively, these listed companies employ about 20%
of all American workers. But they account for almost 40%
o( sales and over 70% of all corporate profits made in the
United States every year.

To qualify for listing on the exchange a company has to
pay an initial listing fee of $29,350, plus a small per share
charge. It also must pay an annual fee for as long as its stock
is listed. This fee ranges from $11,750 to $58,700, depending
upon the number of listed shares. More important, it must
meet certain requirements, which have become more exacting
over the years. In 1982, these were the principal qualifica-
tions a company had to meet if it wished to have its securities
traded on the New York Stock Exchange:

(l) A minimum of a.ooo holders of 100 shares or more.
(a) A minimum of 1,000,000 common shares outstanding, which
must be owned by the public, not by die company itself.

(3) A market value for its publicly owned shares of at least
$16 million.

(4) Annual earnings of at least $2.5 minion before taxes in the most
recent year and at least $2 million in each of the two preceding
years.

(5) Net tangible assets of at least $16 million.

Most of the listed companies exceed these regulations by a
wide margin. The most widely held of the companies, Ameri-
can Telephone & Telegraph, had 3,026,000 shareholders at

HOW STOCKS ABE BOUGHT AND SOLD 55

the beginning of 1981. General Motors ranked second with
1,191,000. American Telephone also held top ranking in the
number of shares listed, with 740.6 million, and in the mar-
ket value of listed shares, with nearly $43 billion.

Not all companies prosper, of course. That's why the
exchange has a set of minimum standards that a company
must meet in order to keep its stock listed there. It might
be delisted unless it has at least 1,200 shareholders, each of
whom must own a minimum of loo shares; unless publicly
owned shares total at least 600,000 with a market value of
$5 million; or unless the aggregate market value of all its
common stock is at least $8 million and net earnings of the
past three years have averaged $600,000 minimum. About 54
common stocks have been delisted every year over the past
fifteen years for various reasons, although many of these de-
listings resulted from mergers with other listed companies.

But these mathematical standards are not the only basis for
delisting. In recent years, companies have been delisted be-
cause management refused to give voting rights to holders of
its common stock, or because of consistent failure to produce
timely and meaningful financial reports. Indeed, the exchange
may suspend or delist at any time a security whose continued
trading it no longer considers advisable, even though that
security still meets listing standards.

All listed companies must agree to publish quarterly re-
ports on their financial condition, as certified by independent
accountants. In the old days, only annual reports were re-
quired. And some companies were admitted on these terms.
Nevertheless, almost all listed companies now report quar-
terly,

A company must agree not to issue any additional shares
without exchange approval. And it must have a registrar in
New York City to see that no more shares of stock are issued
than a company has authority to sell. It must also have a
transfer agent who keeps an exact record of all stockholders,
their names, addresses, and number of shares owned.

The companies whose stocks and bonds are traded on the
exchange have nothing to say about the exchange's operation.
The brokers run their own show, although the paid chairman
of the exchange must be a man who has no connection with
the securities business. The 2i-man board of directors, which

56  HOW TO BUTT STOCKS

includes the chairman, must contain ten public members who
also have no identification with the securities business. The
chairman is chosen annually by the board of directors.

Although the exchange was incorporated in 1971, pri-
marily to relieve its officers and directors of individual liabil-
ity in the event of lawsuits against the exchange, it remains
essentially what it has always been: a purely voluntary as-
sociation of individual members, whose number totals 1,366.
It is this "private club" image of the exchange that has always
disturbed the S-E.C, Although in recent years, as the ex-
change has become increasingly aware of its social responsi-
bilities, it has begun to operate more like a publicly owned
business and less like a club.

The business of trading in stocks in New York goes back
to the early eighteenth century, when merchants and auc-
tioneers used to congregate at the foot of Wall Street to buy
and sell not only stocks but wheat, tobacco, and other com-
modities, including slaves.

In 1792, two dozen merchants who met daily under a
buttonwood tree on Wall Street to trade various stocks agreed
from then on to deal only with each other and to charge their
customers a fixed commission. Thus began the New York
Stock Exchange.

How do you become a member of this association today?
If you are approved by the exchange's board of directors, you
buy a seat. Since nobody but a mailman is on his feet more
continuously than a broker, this term is one of the classic
misnomers of our language. It had its origin in the leisurely
days of 1793 when the new association took up quarters in
the Tontine Coffee House and the members could be seated
while they transacted business.

What does a seat cost? That depends on how good business
is on the exchange at the time of the sale. In 1929, seats were
sold for $625,000 each. Later the number of seats was in-
creased 25%, so that none was worth quite as much. But it is
hard to believe they could ever fall again to the low they hit
in 1942, when one was sold for $17,000, which is less than
the amount given today as a gift to the family of a deceased
member out of the exchange's gratuity fund. In 1968, a seat
was sold for $515,000, and, considering the 25% increase in
the number of seats, this figure represented an even higher
price than in 1929. So discouraging were the succeeding mar-


now STOCKS ARE BOUGHT AND SOLD 57

tet slumps of 1969 and 1973-1974, however, that in 1975 a
stock exchange seat brought only $55,000. By 1982, how-
ever, the price of a seat had rebounded to $250,000.

A number of the seats are owned by men who aren't really
brokers at all. They are registered floor traders, men who buy
and sell stocks wholly for themselves. Because they pay no
commissions, by virtue of their membership in the exchange,
they are able to make money by moving in and out of the
market, trying to make a quarter of a point here, an eighth of
a point there  usually in the most active stocks.

In its extensive study of the market, which supplied the
groundwork for the 1964 act, the Securities and Exchange
Commission took the position that floor traders performed no
useful economic function and that they should be phased out
of existence. The exchange has strongly resisted doing this.
Nevertheless, it did come up with a set of new rules to govern
traders' activities. These rules provide that 75% of a trader's
transactions must be of a "stabilizing" nature. To qualify as
"stabilizing," a purchase can be made only when the price on
the preceding sale was down, and a sale can be made only
when the price on the preceding sale was up. Other rules are

/ designed to make sure that the traders, who now account for
-less than 1% of total volume, en)&y no advantage over the
public.

Many brokers on the floor earn their living by executing
buy or sell orders for the public, especially for large institu-
tions, either directly or indirectly. In 1982, there were 603
member firms represented on the exchange, of which half

^ were partnerships and half were corporations. In 1981, these
brokerage firms operated 4,174 offices throughout the United
States and 247 offices abroad. In still other cities they are
represented by thousands of correspondents. Usually these
correspondents are local security dealers or banks that have
wire connections to some member firm.

i   More than a million miles of private telephone and teletype
wires keep all the offices of these brokerage firms, the so-

> called wire houses, in almost instantaneous touch with the

9 exchange. As a result, the person who has an office next door

^ to the exchange has no advantage in contacting his broker

,. over someone who lives 3,000 miles away.

9

CHAPTER

What It Costs to Buy Stocks

FROM the time the New York Stock Exchange was founded
in 1792 until May i, 1975, any broker in the business could
have told you to the penny just how much commission you
would have to pay on the purchase or sale of 100 shares or
1,000 shares of any listed stock. It was all very simple be-
cause those two dozen founding fathers of the New York
Stock Exchange had agreed from the outset to charge the
same commission on any security transaction. They had fur-
ther agreed to deal only with each other  no outsiders ad-
mitted. For more than 192 years, the succeeding members of
the New York Stock Exchange maintained that same tight
little monopoly.

Then came May i, 1975, the day the Securities and Ex-
change Commission put an end to all fixed commissions >on
the stock exchange. In one fell swoop the S.E.C., on "May-
day," blasted away the very cornerstone of the exchange.

So how much will it cost you to buy stocks today in this
new era of competitive commissions?

There are several different answers to that.

The first is  a lost less than you probably think, especially
if you are thinking in terms of the 6% to 10% commission you
might pay on a real estate transaction, or the even higher
commissions paid to automobile or life insurance salesmen.
The fact is that no goods or services of comparable value
change hands at as low a commission cost as do stocks. And
that has always been true, whether commissions were fixed or
unfixed.

The second and more realistic answer is to tell you that the
amount of commission you pay is going to vary with the total
dollar value of your transaction. H your transaction is a
modest one  say, an investment of $2.000 or $3,000  the
commission is apt to be somewhere near 3% from a full
service broker. But if your investment involves $10,000 or

58

WHAT IT COSTS TO BUY STOCKS 59

$20,000, the commission may be only around 2% from the
same firm. And if you're a really big operator, with a transac-
tion involving $100,000 or more, you might well bargain
yourself into a commission cost that is only a fraction of
l.

Despite the outlawing of fixed commissions, don't be sur-
prised if you find three or four full service firms all quoting
you pretty much the same commission on a modest transac-
tion involving only a few thousand dollars. That won't be the
case, however, if you are talking big money  anything
above $10,000 or $15,000. Then it's going to pay you to shop
around for the best commission deal if you agree to pay for
stock in advance. And if you are willing to give the broker an
extra day to execute your order.

Besides charging you a commission, the broker might also
exact a service charge for executing your order. Service
charges come in a variety of different packages. Some brokers
may charge you for keeping your stocks for you, thus saving
you the cost of renting a safe deposit box. They might even
add a further charge for collecting dividends on your stocks
and crediting them to your account.

Of course, if you are a good customer, if you buy and sell
stocks frequently, your broker might be willing to waive such
service charges on your account just to keep you happy. But
remember, no firm wants to hold 100 shares of stock for you
year after year, credit dividends to your account, and send
you regular statements unless the firm gets some financial
reward out of it. Such service costs the broker money, and he
hkes to see a little action in your account to generate com-
missions that will offset the firm's out-of-pocket costs.

Service charges may also be exacted to cover the cost of
statistical reports that he furnishes you on individual com-
panies  reports that the broker may buy from one of the
large securities research firms or that his own research de-
partment may produce.

And if you hold stocks in a number of different companies
and want advice from his research department on what to
hold, what to sell, and what to buy as replacements  with
reasons why  you may well be charged for that kind of
service, too.

So when you go shopping for a broker, don't just ask about
his commission rates. Ask about his service charges too.

60 HOW TO BUY STOCKS

There are some brokers who make no service charge of any
kind. They figure they ought to be able to give the average
customer whatever he wants just for the sake of the commis-
sions they earn on his business.

The Securities and Exchange Commission, however, looks
with some disfavor on this one-charge-for-everything concept.
It is a strong advocate of what it calls unbundling  hanging
specific price tags on all the services that a broker may ren-
der, over and above the commission that he earns just for
executing orders. The S.E.C. argues that if a broker provides
various services for customers, the customer has to pay for
those services, and the cost of each should be clearly marked.
They shouldn't just be wrapped up together in the total com-
mission cost. Brokers who follow a "no-service-charge" policy
reply that the S.E.C- has no right to tell them how to run
their business. They contend that it's their business if they
want to absorb the cost of supplying special services to their
customers, all for a single commission. If they can cover
those costs and still keep their rates competitive with other
brokers, they figure they will be able to attract more cus-
tomers.

One thing you should always remember is that some brok-
ers will have an interest in your business if you want to buy
only 10 or 20 shares, and some brokers won't. And their
commission schedules are geared that way. Some brokers
may be willing, even anxious, to execute a small order tor
you, even if they lose money on it from a cost accounting
point of view. They are willing to gamble that somewhere
down the line you will become a more substantial customer,
maybe even a big trader. But many brokers, probably most of
them, aren't willing to take that gamble. They are interested
in the big-ticket customer  and you can be sure their com-
mission schedules will be skewed to discourage you from bring-
ing them your ten-share order.

One final word about brokerage service: you can get as
much or as little as you want and are willing to pay for, so it
pays to find your kind of broker. If you are an investor who
makes up his own mind about what he wants to buy or
sell  a person who doesn't want any advice or help from his
broker  you might as well take your order to one of the
scores of new discount, or "no service," brokers who have
sprung up all over the country in the wake of the commission

WHAT rr COSTS TO BUY STOCKS 61

deregulation of 1975. These brokers will buy or sell stock for
you at savings of 60% to 75% over the full service brokers'
charges. But that is all they will do for you. They will not
provide you with research reports on potential investments.
They will not advise you on which stocks to buy and sell.
They will not sit down with you for a long, friendly chat on
your investment objectives. They will simply execute the buy
or sell directives you give them and then deliver the stock
you've bought or send you the proceeds from the stock
you've sold. They are "no frills" order executors. And then-
low commission schedules reflect the narrowness of their ser-
vices.

On the other hand, you may want or need a good deal of
help  maybe even a little psychological support. If you're
that kind of person, then the old-line full service brokers will
happily give you everything you want  at a price.

So while you're shopping around for a broker and collect-
ing commission rate schedules, consider the different kind of
service provided by various brokers to their customers. And
find out what that service is going to cost you. However, one
thing you needn't bother looking for is a cut price below that
paid by other customers on transactions of the same size.
When a broker sets a commission schedule, he expects all
his salesmen to stick by it. And if you think a special excep-
tion should be made in your case, you're probably going to
have to argue your case with somebody pretty far up the line.
And you're not likely to win this argument easily.

While you are looking for a broker, you may find yourself
wondering what brought this revolution to Wall Street. For
almost 200 years you had to pay the same commission charge
no matter what member firm you dealt with. And now brok-
ers are really competing with each other. What accounts for
the change?

The explanation is really very simple. Even the monolithic,
monopolistic New York Stock Exchange could not withstand
the pressures of the marketplace  the inexorable effects of
supply and demand. This is what actually brought the stock
exchange's fixed fee schedule to its knees. The S.E.C. simply
administered the coup de grace.

It all began in the fifties, when big-money institutions
banks, insurance companies, foundations, trustsbegan to
realize that common stocks were pretty good investments in

Qt HOW TO BUY STOCKS

inflationary tunes. When such a big institution goes into the
market, it's apt to make quite a splash, because it buys and
sells stocks in big blocks 10,000, 25,000, maybe even
50,000 shares at a time. But back in the fifties and sixties the
lowest commission rate charged by the New York Stock Ex-
change was the commission on 100 shares, a round lot. K
somebody wanted to buy 5,000 shares of stock, he simply
had to pay 50 times the fixed round-lot commission. If he
wanted 10,000 shares, he had to pay 100 times the round-lot
commission.

That didn't make much sense to the institutions. They felt
they deserved a commission break on their big-volume busi-
ness  a better deal than the fixed round-lot commission rate
gave them. True, the New York Stock Exchange did provide
various means by which big buyers and sellers could circum-
vent the exchange's ironclad commission rules. But these de-
vices were at best cumbersome and cost the institutions more
than they thought they should have to pay.

So the big institutions began looking for a better way, a
way to trade blocks of stock more easily and at a lower cost
to themselves. And they found itoutside the New York
Stock Exchange. They found that there were big securities
dealers  firms like Weeden & Co., that were not members of
the exchange, hence not bound by its commission rules
who were quite willing to trade big blocks of stock for re-
duced rates. They were able to buy, or position, a block of
stocks, thousands of shares at a crack, and then assume the
risk of reselling it, hopefully at a profit, over an extended
period of tune.

Such nonmember firms didn't even bother with commis-
sions. They simply bought the stock at a net price, a price a
little lower than the price prevailing on the exchange but high
enough to guarantee the seller a better net return than if the
seller had sold the stock on the exchange and paid the com-
mission cost.

Thus the third market was bom  "third" because the two
big exchanges, the New York Stock Exchange and the Amer-
ican Stock Exchange, had long ago usurped the right to be
known as the first and second markets for securities in the
United States.

Alarmed by the sensational growth of the third market 
and the loss of institutional business  member firms in 1966




WHAT FT COSTS TO BUY STOCKS 63

went to the S.E.C. and asked for the right to relax the regula-
tory shackles that the exchange had forged for itself.

First, they asked for an amendment to Rule 3Q4, the rule
that compelled members to execute all orders for listed stocks
on the floor of the exchange and effectively prevented any
trading with nonmembers or splitting commissions with them.
This rule, of course, was the twentieth-century successor to
the agreement that the founding fathers had reached under
the buttonwood tree in 1792 that they would buy and sell
securities only with each other. Obligingly, the S.E.C. per-
mitted a modification of Rule 394 to permit a member to buy
or sell off the floor of the exchange  in short, to participate
in the third market  if he could demonstrate that such a
deal would result in a more advantageous trade to his cus-
tomer.

That amendment helped. But still the shackles of the fixed
commission system chafed. In 1969, rates were reduced on
orders of 1,000 shares or more. But that still wasn't enough
to satisfy the institutions. Soon member firms began agitating
for total abandonment of fixed commissions on all big-ticket
orders. The S.E.C. tentatively suggested that commi.ssions on
all orders exceeding $100,000 be made subject to negotiation
between the member firm and theAuyer or seller.

That suggestion shocked many of the more staid members
of the exchange who were used to doing business with a
select clientele that definitely did not include hard-bargaining
institutions. But then came the real bombshell. Robert W.
Haack, then president of the New York Stock Exchange,
advanced the revolutionary idea that no commissions should
be fixed on orders of any size executed on the exchange. He
suggested that the law of supply and demand, the rule of free
competition, should supplant the monopolistic schedule of
fixed commissions.

This was heresy, indeed  and from a paid hand at that!
And when Men-ill Lynch, Pierce, Fenner & Smith, Inc., the
world's largest brokerage firm, and Salomon Brothers, a
member firm that played a dominant role in handling institu-
tional business, endorsed the no-fixed-commission proposal,
the fears of many smaller firms were scarcely allayed.

Caught between the big firms that wanted a larger slice of
the institutional business, and the smaller firms that feared
they might go under without the protection of a fixed-

64 HOW TO BUY STOCKS

commission system, the S.E.C. finally stuck a timid toe in the
water. In April 1971, the commission ruled there should be
no more fixed rates on orders involving $500,000 or more.
From that time forward, commissions on all such orders
should be subject to negotiation or bargaining between cus-
tomer and broker. Soon member firms began to get more and
more of the big-ticket business. Institutional transactions,
which had accounted for only about ao% of exchange vol-
ume in the early sixties, soon doubled. Such trades were
destined to account for 60% of exchange transactions in a
decadesome days even as much as 75%. However, as
long as the third market also continued to prosper, the big-
ticket brokers weren't happy. So within a year, they were
back knocking on the S.E.C/s door asking for the right to
negotiate commissions on all transactions of more than
$300.000.

It was then, just when the S.E.C. was putting its case
together to ask Congress for many basic reforms in the law
governing the securities business, that the decision was made
to go all out and order the abandonment of fixed commis-
sions on all exchanges, effective May i, 1975. This position
was strongly supported by the Antitrust Division of the De-
partment of Justice.

Ten years earlier, a Chicago investor had brought suit
against the New York Stock Exchange, contending that its
fixed commission system violated the antitrust laws. But the
United States Supreme Court held finally that the exchange
was exempt from the antitrust laws because the S.E.C. had
the power to regulate its commission rates. Despite this defeat
in the Kaplan case, the Antitrust Division, which bluntly told
the S.E.C. that it considered all "private rate fixing illegal,"
persisted in its campaign against the exchange. Ironically, the
United States Supreme Court, still turning a deaf ear to the
Antitrust Division, ruled in June 1975 (Cordon vs. New
fork Stock Exchange), as it had before, that the exchange
was immune to the antitrust laws because of the S.E.C.'s
authority to fix commission rates. But by that time, the whole
question was purely academic. Mayday had come and gone
and the fixed commission schedule had become a dead letter
 by order of the S.E.C. and with the obvious blessing of
Congress.

In the end, the New York Stock Exchange, responding as

WHAT IT COSTS TO BUY STOCKS 63

it did to the pressure of outside competition for institutional
business, had no one but itself to blameor creditfor
the result.

With the fixed-commission cornerstone blasted away, the
question arose whether the New York Stock Exchange could
continue to stand. Or maybe the question was how long it
could stand. As long as Rule 394 remained on the books,
exchange members were obligated to try to execute an order
there before concluding a deal with a nonmember in the third
market. But the S.E.C. had the power of life and death over
Rule 394. How would it use that power?

There was no clear or immediate answer. On the one hand,
it was obvious that the commission was dedicated to the
concept of a central securities market in which exchange
members and other market-makers would compete with one
another in offering the best prices for securities. On the other
hand, it was equally obvious that the S.E.C. could not sign
the death warrant of an institution so vital to the stability of
stock trading as the New York Stock Exchange.

The S.E.C. adopted the first alternative when in May 1976
it introduced a second set of rules that increased the competi-
tion among brokers on the trading floor. By forcing them to
bargain among themselves over the commissions they charged
each other, the S.E.C. hoped to reduce eventually the cost of
handling all transactions, regardless of the market where they
took place.

In the long run it could be that the answer to the question
of the exchange's future might not be supplied by the Securi-
ties and Exchange Commission  or even the Congress of
the United States  but again by the inexorable laws of the
marketplace, the interplay of free competition.

Only a few days after Mayday, Weeden & Co.. probably
the biggest factor in the development of the third market,
announced that it had formed a subsidiary. Dexter Securities
Corporation, which would buy a seat on the New York Stock
Exchange. This would enable Weeden & Co. to work both
sides of the street, dealing alike with members and non-
members.

Actually, that idea was not a new one. Five months before
Mayday, Dreyfus Corporation, an institution that buys and
sells many millions of N.Y.S.E. stocks, had applied for mem-
bership on the exchange. Although the application was

66 HOW TO BUY STOCKS

turned down because exchange rules forbade any such insti-
tution to own a seat on the exchange, the message was writ
on the wall for all to see.

Day by day, year by year, pressure was mounting. The
exchange could not fend off forever the big institutions that
sought the right to buy and sell securities without paying
tribute to an intermediaryin short, without paying a
commission. Within days after May i, 1975, some member
firms of the exchange  and many nonmembers  were cut-
ting their rates on big volume orders right down to the no-
profit bone. They were seeking to appease the institutional
customer and trying to postpone the day when they would
demand seats on the exchange for themselves.

And in this brave new world of free competition, what was
the future of the brokerage business? Probably not much
different from that of the broker's customers. The big and
efficient firms seemed likely to grow bigger and more pros-
perous, whether they did business on the New York Stock
Exchange or in the new national marketplace. As for the
smaller firms, the future was not rosy. Without the protec-
tion of the fixed-rate schedule, such firms seemed likely either
to be swallowed up by their big competitors or to fall by the
wayside. By 1982 scores of firms had closed their doors and
many others had been swallowed up by bigger, stronger firms.
And there were those in Wall Street who freely predicted that
only a comparative handful of brokerage firms would be
doing business a decade hence.

Meanwhile, among the big brokerage firms with their
worldwide networks of offices, few were content to sit back
and simply count the commission dollars rolling in. They too
had reason to worry. Nobody was guaranteeing them the
fruits of a future monopoly in the stock-trading business. Not
as long as those big institutions were intent on getting rid of
all middlemen and handling their own securities transactions.
To protect themselves, many firms were diversifying their
business as rapidly as possible, moving into new fields.

Even before Mayday, Merrill Lynch & Co. had ventured
into the insurance field, real estate, merchant banking abroad,
and investment counseling. Other big competitors were fol-
lowing Men-ill's lead.

Clearly, the order of the day in Wall Street was to di-
versify. As rapidly as they could, brokers were putting out

WHAT IT COSTS TO BUY STOCKS 67

anchors to windward. They knew that the storms which had
ravaged the Street for a decade had not really abated.

But despite Wall Street's revolution, despite the ever-grow-
ing dominance of the big institutional customers in the stock
market, the average individual investor could still count on
doing business with his friendly broker in almost any bigger-
than-average town in the United States. And there was even
the chance that that broker would get friendlier and friendlier
as the new competition between member firms of the New
York Stock Exchange grew keener in the years ahead.

CHAPTER   J- \}

How the Stock Exchange Works

WHAT actually happens on the New York Stock Exchange
when a broker gets an order to buy or sell stocks? How is the
transaction completed with another broker so that both buyer
and seller are assured of the best price possible on the ex-
change at that moment?

Consider first the physical layout of the stock exchange. It
is a big building at the comer of Wall and Broad streets in
New York City. The trading room looks somewhat like an
armory, with a high ceiling and a trading ftoor about three-
fifths the size of a football field.

All around the edge of the trading floor are telephone
booths, as they are traditionally called, although today they
might more appropriately be called teletype booths. These
booths bear no resemblance to any other phone booths you
have ever seen. Most of them are open at both ends. Along
the two sides there are spaces at which a dozen or more
clerks, representing various brokers, can work. At each
clerk's space, there is a narrow shelf at which he stands and
does his paperwork. (Once a bastion of male chauvinism, the
stock market community has, since the first edition of this
book was published, become considerably more enlightened
in offering career opportunities to women. Despite the fact
that there are more and more women turning up in positions
of responsibility on Wall Street every day, however, we shall
retain the use of the masculine pronoun when referring to
such employees for the purpose of simplicity.) Above the
shelf there is a bank of telephones connecting him with his
home office. These phones were once the nerve ends of the
entire stock exchange business. It was through them that all
public orders to buy or sell stocks came to the floor of the
exchange- The phones are still used, but as part of its
modernization program, the exchange permitted most large
brokerage firms to install teletype equipment in or near the

68

HOW THE STOCK EXCHANGE WOBIS 69




70 HOW TO BUY STOCKS

telephone booths so that they could receive orders directly
from their branch offices. This eliminated the necessity for
relaying orders by phone from the home office to the floor
clerk. Since teletype orders are printed, the possiblity of error
was also reduced.

Spaced at regular intervals on the trading floor are 22
trading posts, twelve on the main trading floor, six in^ the
"garage" or annex, and an additional four in the new trading
room, called the blue room, opened in July 1969. Each trad-
ing post, or station, used to be a horseshoe-shaped counter,
occupying about 100 square feet or floor space. Behind the
counter, inside the post or station, there was room for a
dozen clerks and for several paid employees of the exchange.
Looking to the future, the exchange, in 1979, launched a
major facilities upgrade program to help assure its ability to
handle anticipated trading volumes of up to 150,000,000
shares a day. At the hub of this program were sleek new
trading posts fitted with a dazzling array of electronic equip-
ment. By 1981 all of the old horseshoe posts had been re-
placed and donated by the exchange to various museums
across the country.

All buying and selling is done around the outside of the
trading post. About 90 different stocks are assigned to each
post in different sections around the perimeter, ten or so to
each section.

Indicators above the counter show just which stocks are
sold in each section. Below each is a price indicator showing
the last price at which a transaction in that stock took place
and whether this price represented an increase or decrease
from the last different price  a plus sign or up tick repre-
sents an increase, a minus sign or down tick a decrease.

When a customer decides to buy or sell a stock he simply
calls his local broker with the order. The broker then calls his
firm's headquarters office in New York City, which in turn
phones the order to a clerk in that firm's telephone booth on
the exchange floor (unless, of course, the order comes di-
rectly to the floor by teletype). Some firms have booth space
for only one or two clerks, while one big wire house has
about 40 spaces in nine booths. When the clerk gets the order
over the phone, he writes it out in a kind of shorthand and
hands it to his ftoor broker to execute. This is because only
members can trade on the floor. If the broker is not at the

HOW THE STOCK EXCHANGE WORKS 71

booth, the clerk can summon him by means of a pocket-sized
radio receiver, or by pushing a button located in the firm's
booth. Every broker has a number. When the clerk pushes
the button, the broker's number is flashed on large an-
nunciator boards in each of the trading rooms.

If the clerk knows his broker is busy with other orders, he
employs the services of a so-called two-dollar broker, an in-
dependent member of the stock exchange who is not con-
nected with a member firm. These brokers own their own
seats on the exchange and make their living by executing
orders for other brokers or for wire houses that are some-
times too busy to transact all of their own business. The two-
dollar brokers got their name in the days when they received
that fee for every order they executed. Nowadays their com-
mission, called ftoor brokerage, is negotiated.

Let's assume that with the passage of years Rod & Reel,
Inc., has grown to the point where its stock is listed on the
New York Stock Exchange. Let's further assume that the
order that the clerk gives his broker is a market order to buy
100 shares of Rod & Reel. A market order is one that a
broker must execute as soon as he can at the best price he
can get. As soon as the broker has the actual order in his
hands he walks  no running is .permitted on the floor 
over to the trading post where Rod & Reel is traded. Here he
knows he will find all other brokers with orders to buy or sell
Rod & Reel

As he approaches the post, the broker looks at the price
indicator and notes that the last sale of Rod & Reel took
place at 18%, which means $18.75 a share. However, some
broker may now be willing to sell it for less than that price.
So as he enters the "crowd" of other brokers  two, three, or
more of them at the trading positionhe simply asks,
"How's Reel?" He doesn't disclose whether he wants to buy
or sell; he just asks the question. Another broker may answer,
"Eighteen and three-eighths to eighteen and three-quarters,"
or simply, "Three-eighths, three-quarters." This means that
18% is the best bid, the most any broker is then willing to
pay, and 18% is the best offer, the lowest anyone will sell
for.

Our broker will try to get the stock cheaper if he can. So
he waits a few seconds for other offers. Finally he decides to
tip his hand and make a bid. He says, "One-half for a hun-

72 HOW TO BUY STOCKS

dred," by which he means that he will pay $18.50 a share
for 100 shares.

If he gets no response, he may raise his bid by % of a
point. This is the minimum fluctuation in the price of most
stocks. So he announces, "Five-eighths for one hundred."
At this point, perhaps, the first broker, who was offering the
stock at 18%, may have decided that he can't get that price.
Or another broker, who may have entered the crowd later,
will decide to accept this bid of 18%. If either one of them
decides to "hit," or accept, the bid he says, "Sold," and the
transaction is concluded, simply on the basis of that spoken
word. Conversely, if a broker decides to accept an offering
price announced in the course of an auction, he simply says,
"Take it." No written memoranda are exchanged by the
brokers. Each broker simply makes his own note of the other
broker to whom he sold or from whom he bought and the
price that was agreed on.

The rules of the New York Stock Exchange provide that
all bids to buy and all offers to sell must be made by open
outcry. No secret transactions are permitted on the floor of
the exchange. Furthermore, a broker cannot conclude trans-
actions between his own public customers without presenting
on the floor their orders to buy or sell. For instance, the
broker may have a market order to buy 100 shares of Rod &
Reel and another market order to sell 100. He can't just
"cross" these orders privately and effect a transfer of the
stock between his two customers. He must send both orders
to the floor, where the appropriate bids and offers must be
made. Only in very rare cases, usually involving thousands of
shares, are off-the-market crosses permitted. Even in these
cases, both buyer and seller must know that the cross is being
made, and the stock exchange must grant permission.

No broker is permitted to execute any orders on the floor
except during the official trading hours of the exchange,
These are from 10 A.M. to 4 P.M., New York time, Monday
through Friday, excepting holidays. (From mid-1968 to mid-
1970, when brokers were struggling with an unprecedented
volume of orders that they were not equipped to handle, the
exchange operated on a reduced schedule of trading hours so
as to catch up with the paperwork generated. But by 1976,
efficiency had so improved that the exchange did not have to
resort to early closings despite the record-breaking volume.)

HOW THE STOCK EXCHANGE WORKS 73

As soon as a transaction such as the Rod & Reel purchase
at 18% is completed, the broker who bought the stock and
the broker who sold it have their clerks report back to their
respective home offices. This is done so the buyer and seller
may each be advised that the transaction has been concluded
and be told what the price was. Brokerage firms with teletype
order service direct to the floor simply send the information
from the floor back to the originating office.

After the market closes, the two brokerage firms involved
in the Rod & Keel transaction must arrange for the real
transfer of the stock and the payment of the amount due.
Actually these two firms might have concluded many transac-
tions with each other in the course of the day, and, in turn,
each of them might have dealt with dozens of other brokers.

Thus, on a given day one firm might have sold 1,100
shares of Rod & Reel for its customers and bought only 1,000
shares for other customers. The transfer of 1,000 shares from
its customers who sold the stock to the customers that bought
the same number of shares is purely an internal bookkeeping
problem for the firm to settle. But it would still owe some
other broker 100 shares.

Time was when the broker who owed shares at the end of
the day would deliver the actual certificates to the Stock
Clearing Corporation, where other brokers to whom shares
were due would pick them up. Later, all member firms simply
kept a supply of all stocks at the clearing corporation. The
transfer of shares between brokers would be accomplished
simply by debiting or crediting each broker's account. Dollar
balances  the net amounts due them  were settled in the
same fashion.

Now, the Depository Trust Company (a subsidiary of the
New York Stock Exchange, formerly known as Central Cer-
tificate Service) has eliminated nearly all that shuffling of
certificates by handling more than 75% of all clearing opera-
tions. It conducts a central certificate operation, which re-
lieves its participants  broker-dealers, banks, clearing cor-
porations, insurance and investment companies, among
others  of the burden of handling hundreds of pieces of
paper each day in both the receiving and delivery functions.

In the vaults of major banks and in the Depository Trust's
own vault are stored about 4 billion shares of stocks, includ-
ing those sold on the exchange and those traded elsewhere.

74 HOW TO BUY STOCKS

Corporate securities held here are worth more than $530
billion. Including registered corporate bonds, more than
16,060 issues are represented.

When certificates are deposited, they are held in non-
negotiable form until it is necessary to transfer them out in
the name of a customer or a firm. The participants in a stock
trade do not have to handle or even see the certificates until
they are delivered upon request.

Computers make daily bookkeeping entries to reflect
changes in the participants' position after the securities have
been traded. AU of this has obviously reduced the number of
securities under a participating broker's care, thus freeing
valuable space and personnel. At the end of the business day,
only one check need be delivered or received from each active

participant.

Ultimately, the problems involved in handling stock certifi-
cates may be further simplified by the introduction of a cer-
tificate like an IBM card on which all the essential data can
be "read" by a computer. Another proposal would involve
adding a half-inch to the width of the present 8" x ia"
certificate and incorporating into that half-inch all the essen-
tial data in characters that could be read electronically by an
optical scanner. But either change would be only a stopgap
measure, for in 1975 Congress directed the S-E.C. to take
steps to eliminate altogether stock certificates as a means of
settling securities transactions. A system of computerized
bookkeeping entry would probably be substituted. Thus, one
of Wall Street's most cherished and colorful traditions will
have vanished from the scene.

To return to our Rod & Reel order, after the sale took
place at 18%, one of the fioor reporters, paid employees of
the exchange who stand outside each trading post, would see
that the price indicator on the post was changed from 18%
to 18%. And since this sale was below the preceding sale, he
would be sure that a minus sign showed beside the price
figure.

For unnumbered years, the reporter then used to write a
report of the salethe name of the stock, the number of
shares involved, and the price  and hand it to a pageboy,
who would take it to the pneumatic tubes that led directly
from each post to the ticker room. There a notation of the
sale was typed onto the ticker tape, and it was carried by wire

HOW THE STOCK EXCHANGE WORKS 75

to the tickers in every broker's office throughout the country.

Here again, modern technology has come to the rescue of
die beleaguered exchange and vastly speeded up operations.
Now when a transaction is completed all the reporter has to
do is draw pencil lines through the appropriate coded boxes
 stock symbol, number of shares, price  and insert the
card into the electronic scanner. The machine automatically
"reads" the essential data from the card and transfers the in-
formation to the computer. The computer is used to drive the
ticker and produce the printouts, showing each transaction on
the tape, or electronic screen. Thus, in a matter of seconds,
the public knows all the essential information about every
transaction.

With automation of floor operations increasing, some
brokers are wondering seriously if the day is coming when
computers will take over the entire trading function and ren-
der both them and the exchange obsolete. After all, they have
seen what a revolution computers have wrought in Just a few
short years in the accounting, bookkeeping, traffic, and even
research departments of their home offices.

On the tape the name of every stock appears only as ini-
tials or a combination of letters, such as C for Chrysler
Corporation, CP for Canadian Pacific, and CRR for Carrier
Corporation. The single-letter symbols are, of course, the
most highly prized and best known. Thus F stands for Ford,
T for American Telephone & Telegraph, and, probably the
best known of all, X for U.S. Steel.

Rod & Reel might have the symbol RAR, in which case the
sale of 100 shares at 18% would appear on the tape simply

as:

RAR

18%

If 200 shares, instead of 100, had changed hands, the
transaction would be noted this way:

RAR

2S18%

If 1,000 shares are involved, it would appear on the tape
this way;

RAR

10S1896

When sales volume is so heavy that the ticker, which can
print 900 characters a minute, falls as much as one minute

76 HOW TO BUY STOCKS

behind in reporting transactions, the price information is ab-
breviated to the last digit plus a fraction, except when that
digit is a zero. If the ticker was one minute late, our sale at

18% would appear as;

RAR

8%

It is assumed that people who are following the stock
closely on the ticker will be able to supply the missing first
digit. If the stock were to go up to 20 or above, hence
involving a new Erst digit, this price would be noted in full,
such as 20%, on the Erst such sale.

When the ticker falls two minutes behind in reporting, the
volume of sales is deleted. Thus, even if 1,000 shares of Rod
& Reel were sold at 18%, the transaction would still appear:

RAB

8%

The ticker rarely falls three minutes or more behind and
then only on big volume days. But when it does, repeat prices
are omitted. In other words, succeeding transactions in the
same stock at an identical price are not printed. As soon as
the tape recovers lost time, it returns to normal routines.

If the tape can't keep up with the pace of trading, you may
wonder why the exchange doesn't simply introduce a faster
ticker. The answer is that anything above 900 characters a
minute would be "blurred," almost impossible to read. Al-
though a high-speed data processing ticker is planned for the
future, it will be available only to Bnancial vendors and to

press associations.

When most people think of buying or selling stock, they

think of doing so on the basis of a market order. This is an
order to be executed as soon as possible after it reaches the
floor, at the best price then prevailing. Actually, an individual
very often wants to buy or sell a stock only if it can be done
at a certain price or better. Thus, you might want to buy 100
shares of Rod & Reel if you don't have to pay more than
18^. You could place an order to this effect with your
broker. It's called a limit order, and you can tell him whether
it's good for a day, a week, a month, or "good till canceled."
All limit orders are treated as day orders, unless they are
clearly marked for a longer period of time. If they are not so
marked they are canceled it they are not executed by the end
of that day's trading.

HOW THE STOCK EXCHANGE WORKS 77

The stock purchased for you on this hypothetical Rod &
Reel limit order will be bought for you only if it can be
bought at 18^ or less. Perhaps when the order is actually
executed, your broker will be able to get the stock at 18^4.
On the other hand, it can happen that the stock may actually
drop to 18^2, and your order still won't be filled. That's
because other orders to buy at 18^ were placed ahead of
yours, and the supply of the stock offered at that price was
exhausted before your order was reached. In that kind of
situation, if you ask your broker why your order wasn't ex-
ecuted, he will tell you that there was "stock ahead."

Limit orders can also be used in selling stock. Thus, if you
owned Rod & Reel stock, you might be willing to sell it, but
only if you could get $19 for itor more. You could place
a sell-limit order to that effect with your broker. Sometimes,
you might like to place a day limit order to buy or sell at a
specified price. But you would still like to have your order
executed that day even if the stock didn't quite reach the
price level you set. You could accomplish that by having the
order marked for execution at the close regardless of the
market level at 4 P.M.

There's still another kind of suspended order: the stop
order.

Suppose you bought Rod & Reel at la or 13, and the
stock rose to a level where you had a nice profit  perhaps to
19 or 20. You might want to protect that profit in case the
market dropped sharply. You could do so by instructing your
broker to sell the stock if it declined to 18. This would be a
stop order to sell. Your broker would see that it was executed
if Rod & Reel ever fell as low as 18. Whenever it hit that
mark, your stop order would become a market order to be
executed at the best price then possible. Again, because other
people might have placed orders ahead of yours to sell at the
18 figure, the price might slip to 17% or even 17% before
your order could be executed.

Conversely, you might not want to buy Rod & Reel when it
was selling at 18 because you felt it might fall further. But on
the other hand if there were a sharp rally, you wouldn't want
to miss your opportunity to pick up the stock before its price
went up too high. In that case you might place a stop order to
buy by instructing your broker to buy Rod & Reel for you at,
let's say, 19.

78 HOW TO BUY STOCKS

Occasionally, the exchange will exercise its authority to
prohibit stop orders in individual stocks. Such action is taken
only when the stock in question has followed a very volatile
pattern of price movements and when the exchange fears that
the execution of stop orders to sell it would trigger a sharp

sell-off.

In theory these fixed-price orders, both limit orders and
stop orders, look pretty attractive as a means of controlling
your profit or losses. In common practice, however, they
don't work as well for the average investor as you might
think. To have any real utility, a limit order has to be pegged
fairly dose to the prevailing market price. For instance, if
Rod & Reel is selling at 18%, there might not be much
point in placing an order to buy it at 16 or even 17. And if
you place a limit order at 18, you might iust as well buy it
outright at 18^. The same logic applies in reverse when it
comes to selling stock.

In short, decisions to buy or sell that turn on getting an
extra point or fraction of a point above or below the market
price prevailing are usually not apt to be sound decisions for
the average investor.

11

CHAPTER

How a Market Is Made

WHENEVER you place an order to buy or sell stocks, your
brokerage firm is responsible for executing it at the best price
possible, the highest price if you are selling, the lowest if you
are buying. Often this responsibility requires the firm's floor
broker to spend far more time on your order than he can
afford to spare if he is going to attend to all his other duties.
Thus, for instance, if you were to place an order to buy Rod
& Reel at the specified price of 18 and the stock was then
selling at 19, you could hardly expect your broker to spend
all his time keeping an eye on Rod & Reel, waiting to see if it
dropped to 18.

In a case like that, he would turn your order over to
another broker, who, as his agent, would watch the stock for
you and execute the order if he could. This agent is usually
the specialist in Rod & Reel stock. .

A specialist is a broker who has elected to confine his
buying and selling activities to a particular stock or stocks
that are traded at one spot around the perimeter of a trading
post. He never moves away from that spot. He is always there
to accept orders from other brokers and, for a negotiated
commission known as floor brokerage, to assume responsibil-
ity for their execution. The individual investor does not pay
anything extra for the specialist's services.

A specialist must not only function as an agent for other
brokers, executing orders that they leave with him; he must
also be willing to buy and sell for his own account those
stocks in which he specializes. In fact, this is his primary
responsibility, fulfilling the obligation imposed upon him by
the exchange to maintain a "fair and orderly market" in these
stocks.

All told, there are about 407 members of the exchange
who operate as specialists. They work for 64 separate spe-
cialist organizations  mostly partnerships or two or three

79

80 HOW TO BUY STOCKS

firms working togetherthat handle the stocks of all the
companies listed on the exchange. Some big specialists units
handle as many as 150 stocks; some only a few.

No member can operate as a specialist except with the
approval of the stock exchange. The specialist must also be a
member of substantial means. Every specialist unit is required
to have enough capital to buy as many as 5,000 shares/of
the common stocks and 1,000 shares of the convertible pre-
ferred stocks in which their members are authorized to deal.
In the case of a common stock priced at $50 a share, a
specialist unit would thus need a quarter-million dollars just
to handle that one stock.

Moreover, each specialist firm must have at least $100,000
readily available for its use, or 25% of the cost of 5,000
shares of all the common stocks and 1,000 shares of all the
convertible preferreds it's authorized to deal in, whichever
amount is the greater.

This means that the big specialist firms that handle dozens
of stocks must have access to many millions of dollars. Some
specialists rely principally on their own resources. But most
supplement their own capital through private financing ar-
rangements. Some specialist firms are so well-heeled that they
can buy as many as twenty or thirty thousand shares of one
or more of the stocks they handle.

When a specialist executes orders for other brokers, he is
himself operating as a broker, for technically, that is what the
word broker means, a man who acts as agent for others. But
when a specialist buys or sells for his own account, he is
acting as a dealer. That is the distinction between a broker
and a securities dealer. A broker simply bargains for you. A
dealer bargains with you, and acts as a principal in the trans-
action. He sells you securities that he owns himself, or buys
such securities from you at an agreed price.

When a member firm broker comes to the trading post
with an order to sell a stock and there are no other brokers
with buy orders for that stock at the post, the specialist will
make a bid for the stock himself. Similarly, when a broker
wants to buy a stock and there are no other sellers, the
specialist will offer it for sale himself.

Normally, about 30% to 40% of stock exchange volume
results from this kind of buying and selling by specialists for
their own accounts. And normally, the specialists count on

HOW A MARKET IS MADE   8l

making about half their income from these transactions. The
other half comes from executing orders for other brokers.

On each of the stocks in which he specializes, the specialist
keeps a book. In this specialist's book are entered all the limit
or stop orders that other brokers have given him for execu-
tion which could not be executed because they were "away
from the market"  either too high or too low in relation to
the price at which die stock was then being traded. If a
specialist gets two or more orders to buy a stock at the same
price  or to sell it at the same price  he enters them in his
book in the order in which he receives them. Those that are
received first are executed first, whenever the price auction
permits, regardless of all other conditions or circumstances.

Thus, if your order for Rod & Reel at 18 was the first one
in the specialist's book, and if the stock was offered at that
price, your order would be filled first. Even if he wanted to,
the specialist couldn't buy the stock for his own account at 18
until your order, and all others in his book at that price, had
been executed.

If the last sale of Rod & Reel was made at 18^, the spe-
cialist's book might typically show one or two limit orders to
buy at 18%. That's because most customers place limit
orders in round figures rather than fractions. On the sell side,
his book might show a couple of orders to sell at 18%, a few
at 18^, and several at 19 or higher. These might be either
limit orders or stop orders, and would be so marked in the
specialist's book.

In that situation, if a broker came to the trading post with
a market order to buy Rod & Reel and there were no other
brokers there with stock to sell, his query "How's Reel?"
would be answered by the specialist. The specialist would
reply, "Three-eighths, five-eighths," meaning 18% bid and
18% offered, since 18% was the highest buy order and 18%
the lowest sell order that he then had in his book. This would
be the hid-and-asked quotation as of then.

Since a specialist's primary responsibility is to see that
there is no violent fluctuation in the price of any stock he
handles, he usually undertakes to see that the difference be-
tween the bid and the asked price is only % of a point or so,
although it might be more on high-priced issues.

Because specialists are generally faithful to their obliga-
tions to maintain orderly markets, well over 90% of aH

82 HOW TO BUY STOCKS

transactions on the exchange take place at prices that show a
fluctuation of ^4 of a point or less from the previous transac-
tion. Whenever there is a larger than normal gap between bid-
and-asked quotations, the specialist, under the rules of the
exchange, is expected to do something to narrow the gap.
Specifically, he is expected to make appropriate bids or offers
of his own  to buy or sell the stock as necessary, f9r his
own account.

Furthermore, if one of his stocks is moving rapidly up or
rapidly down, he is expected to stabilize the market in that
stock. If there is a heavy pressure of sell orders that pushes
the price down, he is expected to buy the stock for his own
account. If buy orders are pushing the price up too rapidly,
he is expected to sell the stock from his own inventory. He
may even be forced to sell stock he doesn't have, hoping that
somewhere along the line he will be able to buy an offsetting
amount of the stock at a lower price to make good the stock
he has sold to other brokers.

The obligation to maintain a fair and orderly market can
impose fearsome and expensive responsibilities on a specialist.
Important news developments can drastically affect a com-
pany's prospects and result in a sudden torrent of buy or
sell orders. Sometimes such a development will delay the
opening of a stock for hours. Sometimes it will force suspen-
sion of trading for a much longer period of time. In such
situations, the specialist will consult with floor officials and
one or two directors of the exchange. Together they will
decide what constitutes a fair price quotation. When trading
in the stock begins again, that's the price at which the spe-
cialist is obligated to buy or sell.

A classic illustration of the kind of dilemma that fre-
quently confronts specialists is that which occurred in early
1964 when Lockheed announced that it had developed the
A-n, a jet plane whose performance, in the words of Presi-
dent Johnson, far exceeded that "of any other aircraft in the
world today." The President made that announcement on a
Friday. Lockheed had closed that day at 38. At what price
would it open on Monday? On Monday morning the Lockheed
specialist was confronted with market orders to buy 30,000
shares. In his book, he had offsetting sell orders that totaled
only 17,000 shares13,000 less than were needed. Floor

HOW A MARKET IS MADE   83

traders were willing to sell 3,200 shares, and the specialist
had 5,600 in his inventory. As for the remaining 4,200
shares, the specialist had no choice but to sell shares he didn't
have, hoping to cover his shortage by buying 4,200 shares
later at a reasonable price.

After conferring with floor officials, the specialist set an
opening price of 40%$2.75 above Friday's dose. Trading
opened on a block of 30,000 shares at that price. Lockheed
closed that day at 40%, after 299 individual transactions
valued at some $5,500,000 had taken place, but the most
significant thing about the day's trading was that the spe-
cialist ran such an orderly market that not one of those
transactions was carried through at a price that varied more
than % point from the preceding transaction.

Occasionally, there may be such an overnight accumula-
tion of buy or sell orders for a stock that the specialist is
unable to arrange an opening price, even with the help of
floor traders or floor officials. On Monday, January n, 1982,
for instance, after the government announced it was dropping
its lengthy antitrust suit against IBM, the giant computer
corporation, its stock wasn't traded at all on the New York
Stock Exchange until just before the dose. When it finally did
open on a block of 714,500 shares, it was up i% points to
58%.

In addition to stabilizing the market and being willing to
buy or sell when there were no brokers with offsetting orders,
the specialist performs another important service, which is
(allied stopping a stock.

Suppose your broker came to the trading post with your
market order for Rod & Reel when the best offering price in
the specialist's book was 18% and when there were no other
brokers present with better offers. Anxious to get a lower
price for you, yet not wanting to miss the market if it went
up, your broker would ask the specialist to "stop" 100 shares
for him at 18%. If another broker came up then and offered
Rod & Reel at 18^, the specialist would buy it for your
broker and cam a floor brokerage commission. On the other
hand, if the stock was not offered at a lower price, but sold
again the next time at 18%, the specialist would execute your
buy order at that figure. He could not execute your order at
more than 18%, for when he was asked to stop the stock, he

84 HOW TO BUY STOCKS

agreed that 18% would be the maximum price your broker
would have to pay. He'd try to buy it cheaper if be could, but
18% would be the top price.

After every sale a whole new auction starts. Thus, if a
transaction in Rod & Reel had just been concluded at 18%,
other brokers in the crowd who might be trying to buy 100
shares apiece would immediately restate their bids, maybe the
same bid  18%. These simultaneous bids would have parity.
If a broker then came up and offered 100 shares of stock at
i81/^, the brokers who wanted to buy at that price would
settle the matter of who got the stock by tossing a coin.

The brokers who lost out might then report to their cus-
tomers that they had matched and lost. Customers who get
such a report often wonder why they never match and win.
The answer is that the broker never reports when he matches
and wins. The customer simply gets the stock.

In the case of simultaneous bids, if one broker has an order
for zoo shares, while the others are trying to buy only 100
shares apiece, the larger order takes precedence if the seller
offers a block that is as big or bigger. If the seller offers 200
shares, the broker who wants 200 will get them all. If the
seller has 300 shares, the broker who wants 200 will get his
first, and the others will have to match for the remaining
100.

Very often, before placing a market order a customer
wants to have an idea of what hell have to pay. To accom-
modate such a customer, the floor broker will try to "get the
market and the size." This means that he will ask the spe-
cialist for the current bid-and-asked prices and for the size of
the orders at these prices. The specialist will reveal only the
highest bid and the lowest offer, such as on Rod & Reel.
"Three-eighths, five-eighths," or 18% bid, offered at 18%.
He is not permitted to reveal any of the lower bids or higher
offering prices shown on his book. As far as the size of the
orders is concerned, he might say, "One hundred either way."
By this he would mean that he has loo shares to buy at 18%
and 100 to sell at 18%. If he had 100 to buy and 500 to sell,
he would say, "three-eighths, five-eighths, one and five."

The specialist is not required to divulge the size of the
orders on his book at either the bid or asked price if he feels
that it would not be in the best interests of the buyers or
sellers.

HOW A MARKET IS MADE   85

Because the specialist's book gives him a "feel" for the
market that no other broker or investor can possibly have,
and because he not only can, but must, buy and sell for his
own account to maintain an orderly market, he is obviously
in a position to affect the trend of prices in a very important
way.

To be sure that the specialist does not abuse his privileged
position or manipulate prices in any way to his personal
advantage, the exchange has circumscribed his operations
with a set of highly technical rules, which have become stead-
ily more stringent over the years.

Despite the fact that various surveys, including the S.E.C-'s
own, have not turned up any evidence of wrongdoing by
specialists on the New York Stock Exchange, and have even
demonstrated what a useful service they render, the S.E.C.
continues to regard their operations with grave suspicion.
There is no doubt that those operations will continue to be
kept under very dose surveillance by both the exchange and
the S.E.C.

Specialists are now required to submit to the exchange 
about eight times a yeardetails of their dealings for vari-
ous one-week periods, selected at random by the exchange
and not revealed in advance. These reports make it possible
for the exchange to study the orderliness of the marked in an
individual stock, the continuity of price, the spread in quota-
tions, and to render a Judgment about how well the specialist
is fulfilling his obligations.

Specialists must also report weekly to the stock exchange
every trade they make for their own account  stating the
time, the "tick" (whether up or down in price), and the
number of shares involved. They are then graded on their
stabilizing record  whether they bought on down ticks and
sold on up ticks, as they are expected to.

In addition, the exchange maintains an on-line price sur-
veillance program based on trading data obtained from the
computers that run the stock ticker. This program monitors
all trades reported on the ticker throughout the market ses-
sion. When the price movement of a stock exceeds preset
standards, the computer calls attention to that fact- The
transaction  stock symbol, time, and price  is reported on
a teletypewriter machine in the exchange's surveillance sec-
tion. The surveillance section then retrieves from the com-

86 HOW TO BUY STOCKS

puter's memory bank the chronological sequence of sales,
before and after the suspicious transaction, and analyzes the
record. If there is no apparent cause for the fluctuation, the
surveillance section alerts a trading floor official in the area
where the stock is traded. The official will then speak to the
specialist to find out just what happened  and why.

Whenever the cry is raised that specialists should not be
allowed to trade for their own accounts, that their func6ons
should be restricted to running the book and executing orders
for other brokers, specialists ask what would have happened
to the stock market if they had not been able and willing to
step into the breach at the time of President Eisenhower's
heart attack in 1955, or on the day President Kennedy was
assassinated in 1963.

On Monday, September 16, 1955, after the news of Eisen-
hower's heart attack had broken over the weekend, the mar-
ket opened with sell orders far outnumbering buy orders. It
was virtually impossible to open trading in any stock. The sell
orders would have depressed prices beyond all reasonable
levels before buying sentiment could be generated. The spe-
cialists met the challenge. They bought steadily for their own
accounts at prices only moderately below the levels that had
prevailed at Friday's close. All told, one-quarter of the stock
purchases that day were made for the specialists' own
accounts  i,759>36o shares with an estimated market value
of $80 million, Eisenhower's recovery enabled the specialists
as a group to work off the stock they bought without loss 
indeed, with profit. But when they took the risk, they did not
know whether or not they would be wiped out.

"How," ask the specialists, "could you get a computer to
do that kind of job?"

On November 22, 1963, the performance of the specialists
was equally noteworthy. The story can be summarized in
terms of what happened to 25 key stocks between 1:40 P.M.,
when news of President Kennedy's assassination hit the ex-
change floor, and 2:07 P.M., when the exchange was closed
down by the governors. At 1:40 P.M. specialists in these 25
issues held 126,000 shares, worth over $7 million, in their
own inventories. When panic selling engulfed the floor, the
specialists stepped in to buy, risking their own personal sol-
vency. In the following 27 minutes, 570,000 shares of these
25 stocks were traded on the floor. Of this total, specialists

HOW A MARKET IS MADE   87

bought more than 144,000, increasing their inventories to
almost 230,000 shares, worth $12,348,000. Floor traders also
helped stabilize the market in these stocks, buying 31,000
shares on balance. True, the specialists sustained no loss,
thanks to a rapid market recovery. But that's something they
couldn't count on when they took their big gamble.

The S.E.C. contends that specialists have not always be-
haved in such exemplary fashion. But, then, perhaps no one
can be a hero all the time.

CHAPTER

12

How Large Blocks of
Stock Are Handled

SUPPOSE you owned a sizable block of stock in a company.
Maybe you acquired the shares as part of your retirement
benefits from that company. Maybe you inherited the stock.
Or maybe you simply bought the block bit by bit over a long
period of time. Now, you have decided you want to sell 5,000
shares, or 10,000 shares, or more. How would you go about
selling that much stock?

Obviously, if you just dumped it on the market all at once,
it would depress the price and you wouldn't get as much for
the stock as you should. Moreover, it might be a period of
days or even weeks before you could dispose of all that stock
in ordinary trades of one or two hundred shares at a time.

In a situation of this kind you would be well advised to let
your broker solve your problem for you. The first thing he
would do is try to "find the other side of the market," to
uncover a buying interest in the stock that would match your
own desire to sell. To do this the department of his firm that
specializes in block business would contact various sources to
find a buyer for your block. These sources would include
other member firms, but also nonmember firms known to
have an interest in the stock. If the stock was not popularly
traded in the market, your broker might see if the company
itself was interested in buying back its own stock, as many
large companies often are.

Your broker might also turn to the specialist who handles
that stock who, in his role as market-maker, often helps
brokers dispose of sizable blocks.

Time was when a broker could turn a block order over to
the specialist to execute on a not-held basis. On this basis the
specialist would be free to exercise his own best judgment
about when and how to feed the stock into the market. He

88

HOW LARGE BLOCKS OF STOCK ARE HANDLED 89

might, for instance, hold the stock back in expectation that
prices would rise. If they dropped before he finished execut-
ing the complete order  if other orders were filled at prices
higher than what he finally realized on his not-held order 
he was at least assured that the broker for whom he was
acting would "not hold him to the tape," that is, hold him
responsible for failing to sell at those better intervening prices.

For some years, however, the S.E.C. has insisted that spe-
cialists not accept not-held orders. This restriction makes the
handling of such orders difficult for the broker. About all he
can do is try to get the customer to change his order to a
limit order. If he succeeds, the broker can then turn the order
over to the specialist to execute as best he can at prices above
the minimum set in the limit order.

(     In the last analysis, the specialist is as interested as your
broker is in disposing of your block with the least possible
impact on his market. The specialist might, for instance,
know some floor traders who would be interested in buying
all or part of the block. Or the specialist might be willing to
buy it outright for his own account, thus assuming the entire
risk that he could sell the block at a profit.

If he took on a block on this basis, it would be known as a
^ specialist block purchase. However, under stock exchange
rules, such a transaction may take "place only when the stock
cannot be sold in ordinary exchange transactions without dis-
turbing the market. (A specialist block sale  just the reverse
of a block purchase  is, of course, subject to the same
restriction.)

Occasionally, a broker with a big order will be able to find
buyers or sellers for the whole block among his own cus-
tomers and handle both sides of the transaction. This is called
a cross  because the broker actually crosses the buy and
sell orders on the floor in a regular trade. The biggest block
handled in this fashion in N.Y.S.E. history involved the sale
of 5,240,000 shares of American Motors on March 14, 1972.
The biggest trade in terms of dollar value was a $103,086,500
transaction in Cutler-Hammer on June 12, 1978.

In this kind of "in house" transaction, if a broker can't find
enough buy orders among his customers to equal the sell
order, he will often buy the balance of the shares for his own
account and assume the risk of selling them later.

^     If a member firm takes on a big block  too big for it to

90 HOW TO BUY STOCKS

handle alone  the technique it is most likely to use to sell
the block is the secondary distribution (secondary, as distin-
guished from an original underwriting, or primary distribu-
tion). A secondary distribution, like a new issue, can be
handled either by a member Brm of the New York Stock
Exchange or by a securities dealer who is not a member. It
will usually involve the participation of member firms as well
as nonmembers.

If the block offered in a secondary is a listed stock, an
announcement of the impending offering is made on the ex-
change ticker on the day of the sale. The actual offering to
the public generally takes place after the close of the market,
This advance publicity that a sizable block of stock is hang-
ing over the market can, of course, have a negative effect on
the price of the stock during the day's trading. Actually, if
the exchange community is in any way concerned about the
overhanging block, the price may already have drifted down-
ward for a day or two. News of an impending secondary gets
around as soon as the broker or dealer who is handling the
sale sets about organizing his underwriting group.

The underwriters participating in the secondary buy the
block outright from the seller and assume the risk of reselling
it to the public, often inviting other brokers and nonmember
dealers to join them in the selling group. The underwriters
charge the seller a gross spread, which typically will amount
to three or four times the going commission rate, although it
can range from as little as twice to as much as six times the
going rate. This spread covers the manager's fee, the under-
writing commission, and the selling concession, which nor-
mally runs from a third to a half of the gross spread. Since
negotiated commissions became effective, the spread or cost
to the seller has generally been reduced in order to meet
competition.

The price at which the block is offered in a secondary
distribution involving a listed stock is usually the price at
which that stock is sold in the last transaction on the floor
that day, although it might be either lower or higher depend-
ing on the attractiveness of the offering.

If you had no particular desire to buy a given stock at the
close of the market, you may wonder how you could be
interested in buying that same stock at the same price just a
little later the same day. The answer is simple. To induce you

HOW LABCE BLOCKS OF STOCK ABE HANDLED Ql

to buy, the underwriters offer the stock on a commission-free
basis, no matter how many shares you buy. The seller pays
all the costs, and that's why the gross spread is so big.

On a secondary distribution the underwriting group usually
undertakes to stabilize the market with S.E.C. sanction, just
as they do on an original underwriting. Obviously, it would
not be possible for them to sell their stock at the price fixed in
their agreement with the seller if the same stock was being
offered in the open market at substantially lower prices 
prices that more than offset the commission saving to the
buyer. In such cases, the underwriters would have to buy up
the stock offered at the lower price and add it to their own
block. If large quantities of the stock appear at considerably
lower prices, they may have to give up their price stabiliza-
tion efforts, withdraw the block, and wait for a better market,
a happier day.

The largest secondary offering of common stock ever made
was the Ford Foundation's first public offering of stock in the
Ford Motor Company in 1956. This was handled by seven
securities firms operating as joint managers. It had a gross
value of $657,900,000. The next-largest secondary  and the
largest ever handled by a single firm  was the sale by Mer-
rill Lynch, Pierce, Fenner & Smith in 1966 of Howard
Hughes's holdings in TWAa-block of 6,584,937 shares
worth $566,304,582.

A second technique for distributing a large block of stock
is the special offering. A special is handled the same way as a
secondary, except that participation is limited to members of
the New York Stock Exchange. Specials take place on the
floor of the exchange during regular trading hours.

A third techniquethe exchange distributionis also
available, although it has declined substantially in popularity.
Such a distribution is usually handled by a single brokerage
firm. The block is disposed of wholly by that firm's own sales
organization to its own customers. It is, in effect, a giant cross.
The seller gives the broker what amounts to a market order.
The broker's sales force then seeks to develop buying interest
among its customers on the assumption that the stock will be
available at or near the price then prevailing on the exchange.
When the sales organization has developed buy orders that
match the size of the block, the broker checks the seller a last
time to be sure he is satisfied with the price then prevailing. If

92 HOW TO BUY STOCKS

he is, the floor broker will offer the block on the exchange
and simultaneously bid for it, usually at the last sale price or
at a price somewhere between the bid-and-asked quotations.

There are two big advantages to an exchange distribution
from the seller's point of view. Since there is no public an-
nouncement of the offering, and since the entire transaction is
usually handled within a single broker's organization, there is
little likelihood that news of the impending block sale will
depress the price of the stock before the offering is made, as
often happens with secondaries or specials. Again, since there
is no need to organize an underwriting syndicate or a selling
group, the cost to the seller is lower  generally about half
of what he would have to pay on either a secondary or a
special. The buyers, of course, get their stock without paying
any commissions, since all costs are borne by the seller.

Banks, insurance companies, and other institutions are
more apt to encounter a serious problem in selling a large
block of securities than they are in buying one, although
institutional business has grown so rapidly recently that it is
sometimes also difficult for these big purchasers to acquire
the stock they want at a fair price without disturbing the
market. To meet this problem, die stock exchange in 1956
established a mechanism known as the exchange acquisition.
This works exactly like the exchange distribution, except in
reverse. The broker who handles such a transaction solicits
sell orders from his customers at a net price, free of all
commission, until he accumulates a number of shares equal
to the buyer's order. The buyer usually pays at least a double
commission.

The exchange acquisition has never been popular. And it
isn't hard to see why. It's one thing for a broker to ask a
customer if he wants to buy a stock commission-free. It's
another  and more awkward  thing to ask him if he
wants to sell a stock commission-free. The customer is im-
mediately suspicious. Why, he asks himself, should his broker
want him to sell that stock, particularly if it is one the broker
recommended that he buy in the first place?

While the New York Stock Exchange has developed all
these techniques for handling the purchase or sale of blocks
of all sizes  and almost automatically grants the required
approval for any secondary, special, or exchange distribution
 many an institution in recent years has found it easier to

HOW LARGE BLOCKS OF STOCK ABE HANDLED 03

take the block to the third market and sell it in toto to a
securities dealer who is willing to position the stock and as-
sume the entire risk of selling it. Obviously, for assuming
such a risk, the dealer expects to buy the stock at a substan-
tial discount from the prevailing market price. If he is selling
a block instead of buying it, he expects to get a price conces-
sion on that side.

The marked success that nonmember dealers have enjoyed
in developing block business for the third market has induced
more and more member firms to employ the same tactics.
Instead of resorting to the machinery of the stock exchange
to move a block of stock, they buy the block outright from
the seller, position the stock, then devise ways and means of
selling it, just as a nonmember would in the third market.
With one small difference: if a member firm wants to dispose
of all or part of the block to a nonmember, he is required to
see that all limit orders for the stock on the specialist's books
at the same or a higher buying price are satisfied first.

Institutions also have available to them a fourth market 
the Institutional Network, or Instinet, as it is called  to help
them trade big blocks of stocks.

Instinet is a privately owned computerized network. Sub-
scribers can notify Instinet of their interest in block purchases
or sales via a cathode ray tube. ^If a seller announces that
he wants to sell a particular block, and if another subscriber
indicates an interest in buying that stock, the two of them can
negotiate prices and terms with each other through a com-
puter terminal. Instinet claims that some of its subscribers
have been able to save up to 70% of the commission they
would have had to pay under the exchange's old fixed-rate
system. Instinet makes its money not by collecting commis-
sions but by charging each subscriber a fiat annual fee.

Once a subscribing institution has indicated its interest in
selling a block of some stock, that indication of interest is
placed in the Instinet file. Perhaps a little later another sub-
scribing member decides on the basis of its own information
that it would like to buy that stock. When it reports that
interest to Instinet, the file is checked and the would-be buyer
is put into computer contact with the organization that has
decided to sell it. Since the whole transaction is handled
privately, there is no chance that a rumor about such-and-
such an insurance company wanting to sell a block can de-

94 HOW TO BUY STOCKS

press the price of the stock for the seller. Conversely, the
potential buyer doesn't show his hand publicly and run the
risk of bidding up the price.

While institutions are the principal sellers of large blocks,
sizable offerings are sometimes made by the directors, officers,
or prinicipal stockholders of a company. Such blocks often
pose a difficult problem for the broker. The Securities Act of
1933 provides that anyone selling shares on behalf of a control
person is acting as an underwriter unless a distribution is not
taking place. As a result, public sales of shares by a control
person may only be made by means of an effective registration
statement or S.E.C. Rule 144. The whole question of just who
is and who isn't a control person is not easily answered. Most
brokers approach this issue very cautiously and treat any
company executive or large shareholder as a potential control
person.

13

CHAPTER

How Small Orders Are Handled

ALL stocks bought and sold on the stock exchange are traded
by brokers on the exchange in round lots, units of 100 shares,
with the exception of a few relatively inactive stocks that are
sold in ten-share units.

But what if you want to buy or sell just twenty shares of
our hypothetical Rod & Reel Company on the exchange? The
answer is that you can buy or sell an odd lot  anything
from one to 99 shares  of any stock listed on the New York
Stock Exchange. But chances are that your cost of buying or
selling it, figured as a percentage of the total value of your
order, will be slightly higher than it would be on a round-lot
trade.

One reason for that is that brokers generally charge higher
commission rates on smaller orders. How much higher de-
pends on your broker. Generally speaking, you will find that
brokers who do a broad public basiness charge less to handle
an odd-lot order than do houses that cater to an exclusive
clientele or specialize in institutional business.

But there's a second reason why it will probably cost you
proportionately more to buy and sell odd lots. That is that
historically the odd-lot customer has been obliged to pay a
kind of service fee, over and above the commission. The
charge used to be mandatory under the rules of the New
York Stock Exchange. But on January 23, 1976, competition
entered the picture and the mandatory service charge rule
was broken. Thus, another time-honored monopoly was shat-
tered,

To understand the significance of that development, it is
necessary to understand just how the odd-lot system formerly
operated.

For many years there were two odd-lot brokers  Carlisle
& Jacquelin and DeCoppet & Doremus. They handled 99%
of all the odd-lot orders that reached the floor of the ex-

95

96 HOW TO BUY STOCKS

change. In 1969 they merged to form the firm of Carlisle,
DeCoppet & Company. This odd-lot brokerage Brm wasn't
really a broker at all. It was a securities dealer. If you
bought twenty shares of Rod & Reel, Carlisle, DeCoppet
would supply your broker with the twenty shares from its
own inventory. If you sold twenty shares, Carlisle, DeCoppet
would buy the odd lot from your broker and put it in its
inventory. If you ordered twenty shares of Rod & Reel, a^-id
Carlisle, DeCoppet didn't have it in its inventory, it would
buy a round lot of the stock, sell you your twenty shares, and
put the other 80 shares in its inventory  an inventory that
might run to many millions of dollars.

Under the rules of the exchange, as they existed just before
fixed commissions were abolished, the odd-lot broker had to
fill your market order for any stock at whatever price pre-
vailed on the next round-lot transaction after your order
reached the trading post. For this service the odd-lot broker
charged a fee, known as the odd-lot differential, which was
% of a point, or i2%(t a share, on every share of stock
bought or sold.

If you bought an odd lot, you paid % point above the
price at which the next round lot was sold after your order
got to the trading post. If you sold, you got % point less. At
an earlier time, the odd-lot differential had been % point on
stocks selling at $40 or above. Later that ^ point was
changed to apply only to stocks selling at $55 or more. The
odd-lot house never dealt directly with the customer, only the
customer's broker. In that sense, the odd-lot house was really
a broker's broker. Although in the sense that he was always
trading on his own account, positioning stocks, and buying
for, or selling from, his own inventory, he was a securities

dealer.

In January 1976, this time-honored system of charging an
odd-lot differential was challenged. Over the objections of the
stock exchangebut with the obvious blessing of the S.E.C.
 Merrill Lynch, Pierce, Fenner & Smith announced that it
would begin buying and selling odd lots out of its own inven-
tory and, in certain circumstances, would not charge the odd-
lot differential on market orders.

That was a serious blow to Carlisle & DeCoppet. Merrill
Lynch, which accounted for about a quarter of all odd-lot

HOW SMALL ORDERS ABE HANDLED 97

business on the exchange, was by all odds the biggest cus-
tomer of the odd-lot broker.

Here is what the Merrill Lynch plan offered the odd-lot
customer.

(1) If you place an odd-lot order on a given day and don't mind
waiting until your stock opens on the exchange the following
day, Merrill Lynch will fiD your odd-tot order at the price
that prevails on the first round-lot transaction. It will charge
you only its regular commission, no odd-lot differential.

(2) If you place an odd-lot market order for immediate execution
during a trading day, Merrill Lynch will execute it for you at
the bid or asked price then being quoted by the specialist in
your stock. It you are buying, you will get the asked price 
the lowest at which any round-lot owner is then willing to selL
If you are selling, you wiD get the bid price  the highest any
round-lot buyer is then willing to pay. Either way, you pay only
Merrill Lynch's regular commission, no odd-lot differential.

If you pick the first option, you realize a dear and obvious
saving of i2%(i a share. But you do have to wait for the next
day's opening to have your order executed. This could work
either in your favor or against you, depending on which way
the market moved after you placed your order. Almost a
quarter of Merrill Lynch's odd-lot customers appeared willing
to take this gamble in the first few months of the plan's
operation.

As for the second option, if the spread between the bid and
asked prices is only % of a point, as it often is on heavily
traded stocks, you have a 50-50 chance of saving that 12%^,
depending on whether the next sale takes place at the bid or
the asked price. Suppose Bod & Reel is quoted at 30% bid,
30-% asked when you give Merrill Lynch your order to buy
20 shares. Your order will be filled at 30%. If the next round-
lot sale takes place at that price, you will indeed have saved
yourself % of a point, the odd-lot differential you would have
had to pay under the old system. But if the next round lot is
sold at 30%, you come out even, for you paid just what you
would have under the old system; 30% pins % differential,
or 30%. So if the spread is only % of a point, and you trade
at the bid or asked price, you may or may not save money.

98 HOW TO BUY STOCKS

But at least you know you can't pay more than you would
have paid under the old system.

If the spread is more than % point, the odds on saving the
odd-lot differential aren't quite so good. Suppose Rod & Reel
were quoted at 30% to 30%. Your odd-lot order to buy
would be executed at 30%. The next round-lot transaction
would generally take place at any one of three prices  30%,
30%, or 30%. At 30%, you would lose %, compared to
what you would have paid under the old system. At 30%,
you would break even. At 30%, you would be % point ahead
of the game.

As the spread between bid and asked prices widens, your
chance of saving that odd-lot differential by trading on the
bid-and-asked prices diminishes. Thus, if the spread were %
point, you would have one chance of saving the odd-lot
differential, one chance of breaking even, and two chances of
paying more than you would have under the old system.

If the customer doesn't want to place an order to buy or
sell at the bid-or-asked price, he doesn't have to. He can insist
that his odd-lot order be executed in the traditional manner
 at whatever price prevails on the next round-lot sale. But
if he does, he will pay the standard % point differential.

As a matter of fact, this conventional method is the way
Merrill Lynch announced it would handle all odd-lot limit
orders  through Carlisle, DeCoppet. The execution of an
odd-lot limit orders differs from the execution of an odd-lot
market order in one particular. A buy order for 10 shares of
Rod & Reel at a limit price of 18% is filled on the next round-
lot transaction at 18%, so that when the differential is added
the buyer gets his stock at the 18% limit and the odd-lot
broker is assured his %. Conversely, an odd-lot sell order is
executed when a transaction takes place % above the limit
price.

The first reaction of the exchange, when it was faced with
this competitive threat from its single biggest member firm,
was to announce that it would buy out Carlisle, DeCoppet
and use its computer facilities to go into the odd-lot business
itself, relying on floor specialists to supply the required odd
lots from their round-lot inventories.

Then second thoughts set in. Maybe the Merrill Lynch odd-
lot system didn't pose as big a threat as it seemed to at first.
Maybe competition would be a good thing for- the odd-lot

HOW SMALL ORDERS ARE HANDLED 99

business- Maybe the old and new methods of odd-lot trading
could coexist. Or, if worse came to worst, the exchange itself
could adopt the Merrill Lynch system  something the ex-
change obviously had in mind. It had ordered Carlisle, De-
Coppet, even before it had actually acquired the firm, to
execute odd-lot orders at the market opening without charg-
ing a differential.

With Merrill Lynch competing for odd-lot business and
with the New York Stock Exchange handling odd-lot orders
itself, it appeared that even the small investor might get some-
thing of a break in the new era of competition.

How important is the odd-lotter in the overall brokerage
picture? One answer to that question is that he is both more
important and less important than he used to be. With the
great growth in the number of shareholders since 1950 he has
become numerically much more important Yet collectively
he has accounted for a steadily decreasing percentage of the
volume of total shares traded.

In the era that culminated in the bull market of 1929, the
little man represented almost 20% of stock exchange volume.
Twenty years later, odd-lot trading was still accounting for
about 15% or 16%. But from then on it headed pretty stead-
ily downward to a level of less than 10% in 1968 and below
5% in 1974. By 1981 it had fallen to'only 1.6%.

14

CHAPTER

Monthly and Other Accumulation Plans

UNTIL January 1954, the smallest amount ot stock anyone
could buy was one share. In that month, however, member
firms on the New York Stock Exchange initiated the Monthly
Investment Plan  commonly known as M.I.P.  under
which it became possible to buy a fractional share of stock, a
fraction figured out to the fourth decimal point. The plan
wasn't formulated, of course, just to permit an investor to
buy part of a share. It was designed to permit people to invest
a set sum of money every month  or every quarter if they
preferred  and to acquire for that money full of fractional
shares of any stock listed on the New York Stock Exchange,
except those few sold in ten-share units.

By the method of systematic saving and systematic invest-
ing inherent in the M.I.P, a person is able to acquire a worth-
while interest in the stock of some company on a regular
budget basis. He does not have to wait to become an investor
until he has acquired enough money to buy five or ten shares
of the stock.

The Monthly Investment Plan, in short, is geared to the
tempo of life today, since most American families are used to
settling their bills and making their installment payments on a
monthly budget basis.

M.I,P. is a method of buying stock by the dollar's worth,
regardless of how the price may change from month to
month, just as you buy $10 or $20 worth of gasoline, regard-
less of what the per-gallon price is.

In March 1976 the exchange announced that it was aban-
doning its sponsorship of the Monthly Investment Plan. But
many individual member firms continue to offer small in-
vestors the opportunity to buy stocks on an M.I.P. basis, or
through various accumulation plans of their own devising.
Men-ill Lynch, for example, offers its customers a "Share-
builders" plan, which is based closely on M.I.P. principles. In

MONTHLY AND OTHER ACCUMULATION PLANS   101

early 1982 Sharebuilders had over 400.000 accounts buying
stocks on a regular basis. The exchange withdrew its sponsor-
ship because it did not want to handle the business itself, as it
would have had to do after its acquisition of Carlisle, De-
Coppet & Co. That odd-lot house had handled 17,000 M.I.P.
plans for a number of small brokerage firms. Although Car-
lisle, DeCoppet's M.I.P. business was only 5% of all M.I.P.
business, it was more than the exchange wanted to deal with,
so it disowned its own brainchild.

Under M.I.P. types of plans, the buyer signs a "contract"
 it is actually nothing more than a declaration of intent 
with a member firm of the exchange. Under this contract the
buyer agrees to accumulate shares of a particular stock listed
on the exchange and to invest a regular sum of money every
month, or every quarter, toward the purchase of that stock.

Since M.I.P. contracts can be canceled by the buyer at any
time, and are so drawn that the buyer can skip payments
without penalty, they are in no sense binding or obligatory.

Here's how the plan works: suppose you want to buy
shares in Rod & Reel at the rate of $50 a month. Out of each
payment, the broker gets a commission, and with the balance
the operator of the M.I.P, plan buys whatever number of
full and fractional shares he can for you, at whatever price
prevails at the opening of the market the day after each
payment is received.

When the buyer doses out his M.I.P. contract, he gets a
stock certificate for whatever full shares he has purchased.
Any fractional share that may remain is sold at the prevailing
price and the proceeds remitted to the buyer. The broker may
levy a minimal extra charge for stock certificates representing
anything less than 100 shares.

Dividends become due and payable on all shares, including
fractional shares, from the moment any shares are bought
These dividends, as they are received by the broker, are cred-
ited to the customer's account and can be automatically ap-
plied to the purchase of additional shares. This is one of
M.I.P.'s unique features. The investor can automatically rein-
vest the dividends he collects in any one of the common
stocks available through M.I.P.

The small investor always pays the highest commission
rates percentagewise  and no investor can be smaller than
an M.I.P. customer. Still many brokers, since the arrival of

102 HOW TO BUY STOCKS

negotiated commissions> have shaved their charges on M.I.P,
business, partly to encourage new, small investors, and partly
because computerized operations have made it possible to cut
handling costs. Thus. Men-ill Lynch, Pierce, Fenner & Smith
cut its commission about 25%. Nevertheless, because they
may get a better commission break on purchases involving
larger dollar amounts, some M.I.P. customers let their funds
accumulate for three months, in order to buy bigger dollar
amounts on a quarterly basis.

No matter how high commission costs may be, M.I.P.
types of accounts have the advantage of helping investors
establish regular habits of thrift. Then, too, consistent buying
of the same stock provides protection for the small buyer in
the event of a decline in price. If he continues buying in the
same dollar amount while the price declines, the average cost
of all the shares he owns will be reduced. Then, if the market
rises again, he stands to make a tidy proBt. Of course, if he
stops buying in a downtrend and sells out when the value of
his accumulated shares is less than their purchase cost, he
will incur a loss.

In general, however, the "dollar cost averaging" technique
of buying stocks  buying a set amount of a certain stock or
stocks at regular intervals regardless of the current price of
the stock or general market conditions  has proven to be
one of the most successful methods of buying stocks over the
years, whether it is done within an M-I.P. format or by an
individual investor on his own. Because it eliminates the luck
involved in guessing periodic market swings, and concentrates
instead on the gradual accumulation of participatory posi-
tions in top-drawer companies at averaged prices over a long
period of time, it eventually rewards the patient investor in
quality stocks to a much greater extent than more random
trading patterns can.

The big reason M.I.P. caught on so well initially was that
in 1965 several brokers began pushing M.I.P. as a means by
which listed companies could initiate employee stock pur-
chase plans, on a voluntary, payroll-deduction basis. Hun-
dreds of companies joined forces with brokers to promote
such plans. Tens of thousands of their employees thus be-
came stockholders in their companies for the first time.

There is nothing new, of course, about company-sponsored
stock purchase plans. Many N.Y.S.E.-listed companies have

MONTHLY AND OTHEH ACCUMULATION PLANS   103

them in some form. But the M.I.P. angle has been particularly
attractive to many managements because the broker carries
the onus of selling the plan. Therefore the management feels
less responsible for the price action of its stock. The plan is
attractive to the employees because they acquire their stock
commission-free, since the company usually picks up the
commission tab. Also, the employee escapes payment of vir-
tually all fees charged for purchasing in small lots, since the
company purchases the stock for all the employee accounts
monthly in a single block.

In addition to sponsoring automatic stock purchase plans
for their employees, many publicly traded companies have
also begun offering their own Dividend Reinvestment Plans
(D.R.P.). In these plans dividends paid by the company's
stock are automatically used to buy additional shares of that
stock for the shareholder instead of being remitted directly to
that shareholder in cash. Some companies even offer dis-
counts up to 5% on the price of the stock being bought
through D.R.P/S.

Utilities have been the most frequent sponsors of Dividend
Reinvestment Plans. And the Economic Recovery Tax Act of
1981 made their plans even more attractive to investors when
it stipulated that an individual (but not a trust or an estate)
could exclude from taxable income up to $750 ($1,500 for a
joint return) of dividends paid by a public utility if the divi-
dends were reinvested in the utility's stock through a D.R.P.
The shares, however, would have to be held more than a year
to get the exclusion. When sold after a year, the capital gains
rate would apply.

Certain banks too have initiated accumulation plans or
variations of M.I.P. for the benefit of their customers. The
Chase Manhattan Bank, for instance, offers an Automatic
Stock Investment Plan through which depositors can agree to
have funds withdrawn automatically from their checking ac-
count each month and applied toward the purchase of any or
all of a selected list of stocks. The bank then combines the
funds that are allocated to particular stocks, makes bulk pur-
chases, and divides the shares up in proportion to individual
payments. The stock accumulation plans of other banks
operate in essentially the same way.

Since the Pension Reform Act of 1974 and the Economic
Recovery Tax Act of 1981 were signed into law Keogh Tax-

104 HOW TO BUY STOCKS

Shelter Retirement Plans and Individual Retirement Accounts
have become increasingly popular. The Keogh Plan permits
self-employed individuals to postpone payment of taxes on
15% of their earned income up to a maximum of $15,000
annually. The I.R.A. Plan allows persons earning wage and
salary income to postpone payment of taxes on $2,000 of
that income, even though they may already be participating,
through their employer, in another retirement program. The
income tax on such funds put into a Keogh or I.R.A. plan 
as well as taxes on capital gains and dividend or interest
income to be earned in the future  is deferred until the
person retires. Since his tax bracket then is likely to be a lot
lower than it was during his high-earning years, he will pay a
lower tax on all the money he set aside than he would if he
paid it when he earned it. Meanwhile, he has had the use of
all that money for years. The basic concept of the Keogh
and I.R.A. plans is to defer taxes as long as possible; to
build a nest egg for the future.

The growth of tailor-made accumulation programs and
other regular investment plans demonstrates the willingness
of investors to pay premium prices for new and special brok-
erage services offered in package form. The appeal of these
programs lies in their streamlined, automatic operation, and
in their minimum transaction costs.

Many M.I.P. investors have become regular brokerage cus-
tomers, having learned to accumulate money until they could
afford to buy an odd lot in a regular brokerage account. But
others, many others, have fallen by the wayside. They found
it easy to drop out of M.I.P. because there was no compul-
sion, actual or implied, to keep up their payments.

If M.I.P.'s performance has been somewhat disappointing,
reasons are not hard to find. Since M.I.P. began, the market
has been extraordinarily active. And brokers* sales representa-
tives are generally too busy attending to their regular cus-
tomers to undertake much missionary work on behalf of
M.I.P. It is no overstatement to say that M.I.P. is seldom sold
by the brokers, but rather it is bought by the customers.

There is a second explanation for the disinclination of
brokers to push M.I.P. Many of them feel that it is not right
to impose relatively higher commission rates on the investor
who characteristically is least able to pay them. On the other
hand, it can be argued that the high commission cost is

MONTHLY AND OTHER ACCUMULATION PLANS  105

Justified because America has to pay a price to leam thrift.
Consider the high interest rates charged for mortgage money,
as high as 20% in 1981-1982; indeed, the high rates tor any
type of loan. Consider the high carrying charges on all in-
stallment purchases. The pay-as-you-go person is used to pay-
ing both going and coming.

15

CHAPTER

Other ExchangesHere and in Canada

ALTHOUGH they differ somewhat in rules, regulations, and
operating mechanics, the other registered exchanges in the
United States function fundamentally the same way as the
New York Stock Exchange does.

In dollar volume, about 80% of the business is still done
on the New York Stock Exchange  the Big Board, as it is
called  with 2,220 common and preferred stocks listed on
January i, 1982. However, in recent years other exchanges
have been steadily increasing their volume  twenty-six years      ,
ago the New York Stock Exchange had 85% of total exchange
volume.

The American Stock Exchange has been this country's sec-
ond biggest stock exchange for generations. With 918 corn-      >,
panics represented, the Amex normally handles about an
eighth as large a volume as the New York Stock Exchange.      ii?
But, because the average price of its shares is much lower, it
accounts for only about one-tenth of the total dollar volume
in trading.

Rightly or wrongly, the American Stock Exchange has      ^
long been regarded as a kind of prep school for the New     ;

York Stock Exchange- Many important companies like Gen-     <-
eral Motors and the various Standard Oil companies got their      $
start on the Amex. But there are many other well-known
companies such as Honnel, Horn & Hardart, and Prentice-
Hall, which remain faithful to the American Stock Exchange.

Until 1953, the Amex was known as the New York Curb     ^
Exchange. It got this name from the fact that it actually      s
began as a curbstone market, first on Wall and Hanover
streets in New York City, and later on Broad Street. It re-      ^
mained an outdoor market until 1921, when it finally moved      ii
indoors, thus depriving the city of one of its most colorful      ^
spectacles. Before it moved inside most of its trading was      ^
done by hand signals. Orders were relayed to the brokers in     ^

106                                                            fc

OTHER EXCHANGES  HERE AND IN CANADA  10/

the street by shouts and whistles from the clerks perched on
the windowsills of their offices in adjoining buildings. Even in
its spacious headquarters today, far more modem than those
of the New York Stock Exchange, phone clerks relay their
orders to floor brokers by hand signals.

Included among the 661 members of the American Stock
Exchange are all of the nation's major brokerage firms. With
increased trading activity during the sixties, seat prices rose
steadily  to an all-time high of $350,000 in 1969. But the
market decline of 1973 hit the American Stock Exchange
hard, just as it did the Big Board, and seat prices tumbled to
$27,000the lowest since 1958. By 1982, however, the
price of an Amex seat had rebounded to $250,000.

The two New York exchanges operate in rather similar
fashion. On the American Stock Exchange odd lots were
always handled by specialists, just as they are now on the
New York Stock Exchange, instead of by an odd-lot broker.
An odd-lot differential was charged by the Amex until Janu-
ary 1976 when Men-ill Lynch, Pierce, Fenner & Smith went
into the odd-lot business and extablished a new schedule of
fees. The American Stock Exchange decided to meet that
competition at once and initiated the same rates as those
quoted by Merrill Lynch. If you want to place an order
through your broker for an odd lot on the Amex to be filled
at the opening on the following day, it will be filled at the
price of the first round-lot transaction in your stock, and you
will not be charged an odd-lot differential. If you place a
market order during the trading day, it will be filled at the bid
price in the specialist's book if you are selling, or the asked
price if you are buying. By paying the % point odd-lot differ-
ential, you can have your order executed at whatever price
prevails on the next round-lot sale. You also pay the %
differential if you place a limit order to be executed at a set
price. Because the average price per share is much lower on
the American Stock Exchange, a greater proportion of its
traders buy and sell in round lots rather than odd lots.

Although it was a price-manipulation scandal involving
two specialists on the American Stock Exchange that touched
off the whole S.E.C. investigation of the market and led to
the 1964 securities legislation, it must be said that this ex-
change moved more rapidly than the Big Board to put its
house in order and conform to S.E.C. standards of self-regula-

108 HOW TO BUY STOCKS

tion. The reforms were pushed through by the American
Exchange in 1963 as part of its complete reorganization
program.

The American Stock Exchange also moved more rapidly
than the New York Stock Exchange to automate its proce-
dures and to maximize computer application in the conduct
of business  including a stock-watch technique to spot un-
usual trading patterns. The American Exchange also installed
electronic equipment to speed reports of transactions from
the floor to the ticker before the Big Board did. Moreover, it
introduced its own market averages one month sooner, in
1966.

In 1975, the Amex scored another "Brst" when it intro-
duced trading in odd-lot quantities of certain United States
government securities on the floor of the exchange. It later
augmented this innovation with trading in government agency
issues. The Amex also provides a marketplace for all out-
standing issues of U.S. Treasury bonds and notes.

In a spirit of cooperation rather than competition, the two
big exchanges in 1969 announced that they would undertake
to combine many of their key services and computer opera-
tions. Not only did they consolidate their stock-clearing sys-
tems, but on the trading floors of both exchanges they de-
veloped ]'oint automation programs that can save member
firms an estimated $5 million annually in duplicate costs.

Such cooperative efforts naturally gave rise to a proposal
that the New York and American exchanges be merged into
one market. A study of the feasibility of such a merger was
given top priority by both exchanges in 1970. Although nei-
ther exchange expressed any great enthusiasm for the idea of
a complete merger, they did form the jointly owned Securities
Industry Automation Corporation in 1972 to consolidate all
their technical facilities and agreed to pursue still further the
idea of combining die two exchanges into one. However, in
July 1975, the death knell was sounded for the merger con-
cept when the Amex board of directors voted unanimously
against it. Still, no one would be surprised if the proposal was
resurrected someday.

The third biggest United States exchange, the Midwest
Stock Exchange, came into being in i949 when the Chicago
Stock Exchange undertook to effect a consolidation of its

OTHER EXCHANGES  HEBE AND IN CANADA lOQ

activities with those of other exchanges in Cleveland, St.
Louis, and Minneapolis-St. Paul.

Other regional exchanges include the Pacific Stock Ex-
change, located in both Los Angeles and San Francisco; the
Philadelphia Stock Exchange, which opened a Southeastern
Stock Exchange division in Miami in 1974; and the stock
exchanges in Boston, Cincinnati, Salt Lake City (Inter-
mountain Stock Exchange), and Spokane.

All of these exchanges are registered with the Securities
and Exchange Commission, which means that the S.E.C. has
approved their rules and regulations and adjudged them ade-
quate for the discipline of any member who violates his public
trust.

The regional exchanges were originally organized to pro-
vide a marketplace for the stocks of local companies. But as
these companies grew and acquired national reputations,
many of them wanted their securities listed on an exchange in
New York City, the nation's biggest money market. And as
the Big Board succeeded in luring many issues to New York,
the regional exchanges languished.

But in recent years the regional exchanges have managed
to turn the tables on the Big Board. They trade many of the
same securities that are listed on the New York Stock Ex-
change, and in recent years the amount of business they did
in these stocks accounted for 75% to 85% of their total
volume. It was a business that kept growing every day, and
local or regional types of issue account for less of their vol-
ume all the time.

To attract this business in Big Board stocks, the regional
exchanges either induced some N.Y.S.E. companies to list
their securities on one or more of the local exchanges as well
as on the New York Stock Exchange, or, if a company didn't
want to go to the expense of dual listing, made arrangements
to trade in those securities without formal listing. Such ar-
rangements have to be approved by the Securities and Ex-
change Commission. But in view of the S.E.C.'s determina-
tion to break up the Big Board's monopoly, such approval
has never been hard to get.

More than half of all Big Board stocks are now also traded
on one or more regional exchanges- In the main, these are the
most popular stocks, those that account for over 80% of Big

110 HOW TO BUY STOCKS

Board volume. (The American Stock Exchange has not been
able to share in this dual trading bonanza because, under
S.E.C. rules, a stock cannot be traded on two exchanges in
die same city.)

The reason for the great growth of trading in Big Board
stocks on the regional exchanges traces back to old Rule 394
of the New York Stock Exchange. This is the rule that for
years forbade a member firm to split commissions with' a
nonmember.

Formally, when a securities dealer who did not belong to
the Big Board had a sizable block of some Big Board stock to
buy or sell, he often arranged to have the order executed on a
regional exchange by a firm that had memberships both on
the Big Board and on the regional exchange and that under-
took to develop the other side of the order  finding a pur-
chaser to match the dealer's sell order or a seller to match his
buy order. The nonmember dealer and the member firm split
the commission, and everybody was happy. Everybody except
the New York Stock Exchange.

A 1965 amendment to Rule 394, permitting Big Board
member firms to deal with nonmembers, made it seem likely
that some of the regional exchange business in Big Board
stocks would dry up. But such was not the case. Under the
1975 securities law, the Big Board and all other exchanges
were required to scrap any rules that restricted off-board trad-
ing by member firms.

Though the Big Board offered to ease Bute 394 in an
attempt to offset more radical moves by the S.E.C., the com-
mission turned a deaf ear and set a deadline of April i, 1978'
for lifting all restraints on the freedom of a member firm to
execute a customer's order for a Big Board stock wherever he
pleasedin the over-the-counter market, on a regional ex-
change, or on the New York Stock Exchange.

Additionally, much of the competition that faces the New
York Stock Exchange comes not only from the regional ex-
changes in the United States but from the exchanges north of
the border, where the big boom after World War II stimu-
lated worldwide interest in the ownership of Canadian stocks.

Of the five Canadian exchanges, by far the largest is the
Toronto Stock Exchange. From the standpoint of dollar vol-
ume, Toronto does more than twice the business of all the

OTHEB EXCHANGES  HERE AND IN CANADA  111

other Canadian exchanges combined. Almost 30% of its
business is in securities listed on the other Canadian ex-
changes as well. In 1981, the Toronto Stock Exchange
ranked fourth among all North American exchanges in dollar
volume.

The other Canadian exchanges are in Montreal, Calgary,
Vancouver, and Winnipeg. Interest in ofl and mining shares
runs especially high in western Canada, while industrial
shares are still the prime attraction on the more staid market
in Montreal.

In the main, stocks are traded on the Canadian exchanges
much as they are in the United States. But there are several
significant differences.

For one thing, floor trading in Canada is not restricted
exclusively to member brokers. Thus, on the Toronto Ex-
change, authorized nonmember brokers are entitled to split
commissions. There are also significant differences in the
units of trading. On the Toronto Stock Exchange, stocks
selling at less than ioi a share and those selling at more than
10^, but under $1, are traded in units of 1,000 and 500
shares, respectively. If the price is at least $1 but under $100,
the trading unit is 100 shares. Stocks selling above $100 are
traded in ten-share units. All of these different units are
known as board lots, rather than round lots.

Moreover, the minimum allowable price fluctuation is not
% point (12%^), as on the New York Stock Exchange. On
stocks selling below 50^, the minimum spread is %i', at more
than 50^ but under $3, it is i^; at more than $3 but under $5,
it is 5^; at $5 and over, it is 12%^.

Odd lots are also bought and sold in Toronto, but they are
called broken lots. Whether a particular order is classified as
a broken lot or a board lot depends on how many shares
constitute a board lot of that particular stock.

If a floor broker has a broken lot to sell, he cannot look to
either an odd-lot dealer or a specialist to help him, for there
are none on the Toronto exchange. He turns instead to a
registered trader, the nearest equivalent to a specialist. A
registered trader has the responsibility for maintaining a mar-
ket in certain stocks, and a broker with a broken-lot order
on his hands can compel the registered trader in that stock to
take it off his hands. If it is a buy order, the registered trader

112 HOW TO BUY STOCKS

must supply the stock at the current quotation, plus a
premium. If it is a sell order, the trader must buy the stock,
but he is allowed a discount from the current quote.

Canada does not have a national agency like our S.E.C. to
regulate its securities business. Instead, each province has
its own commission. The control these commissions have ex-
erted over the securities business has been something less
than rigorous. As a consequence, boiler shop operations, in-
volving the sale of questionable oil and mining stocks, flour-
ished in Canada for many years. Typically, a promoter of
such a stock would offer an unsuspecting prospect the
"chance of a lifetime" to buy some new issue of stock at a
price below that at which it was presumably scheduled to be

offered to the public,

The promoter would try to high-pressure the prospect by
long-distance telephone, assuring him that he had to "act
now" if he wanted to get in on the ground floor. He would
glibly cite "engineers' reports" that established the value of
the mineral deposit or oil field that the new company in-
tended to work. The prospect would rarely be able to lay his
hands on a copy of any such report, much less a prospectus.
As a matter of fact, whether or not the company actually
proceeded with its venture often depended on how many
suckers the promoter was able to sell his scheme to.

Many of these boiler shops used to operate in Ontario and
prey on prospects in Boston, New York, and other big eastern
cities. But they have generally been put out of business as a
result of the Ontario Securities Acts  enacted in 1966 and
1970 as a result of widespread public complaints.

But there's always a chance that you'll be invited someday
to buy a block of stock at a bargain price in the Pipe Dream
Mining Company. If you are, check with some reputable
broker first. Don't worry about missing out on your big
chance by failing to say yes right away. If the stock is worth
buying, it will be as good a buy tomorrow as it was today.

16

CHAPTER

How the Over-the-Counter
Market f^orks

IF you can buy the stocks and bonds of only a few thousand
companies on the registered stock exchanges, where can you
buy or sell the securities of the tens of thousands of other
companies that exist in this country?

Where, for instance, would you have bought the stock of
the Rod & Reel Company in the days when it was growing
up, before it could ever hope to be listed on any exchange?

The answer is that you would have bought it in the over-
the-counter market, the place where all unlisted securities are
traded. Actually, this market isn't a place. It's a way of doing
business, a way of buying or selling securities other than by
trading them on a stock exchange. Buying interest is matched
with selling interest, not on a trading floor, but through a
massive network of wires linking thousands of securities firms.

The over-the-counter market is difficult to define or de-
scribe, because transactions that take place in this market
have few common characteristics.

You might, for instance, conclude a purchase or sale with
a securities dealer who operated a one-man shop in a small
town. Or you might deal with a large securities firm in Wall
Street that used the facilities of the over-the-counter market
to trade large blocks of stock at lower cost.

You might buy an unlisted stock, or one that is regularly
traded on the Big Board, the Amex, or a regional exchange.

You might buy a security that the dealer himself owned
and sold to you from his inventory, or you might buy a
security that he bought from another dealer just to fill your
order.

You might pay a negotiated commission, or you might pay
a flat price. You might buy a highly speculative $2 stock in
some little-known company, or you might buy the stock of

113

114 HOW TO BUY STOCKS

such well-known corporations as Chubb Corporation, Tarn-
pax, or U.S. Sugar. You might even buy stock in some well-
known foreign company by purchasing an American Deposi-
tary Receipt. (An A.D.R. certificate is simply the evidence
that the shares you bought in such a foreign company are
deposited to your credit in a foreign office of an American
bank or one of its correspondent banks abroad. Such cer-
tificates are traded in the over-the-counter market  only a
few are listed on the exchanges.)

You might buy the initial stock offering of a new company
like Rod & Reel, for this is where all companies first offer
their securities to the public. Or you might buy stock in a
bank that has paid dividends for over 190 years  fifty years
longer than any New York Stock Exchange security. The
stocks of all but a score of major banks are bought and sold
exclusively in the over-the-counter market, as are virtually all
insurance company stocks.

Finally, your over-the-counter transaction might not in-
volve stocks at all. It might involve the purchase or sale of a
bond. More than 99% of all United States government
bonds, all municipal bonds, and the great bulk of corporate
bonds are traded in the over-the-counter market, not on the
exchanges.

The over-the-counter market is, indeed, all things to all
men, whether they be conservative investors or wild-eyed
speculators, and whether they have millions 01 simply hun-
dreds of dollars to put in the market.

Despite the diversity of this market, all over-the-counter
transactions have about them one common characteristic.
The price arrived at in any transaction is not determined by a
two-way auction system, such as prevails on a stock ex-
change. It is arrived at by negotiation  negotiation between
the securities dealers on both sides of the transaction, and
further negotiation between one of those dealers and you, his
customer.

Probably the most common kind of over-the-counter
transaction is one that takes place on a net price basis. A net
trade is one in which no commission is charged. Instead of
a commission, the securities dealer expects to make a profit
by selling the stock to you at more than he paid for it, or by
buying it from you at less than he expects to get by selling it
to somebody else.

HOW THE OVER-THE-COUNTEB MARKET WORKS  115

Suppose you got interested in Rod & Reel when it was a
new company and decided you would like to buy 50 shares of
it. You can buy any number you like in the over-the-counter
market, because there are no round lots or odd lots  no
standardized trading units.

Now, it might happen that the securities dealer to whom
you gave your order was able to fill it from his own inven-
tory, since he had bought some shares recently from another
customer. Thus, he would be able to quote you a price and
conclude the sale on the spot.

At the time you made that purchase the prevailing quote
might have been 18 bid, offered at iS^. Your dealer might
quote you that same offering price of $18.50 a share. Or he
might offer it cheaper, say $18.25, if he were anxious to move
it out of his inventory, especially if he had been able to
purchase the stock at $17.00 or $17.50 originally.

Now, let's suppose he doesn't have 50 shares of Rod & Reel
in his inventory. He would have to buy the stock from an-
other dealer in order to fill your order. So he checks with
other dealers and finds that the lowest price at which he can
buy the stock is 18%, or $18.25. That's the price to him, the
price one dealer quotes another. Such a price is called the
wholesale price or dealer price  sometimes the inside price.
It is not the price at which he will sell the stock to you. That
price, the retail price, might be $18.75 or $19.00 a share,
perhaps even more. The difference between what he paid the
other dealer for the stock and the price he charges you is his
markup. Since this is a net trade, it is this markup that he
takes, instead of a commission, as his profit on the transac-
tion.

If you were selling the stock instead of buying it, the dealer
would simply reverse the procedure. If he knew that ifPA
was the best inside price, the highest price at which another
dealer would take the stock off his hands, he might offer to
pay you 17% or 17'!^ for your stock. The difference, or
markdown, would represent his profit-

Of course, once he bought the stock from you, the dealer
might decide not to sell it. Instead, he might decide to hold it
in his inventory. In such a case, he would be said to be taking
a position in the stock. If he then began to trade the stock
actively, buying and selling it in substantial volume, he would
be making a market in the stock.

116 HOW TO BUY STOCKS

Price differences or spreads between the wholesale and re-
tail, such as those on your Rod & Reel transaction, are fairly
typical of spreads on net trades of low-priced stocks that
aren't too well known in the over-the-counter market. If you
were buying or selling one of the actively traded stocks in the
market, the spreads between the retail and wholesale prices
might narrow to 14 point on low-priced stocks. The differ-
ence between the bid and asked quotations might be only %

point.

On the other hand. if the over-the-counter stock you
wanted to buy or sell was almost unknown, if it did not enjoy
any public market to speak 'of, there might be a spread of a
full point or more on the wholesale market and of several
points between the retail bid and asked quotations.

Suppose, for instance, you were in New York and wanted
to dispose of some stock you owned in a little lumber com-
pany out in Oregon, a company that was virtually unknown
outside its hometown. Your dealer would try to find a bid tor
the stock by contracting other dealers, principally in New
York, where most dealers are located. He might then try his
luck in Chicago or San Francisco or Portland by calling or
teletyping dealers in those cities. Ultimately, to promote a
bid, he might wire or phone local banks in the area to see it
they knew of any possible buyers. He might even phone the
company itself to see if it wanted to buy back any of its own
stock. For such special service the dealer is obviously entitled
to an extra profit.

In ordinary transactions, trades that involve no special
effort on the part of the dealer and in which he assumes no
risk, the National Association of Securities Dealers
(N.A.S.D.) has long taken the stand that the dealer should
restrict his markup to a maximum of 5%. Thus, if the inside
market for Rod & Reel were 19 bid, offered at 20, when you
placed an order to buy, your dealer would be entitled to mark
the offering price up 5%, or i full point. His retail price to
you could be $21 a share ($20 plus 5%), Another dealer
might have quoted you a retail price of $20.50 or $20.75. But
this is not something you are likely to know unless you shop
around. The S.E.C. has long looked with disfavor at that 5%
markup on a riskless transaction and feels that the customer
should demand that his dealer reveal the amount of his
markup. As a result, some securities firms now voluntarily

HOW THE OVEB-THE-COUNTER MARKET WORKS  117

disclose the amount of their markup on the trade confirma-
tions that they send their customers.

Remember, when you buy a stock from a dealer on a net
price basis, you are negotiating or bargaining with him. You
are asking, "How much will I have to pay?" And the dealer,
in effect, is asking, "How much will you pay?" He is not
acting as your broker or agent, trying to buy or sell some-
thing for you at the best price possible, plus a commission-
He is dealing with you as a principal in the trade. As a dealer,
he doesn't collect a commission; he expects to make a profit
on the price you are willing to pay.

While the great majority of over-the-counter transactions
are handled on a net price basis, it is possible, especially if
you are dealing with one of the big national brokerage firms,
to buy or sell over-the-counter securities on an agency basis.
Operating as an agent, your broker would seek the best pos-
sible inside price. He would buy or sell the stock tor you at
that wholesale price and charge you a commission, just as he
would if he were buying or selling a stock on an exchange for
you. The commission he charges is usually the same as he
would charge for buying or selling the same number of shares
at the same price on an exchange.

In the big brokerage firms, over-the-counter business is
handled by a separate trading "department located in the
headquarters office. But sales representatives in the firm's
offices across the country still handle orders for both stock-
exchange and over-the-counter securities. Most firms that
operate both as dealers and as brokers usually make a market
in a specified number of over-the-counter stocks. That num-
ber may run into the hundreds in the case of really big firms.
If you buy or sell one of these stocks, the transaction will
almost certainly be handled on a net price basis. On other
over-the-counter stocks in which the dealer does not make a
market, he is generally willing to act as your agent or broker
in concluding a trade.

Whenever you buy an over-the-counter stock, you may
wonder whether your dealer really did get the best possible
inside price for you. Nowadays, you can get a dear-cut,
instant answer to that question if you are buying or selling
any one of the several hundred most popular and widely held
over-the-counter stocks. You merely consult the automated
quote system developed in the late sixties by the Bunker

118 HOW TO BUY STOCKS

Ramo Corporation, a company specializing in quotation
equipment for the securities business, and the National As-
sociation of Securities Dealers, the industry's self-regulatory
agency. The N.A.S.D, represents over 4,000 dealers in the
over-the-counter market and operates under the authority of
the Securities and Exchange Commission.

Before the development of the National Association of
Securities Dealers' Automated Quotation System, popularly
known as NASDAQ, there was no way a dealer himself could
be absolutely sure that he was getting the best possible price
on a particular stock. There was no way he could know all
the firms throughout the country that might be making a
market in the stock or what their current price quotations
were. He might be able to contact the principal market-
makers in New York and Chicago, maybe even San Fran-
cisco. But at any given time some dealer in Cleveland or
Atlanta or Denver might be making a better market in the
stock.

For a long time, the National Quotation Bureau has pro-
vided at least a partial solution to that problem. Every day
this privately owned price-reporting service publishes in its
pink sheets the wholesale prices of more than 10,000 over-the-
counter stocks and half as many bonds. These are the prices
at which hundreds of different dealers are currently buying or
selling various securities in trades between themselves.

Any dealer who wants to have his prices quoted in the pink
sheets simply supplies them to the bureau every afternoon.
The quotation sheets are pnnted overnight and distributed
nationwide prior to the opening of the N.Y.S.E. Since any
dealer who has an important position in a stock wants to
stimulate inquiries about it from other dealers, the pink sheets,
subscribed to by almost every important dealer in the coun-
try, render a valuable service- In its study of the over-the-
counter market however, which preceded the 1964 Securities
Acts Amendment, the S.E.C. expressed its concern about
how dealers used  or abused  the pink sheets.

The S.E.C. wants to be sure that every dealer stands behind
the prices he announces in the sheets, that they are not used
to create a false impression of value or market activity. If a
dealer announces a price he is willing to pay for a given
stock, he may get away with a refusal to buy the stock that is
offered to him at his annnounced bid on any one particular

HOW THE OVEB-THE-COUNTEB MABKET WORKS  119

dayhe might defend himself by saying that the market
had moved away from his bid  but if he publishes the same
price the next day, he has to take any stock offered to him at
that price or run the risk of having an official complaint
lodged against him.

When the 1964 act was under consideration, the commis-
sion made it clear that it felt automation was in order for
the over-the-counter market. It wanted a computerized elec-
tronic system, operating on a national scale, which would
assure a more accurate and rapid exchange of price and
market information. And that is how NASDAQ was born.

Beyond question, NASDAQ has revolutionized the over-
the-counter business. By hooking dealers together in one wire
system, capable of providing exact, instantaneous wholesale
price quotations from all dealers who make markets in impor-
tant over-the-counter stocks, NASDAQ has virtually elimi-
nated the vast jumble of telephone wires on which the busi-
ness previously depended. NASDAQ has become, in effect, a
new kind of securities exchange in which the computer and
assorted electronic gear constitute a 3,ooo-mile-long trading
floor stretching from coast to coast, to which securities deal-
ers in some 6,000 offices have immediate access.

NASDAQ began its operations by supplying bid-and-asked
quotations on 2,500 over-the-cdunter stocks. It has been
gradually increasing that number ever since. It will not put
any stock into the NASDAQ System however unless there are
at least 100,000 shares in the hands of 300 or more stock-
holders, and unless the company has total assets of at least $1
million and net assets of a half-million.

At any time during the trading day, a market-maker can
feed into NASDAQ the price at which he is willing to buy a
particular stock and the price at which he is wOling to sell it,
changing these quotations during the day as competition dic-
tates. NASDAQ records all these thousands of different
entries in its memory bank. Whenever a dealer wants to know
at what price other dealers will buy or sell a stock, he simply
turns to his NASDAQ machine.

NASDAQ provides different levels of service. Level i is a
quote machine for the use of securities salesmen. Simply by
pushing buttons for the alphabetical symbol of the stock on
his desk-model machine, the salesman can get a representative
bid price and a representative ask price on that stock. The

120 HOW TO BUY STOCKS

data appears on a small fluorescent screen, which is part of
the machine. The representative bid is the median wholesale
bid of all the firms making a market in the stock. Thus, if five
dealers quoted bids on a particular stock of 40, 4014, 40^,
40%, and 41, the representative bid would be 40%.

If a customer finds a representative quotation to his liking,
he may decide to make a purchase or a sale. With the order
in hand, the salesman now turns to the Level a machine in
the trading department. Again, by punching out the stock
symbol, he gets the actual quotes of five firms making a
market in that stock. The names of those firms are shown
beside their quotes on the screen. There may be fewer than
five market-makers in the stock, but if there are more than
five, the indication MOR appears on the screen. When the
MOR button is pushed, the bid-and-asked quotes of the ad-
ditional dealers, ranked in order of best price, appear. Once a
trader knows what firm offers the best quotation, he contacts
that market-maker by phone or wire and concludes the
purchase of sale in the usual manner. All trades in over-
the-counter securities are settled and cleared through the
National Clearing Corporation (N.C.C.), a wholly owned
subsidiary of the N.A.S.D. The N.C.C. has facilities in numer-
ous major cities to serve hundreds of clearing members.

The N.A.S.D. does not attempt to dictate what the spread
should be between bid and asked prices on any stock. It
leaves that to be determined hy the competition of the mar-
ketplace. But, the automatic quotation system is geared so
that each time a market-maker enters a bid-and-asked quota-
tion it is checked by computer against the "representative
spread"  the average spread of other market-makers in that
security. If this representative spread is half a point and the
market-maker enters a spread that is a point or more, he is
notified instantly that his spread is excessive. This report of
excess spread is forwarded from the computer to the
N.A.S.D., which may then take disciplinary action against
the market-maker.

A company whose stock is included in the NASDAQ sys-
tem generally must register under the Securities Exchange
Act of 1934 and meet the same disclosure requirements as a
listed company. Furthermore, there must be at least two deal-
ers who make a regular market in the stock, and each dealer
must have a net capital of $25,000, or $2,500 for each se-

HOW THE OVER-THE-COUNTER MARKET WORKS  121

curity in which he is registered as market-maker whichever is
more.

Once he registers with the N.A.S.D. as a market-maker in
a stock, a dealer must be willing to buy it or sell it at any time
and announce through NASDAQ the prices at which he will
trade.

Perhaps the single most dramatic new development the
S.E.C. initiated with the 1964 act was the newspaper publica-
tion of more accurate and dependable quotations on over-the-
counter stocks, thanks again to NASDAQ.

Over-the-counter quotes were not  and are not today 
actual prices. They have always been only indications of the
price range within which the customer might then expect to
trade. Prior to 1966, quotes on the bid, or buy, side furnished
to newspapers by the National Association of Securities Deal-
ers were always reasonably accurate. But the asked, or of-
fering, prices were characteristically inflated by 4% or 5%,
sometimes even more. Thus, a stock with a published quote
of 21 on the asked side might actually have been available at
20  and the customer who was asked to pay only 201^
would be delighted at the "bargain" he thought he got.

The S.E.C. took a dim view of this practice, and after a
bitter fight with many small dealers in the industry, the com-
mission forced the daily publication of more realistic quotes
on the 2,500 stocks with national or regional markets. As a
result, virtually all prices for over-the-counter stocks that are
now published in newspapers are reliable quotes, not inflated
on either side. Throughout the trading day, NASDAQ re-
leases to the press lists of closing representative bid-and-asked
quotations for all issues quoted in NASDAQ. These lists also
indicate the trading volume and the price change, if any, in
the bid from the previous day's close,

Quotations and trading volume figures for securities on the
national NASDAQ list (approximately 1,400 issues) are pub-
lished in more than 200 newspapers across the country. In
addition, over 130 local N.A.S.D. quotations committees se-
lect securities with local investor interest, and newspapers are
supplied with additional NASDAQ quotes on these. The
NASDAQ system also computes a number of market indexes
and trading statistics, which are furnished to newspapers and
radio and television stations.

In addition to the publication of reliable wholesale quotes,

122 HOW TO BUY STOCKS

many other reforms have flowed from the enactment of the
1964 and 1975 legislation. One of the most important is the
requirement that companies whose stocks are sold over-the-
counter (except insurance companies, which are regulated by
state insurance commissions) must make annual reports to
the Securities and Exchange Commission, and to their share-
holders, if they have assets in excess of $1 million and more
than 500 stockholders.

One of the chief benefits of the S.E.C.'s long-envisioned
central securities market, which would link stock exchanges
and the over-the-counter market, is a composite quotation
system for securities transactions. At the S.E.C.'s request, the
exchanges eliminated the rules and practices that formerly
restricted the use of stock quote information. Thus, the con-
solidated quotation service was introduced in early 1977 and
expanded in 1978.

Slowly but surely over the years, the Securities and Ex-
change Commission has forced on the over-the-counter
market most of the regulations that have long been imposed
on stock exchanges and their member firms. Thus, provision
has been made for the regular inspection of all dealer organi-
zations by the N-A.S.D., with authority to compel compli-
ance with all rules and regulations. Salesmen of both member
and nonmember firms must take tougher examinations, and
controls have been established to assure the honesty of ad-
vertising and sales literature.

Since the 1964 act gave the S.E.C. the authority to suspend
trading in any over-the-counter stock for ten days, it now has
the necessary power to control the so-called hot issues. These
are the over-the-counter stocks, often little-known, which in
past bull markets have skyrocketed in price in a relatively
short time, only to plummet back to their starting point, or
lower, just as rapidly, without any provable price manipula-
tion.

Intent on preventing such disorienting price swings, the
Securities and Exchange Commission has been using a com-
puter since 1966 to help it police its over-the-counter beat.
The computer ma^es regular surveys of the market. It can
scan 32,000 quotations in 90 minutes. Regularly, it turns up
300 or 400 suspicious price jiggles, sharp rises or drops that
suggest the need for further investigation. In each such case,
the computer supplies the name of the dealer involved. Unless

HOW THE OVER-THE-COUNTER MARKET WORKS  123

Ae investigation proves there was sufficient reason for the
price movement, that dealer becomes a marked man. From
then on, his name can be fed into the computer regularly and
all his trades subjected to close scrutiny.

Despite this improved climate of regulation, the phrase
"over-the-counter" will probably continue to suggest to some
investors the kind of questionable dealing associated with the
phrase "under-the-counter." The unfortunate term "over-the-
counter"  which goes back to colonial times, when the few
securities that existed were often traded by a merchant, just
like his other merchandise, right over his store counter will
not die, despite concerted efforts to substitute other terms,
such as unlisted, or off-board, or off-exchange.

However, as more people have become familiar with the
over-the-counter market and come to have more confidence
in it, thanks to S.E.C. reforms, its business continues to in-
crease. Nowadays share volume in the over-the-counter mar-
ket is apt to be a third of Big Board volume, although the
dollar value of shares traded is apt to be somewhat less than
on the Big Board because of the lower-priced stocks.

Because the over-the-counter market is essentially a ne-
gotiated market instead of an auction market like the New
York Stock Exchange, day-to-day price fluctuations may not
be as pronounced. But the long-term trend is usually pretty
much the same in both markets,

17

CHAPTER

Investingor What's a Broker For?

SUPPOSE you decide that the time has come for you to put
some of your extra savings into securities. What do you do
next? How do you go about buying stocks or bonds?

You might go to your local banker and ask him how to
proceed. He'll know several investment firms in your general
community and probably at least one broker in each of them.
But don't forget that the banker is actually in competition
with those security houses for your savings. He is quite apt to
look with a jaundiced eye on your buying securities rather
than adding to your savings account or employing your
money in other ways through his bank  by its investing in a
local business, real estate, or mortgages, for example.

Most bankers are extremely conservative. It's their business
to be. When it comes to investing the bank's own money,
they have been legally compelled to confine investments
largely to government and other high-grade bonds. They may
have little familiarity with stocks and understandable misgiv-
ings about them. They don't realize that an individual in-
vestor's investment problem probably differs considerably
from a bank's.

This is apt to be true of lawyers too. They are likely to be
almost as conservative, because they think of investments
principally in their roles as trustees, individuals legally re-
sponsible for the administration of estates and the preserva-
tion of the capital in those estates,

So where else may you turn for help if you want to buy
securities?

The ultimate answer to that question is to a broker, be-
cause a broker is obviously the one person best qualified to
help you with your investment problem. That's his whole
business. If you don't know the name of a broker, one or
your friends or associates surely does. And if you don't want
to ask, look in the financial section of your daily newspaper

124

INVESTING  OR WHAT'S A BROKER FOR?  125

or the Wall Street Journal or the Sunday New York Times,
where you'll find many brokers' advertisements. Study those
advertisements for a while. Decide which firms have the kind
of policy you like and the service you need. Then visit the
firm. You don't need a letter of introduction.

But can you trust broker's advertising? After all, advertis-
ing is always special pleading, notoriously given to overstate-
ment, exaggeration, and excessive claims. While that may be
generally true, you can place much greater confidence in
brokers' advertising than you can in the advertising of virtu-
ally any other product or service. This is equally true of all
their sales promotion literature. Almost all member firms
submit their advertising and their sales literature to the
scrutiny of their own legal counsel, as well as to the ex-
change, because any misstatement in such promotional ma-
terial can subject a broker to expensive lawsuits.

In the early sixties when the S.E.C.'s study of the securities
industry pointed up the need for many reforms, the exchange
tightened up its regulation of advertising and all other forms
of communication, spelling out its standards in meticulous
detail. Specifically forbidden is language that is promissory or
flamboyant or that contains unwarranted superlatives; opin-
ions not clearly labeled as such; forecasts or predictions not
stated as estimates or opinions; recommendations that cannot
be substantiated as reasonable; testimonials; boasts about
the success of past recommendations unless they meet a set of
exacting requirements; and any evasion of a broker's re-
sponsibility to disclose special interests he might have in a
security he recommends.

Shortly after the exchange adopted its standards, the Na-
tional Association of Securities Dealers adopted roughly sim-
ilar regulations, which apply to all over-the-counter dealers in
that association. Both the N.A.S.D. and the exchange are con-
tinually tightening those regulations  strictly enforcing
them and adding new ones. They can't afford not to.

Still, lots of people shy away from brokers for a variety of
reasons. Some of them feel embarrassed about the small
amount of money they have to invest. Maybe they have only
a few hundred dollars to put into stocks, perhaps only $40 or
$50 a month. They figure a broker wouldn't be interested.

Maybe some brokers wouldn't be. But the big wire houses
have been spending millions of dollars in advertising every

126 HOW TO BUY STOCKS

year to tell the smaller investor that they definitely are inter-
ested in him and in helping him invest his money wisely.

Still people hesitate. Perhaps they think of the broker as a
somewhat forbidding individual who gives his time only to
Very Important People, people who are well heeled and travel
in the right social circles. That's not true. There's nothing ex-
clusive about the brokerage business today.              ,

Another thing that stops a lot of people is the jargon that
brokers talk. You know now that there's nothing mysterious
about words like "debenture" or "cumulative preferred."
True, they're specialized words, because they apply to very
specialized things. But there's nothing difficult to understand
about either the words or the things they stand for, if you
take the trouble to learn them.

Finally, some people shun brokers because, frankly, they
distrust them. They're afraid of being sold a bill of goods, a
block of stock in some worthless company. That used to
happen occasionally. Nobody can deny it. Maybe it happened
to people you know  your father, your uncle, some other
member of your family.

Can it happen today? Yes, it can. Because no law or regu-
lation has ever been devised that can guarantee that some
dishonesty will not exist in the marketplace. Occasionally 
very, very occasionally  you may still encounter a con art-
ist in the securities business intent on unloading some stock
on you so he can run the price up and then sell out his own
holdings at a fat profit, leaving you to hold the bag when the
price subsequently plummets.

Occasionally  but again, very occasionally  you might
be sold such a stock at a highly inflated price by a thoroughly
honest but somewhat naive or irresponsible broker who him-
self has been taken in by the propaganda con artists always
spread. The S.E.C. and the exchange are constantly on the
alert to track down and scotch such false and misleading Ups
or rumors. Their circulation is a clear-cut form of illegal
price manipulation or outright fraud. But, alas, brokers 
like all human beingscan fall prey to propaganda that
promises an easy dollar.

A broker may logically and legitimately try to sell you on
the idea of buying a particular stock because he believes in it.
But unless his firm is involved in underwriting or selling a
large block of that stock, he hasn't any selfish reason to try to

INVESTING  OR WHAT'S A BROKER FOB?  127

sell you that particular stock rather than another. His only
reward is a percentage of the commission his firm charges.
And there is usually not much difference in the commissions
generated when you buy one stock rather than another. So it
doesn't matter to your broker which stock you buy.

Of course, when you buy stocks on a net price basis 
over-the-counter stocks  there is more chance that you can
be sold something the dealer has an interest in unloading at a
profit.

And there is always the outside chance that you will come
across the occasional unscrupulous broker who is more inter-
ested in the level of activity in your account than in the
quality of the transactions that activity represents. Such
brokers do not care what you buy or what you sell as long as
you buy or sell something, and do so often enough to keep
the commission dollars rolling their way. Such cnurm'ng is
usually easy to spot, as when a broker frequently calls his
customer to recommend the sale of a stock the purchase of
which he had advocated only a short time ago. Churning
occurs most frequently in discretionary accounts, accounts in
which individual investors have given complete trading au-
thority over to the broker.

None of these abuses occurs often. Few businesses are as
competitive as the American securities business. Every broker
and dealer in the country is anxious to get customers and
keep them for a good many years to come. In that kind of
situation there's not much room for the second-story operator
who plays fast and loose with the customer's best interests.

Credit the Securities and Exchange Commission, if you
wish. Or credit the stock exchange's own housecleaning. Or
credit the moral influence of healthy competition-
But credit also the fact that the people in the securities
business are, in the vast majority, individuals of conscience
and probity, responsible to a standard of ethics as high as
prevails in any business you can name.

What it all comes down to is this: the safest way to begin
investing in stocks is to choose some listed stock through a
member firm of the New York Stock Exchange. Then study
that stock, and the company behind it, before you buy.

It there's no member firm near you, you can write to one
and buy by mail. You should request a copy of the broker's
commission schedule and inquire about possible extra charges

128 HOW TO BUY STOCKS

what they are for, and what added cost they could mean
to you.

You can also order stock through virtually any bank or
securities dealer in the country. You will probably have to
pay an additional handling charge if you make your stock
purchases this way. Such a charge is wholly legitimate.

One last word of caution: if any broker or securities dealer
tries to dissuade you from buying stock in some well-estab-
lished company, if he tries to switch you into Wildcat com-
mon or Pipe Dream preferred or some other dubious stock,
you had better check with another brokerage house.

To help protect investors against the high-pressure, "fast-
buck" peddlers of dubious stocks, the S.E.C., with the co-
operation of industry trade groups and the Better Business
Bureau, has published an investor's guide, which make these
ten recommendations to all investors:

(1) Think before buying.

(2) Deal only with a securities firm you know.

(3) Be skeptical of securities offered over the telephone by any
firm or salesman you do not know.

(4) Guard against all high-pressure sales.

(5) Bewareof promises of quick, spectacular price rises.

(6) Be sure you understand the risk of loss as well as the prospect
of gain.

(7) Get the facts. Do not buy on tips or rumors.

(8) Request die person offering securities over the phone to mail
you written information about the corporation, its operatiom,
net profit, management, financial position, and future
prospects.

(9) If you do not understand the written information, consult a

person who does.

(10) Give at least as much thought when purchasing securities as
you would when acquiring any valuable property.

18

CHAPTER

How You Do Business with a Broker

LET'S assume you finally make up your mind to buy some
stock. You go to a broker, a member firm of the New York
Stock Exchange, to place your order.

What's likely to happen? What's a broker's office like?
What do you say and what do you do? How does a broker
operate?

Lots of people go in and out of brokers' offices every
day, people who want to know how the market is doing or
people who just like to watch the passing show. So if nobody
pays any attention to you when you first walk in, don't feel
you're being neglected. Just walk up to the first person who
looks as though he works there and tell him you would like
to talk to somebody about buying some stock. That will get
action fast.

Maybe that person will take you to the manager, who in
turn will introduce you to a registered representative with
whom you can discuss your interest in more detail. Maybe
you'll skip the manager and be referred directly to a regis-
tered representative.

What's a registered representative? In the twenties he was
called a customer's man. That's not a title in favor anymore,
because the customer's man got a bad reputation as a fast-
work artist with a glib line when it came to selling bonds to
old college chums or clubhouse cronies. Today's registered
representative bears little resemblance to that character.

The old customer's man used to "play the market" a good
deal himself too. Most brokerage firms today are happy to see
their employees invest in securities, but they frown on too
much "in and out" trading by registered representatives for
their personal accounts. In fact. New York Stock Exchange
rules, with rare exceptions, prohibit any employee of a brok-
erage firm from buying or selling securities except through
the firm for which he works.

129

130 HOW TO BUY STOCKS

Many customers refer to the registered representative as
"my broker." Actually, of course, he isn't a broker at all. He
is an employee of the brokerage firm, and as such simply
represents the firm's floor broker to you. It is this floor broker
who will acutally execute your orders on the exchange. The
"registered" part of the registered representative title means
that he has been licensed by the S.E.C. and approved by fl\e
exchange as a person of good character who is thoroughly
informed about the operations of the securities business. In
fact, he has had to pass a searching examination, adminis-
tered by the New York Stock Exchange, on the subject. The
National Association of Securities Dealers gives the same
kind of examination to representatives of nonmember dealers.

Registered representatives  also called customer's brokers
or account executives by some firms  come in all kinds and
qualities. Some are young. Some are old. Some are Demo-
crats. Some are Republicans. Some are men. Some are
women. Some have been in the business tor years. Some are
comparative newcomers.

These newcomers deserve a special word, because their
entrance into the field is itself evidence of how the business
has changed. From the time of the depression to the end of
World War II, only a handful of college graduates went into
Wall Street. They looked for greener pastures  the big cor-
porations.

But nowadays, the securities business can count on getting
its share of individuals from every graduating class. Many an
old customer's man coasted for years on his reputation as an
all-star halfback. His successor's career is apt to be based
more on a record of scholastic achievement, plus extracur-
ricular leadership. Often, he will have earned a degree at
some university's graduate school of business.

Again, the customer's man of yesteryear rarely bothered to
acquire any formal training in the business. He just picked
it up as he went along. The present-day registered representa-
tive usually has served a much more painstaking apprentice-
ship. More often than not, he has attended some firm's
training school, plugging away eight hours a day for several
months at basic lessons in accounting, economics, security
analysis, and investment account management. It costs a
sponsoring firm thousands of dollars to train each representa-

HOW YOU DO BUSINESS WITH A BROKER  131

tive. He or she has really to make a serious commitment to
succeed.

The registered representative is "your broker" in the sense
that he's the person you deal with when you do business with
a brokerage firm. He's usually assigned to you by the man-
ager of the office. If at any time you find his service less than
satisfactory, all you have to do is ask the manager to be
assigned another.

And if you don't like the brokerage firm itself, try another.
There are plenty of them, some big and some little, some
offering a wide variety of special services and facilities, and
some specializing in just one phase of the securities business,
such as municipal bonds or institutional investment.

All of them can buy and sell securities for you. And all of
them will execute your orders faithfully. They won't "bucket"
them.

A bucket-shop operator is a man who accepts your order
to buy a stock at the market. He takes your money. But he
doesn't execute the order. Instead he pockets your money and
gambles on his ability to buy stock for you sometime later at
a lower price and make a profit for himself on your order. He
reverses the method on a sell order. Needless to say, all such
operations are thoroughly illegal. Today they are virtually
nonexistent, thanks to the vigilance of the Securities and Ex-
change Commission and the stock exchange.

You can talk to your registered representative with com-
plete candor, because whatever you tell him about your
affairs will be held in strict confidence. A broker never reveals
who his customers are, much less anything about their cir-
cumstances.

The more you tell your registered representative about
your finances  your income, your expenses, your savings,
your insurance, and whatever other obligations, like mortgage
or tuition payments, you may have  the better he wiD be
able to help you map out an investment program suited to
your particular needs.

It is a part of his job to see that you get information or
counsel whenever you need it. Don't be embarrassed about
asking him the simplest kind of question about investing
about a company, about some financial term, or about the
way your orders are handled.

132 HOW TO BUY STOCKS

At the same time, you should remember that you have
certain obligations to your broker, just as he has to you. You
should pay promptly for any securities you buy. You should
inform him o any change in your address and whether the
securities you buy and pay for are to be transferred into
your name and mailed to you, or held by the broker in your
account. And you shouldn't keep him on the phone for long
periods of time during trading hours passing the time of day.
Registered representatives are essentially salesmen, and like
all salesmen they make their living on the phone.

If you give your broker an order to buy or sell, be sure
there is no misunderstanding about what you want him to do.
He may seem overly meticulous and careful about your
order. This is not only because he wants to give you prompt
and efficient service, but also because the cost of correcting
errors has gone up like everything else. Moreover, the firm he
works for very likely penalizes him for any error, an error
which might very well be attributable to you. Indeed, the
phrase common to many boardrooms for decades, "Put it in
the error account," is translated today to mean "Charge it to
the registered representative."

The ticker tape itself is no longer what it was in the days
when conquering channel swimmers, visiting statesmen, and
astronauts rode up Broadway through paper snowstorms.

Paper ticker tape began to fade from the scene over a
quarter-century ago when the eight-foot TTans-Lux screens
became a standard fixture of brokerage offices. The tape it-
self, printed on cellophane, was magnified and projected on
the Trans-Lux screen, and quotations marched across the
screen from right to left, so that the brokers, customers, and
boardroom loafers could all watch the market action on both
the New York and American exchanges.

The Trans-Lux screens were replaced in the late sixties by
electronic screens on which the stock symbols and prices
marched across a black background, as in an animated elec-
tic sign. These electronic displays give brokers and their cus-
tomers ready and convenient access to an almost bewildering
array of last-second market information, all right at their
fingertips.

Gone with the paper ticker tape is the old-fashioned quote
board on which board markers chalked up quotations for
various stocks as they came in on the ticker. It has given way

HOW YOU DO BUSINESS WITH A BROKER  133

to the highly sophisticated computer-operated desk model
quote machines.

Simply by pushing a few keys, the registered representative
can get an incredible array of statistical information on thou-
sands of different stocks  all those listed on the New York
and American exchanges, as well as many on leading regional
and Canadian exchanges, plus many hundreds of leading over-
the-counter stocks and mutual funds. On most stocks, he can
instantly obtain the latest price, with an indicator to show
whether it is an up tick or down tick, the bid-and-asked
prices, the open, high, low, and previous close, the volume
of trading, earnings, dividend and percentage yield per share,
the price-earnings ratio, and the time of the last sale. Some
machines will also provide essential news about the stock or a
brief appraisal of it. Equally comprehensive information on
the trend of the market as a whole can be obtained on the
desk-model screen. On some models the current tape is also
projected.

With the development of computers and various electronic
gear to provide instantaneous price and market information
for thousands of stocks, listed and unlisted, it was only a
matter of time before the securities industry developed a con-
solidated ticker system covering all major markets.

Under the sponsorship of the Consolidated Tape Associa-
tion, composed of the principal exchanges and the National
Association of Securities Dealers, a consolidated stock tape
was introduced in June 1975. It consisted of two sections:

Network A and Network B. Tape A reporting all transactions
on Big Board stocks  both common and preferred 
regardless of the exchange where the trade took place. Thus,
when a transaction is effected in any Big Board stock on a
participating exchange, in the over-the-counter or third mar-
ket, or in any other market such as that operated by Instinct,
the stock symbol printed on the New York Stock Exchange
consolidated tape is followed by "&" and then a letter iden-
tifying the marketplace: M (Midwest), P (Pacific), X (Phil-
adelphia). B (Boston), T (Third Market), 0 (Other Mar-
kets, including Instinct). Transactions in Big Board stocks
that are executed on the New York Stock Exchange, of
course, have no identifying letter since that is the primary
market for those listed stocks.

For instance, a trade involving 1,600 shares of Ford Motor

HOW TO BUY STOCKS

134

that took place in the third market at a price of 22 would be
reported on the upper line of the consolidated ticker tape by
the letters "F & T," followed on the lower line by "i6ooSza."
In order to report trade executions of N.Y.S.E.-listed issues
on the Pacific Stock Exchange, which remains open an hour
and a half later than the Big Board, the tape runs until 5:30
P.M., E.S.T.

Here's a sample section of the consolidated tape, showing
transactions made in Occidental Petroleum (N.Y.S.E.),
Northern States Power (Third Market), Fluor Corp. (Phila-
delphia) , duPont (Midwest), and Transamerica (Phila-
delphia).
OXY         NSF&T    FLR&P    DD&M     TA&P

3S7% 4S%       4%       39%       118%     4S8%

Since all brokerage operations have become more stream-
lined and efficient, it is easy to visualize the day when a
central securities market and a national clearance and deposi-
tory system will be introduced. The traditional broker's
boardroom might disappear completely. There would no
longer be a quote board, nor any reason for having one.
There would no longer be quote machines, which in many
brokerage offices can even now be operated by the customers
themselves if they want the latest price information on a

stock.

These and other innovations will inevitably change the

character and atmosphere of the broker's office.

Far more important than the change in physical appear-
ance, though, will be the improvement in the quality of ser-
vice that the broker will be able to supply his customers 
instant information on any stock or on any market as a whole
 and instant information on the customer's transactions
and on the exact position of his account, whether cash or
margin.

19

CHAPTER

How You Open an Account

EVERY new customer of a brokerage firm must open an
account with that firm before the customer can either buy or
sell securities.

Opening a cash account with a brokerage Brm is very
much like opening a charge account at a department store. It
simply involves establishing your credit so that the broker is
sure you can pay for whatever securities you order. The New
York Stock Exchange has a rule, widely known as the know-
your-customer rule, which it requires all member firms to
enforce strictly. If the broker doesn't know you, he might ask
you to make a good faith deposit on opening an account. But
most times he will be satisfied with a bank reference.

He has to be sure of your credit responsibility because
when you place a market order for a stock, neither you nor
the broker knows to the exact penny what you will have to
pay for the transaction. You may Icnow that the last sale took
place at 18^ a share, but when your order is executed, even
a few minutes later, the price may have gone up or down.
When the purchase is made, the broker assumes the responsi-
bility of paying for the stock and sends you a bill. This bill
must be paid in five business days, not counting Saturdays,
Sundays, or holidays, because your broker must settle his ac-
count within that time-

Because no one can know just when an open order  a
limit order or a stop order  may be executed, and because
Uie customer may be away from his home or office at the
time of execution, brokers can in their own judgment extend
the payment date to seven business days after the transaction.
But if payment is not received by then, a further extension
can be granted only by the exchange. This is because by your
delay you will have violated the Federal Reserve Board's
Regulation T, governing all matters of credit on stock
transactions.

i35

136 HOW TO BUY STOCKS

In the case of a Monthly Investment Plan account or simi-
lar plan, the broker has no credit problem. The customer
makes his payment in advance of the purchase.

If your first transaction with a brokerage firm involves the
sale of some stock that you already own, instead of a pur-
chase, you will still be required to open an account. The
brokerage firm must still comply with the stock exchange rule
that compels every broker to know his customer in order to
protect himself against fraud or other illegal practices. For
one thing, the routine of opening an account provides the
broker with some assurance that the securities you offer for
sale are really yours.

A bearer bond, for instance, can be sold by anybody who
holds it. The broker doesn't know it's not a stolen certificate.
Even a registered bond or a stock with your own name on it
can present a problem to the broker. It may be made out in
the name of John Smith, and John Smith may bring it to a
broker to sell it. But if John Smith hasn't done business there
before, how's the broker to know that he really is the John
Smith named on. the security?

Many husbands and wives prefer to open joint accounts
with a broker, just as they have joint checking accounts. In
case one of them dies, the other can generally sell the securi-
ties without waiting for the courts to unsnarl the legal prob-
lems involved in settling an estate. But because of tax consid-
erations and variations in state law, a married couple may
want to consult an attorney before opening a ]'oint account.
Joint accounts are also used by individuals who are not re-
lated but have pooled their resources in a cooperative invest-
ment venture, often just for the sake of reducing commission
costs on their trades.

People frequently want to open accounts for their children
or for the children of relatives. Historically this has presented
a thorny problem to brokers. In the absence of state legisla-
tion specifically authorizing such gifts to children, brokers
have incurred a measurable risk in selling stock that was
registered in the name of a minor. A minor is not legally
responsible for his acts. And if brokerage transactions were
carried on in the name of a minor, that minor could, on
coming of age, repudiate them, and the broker would have no
redress.

Beginning in 1955, the various states began enacting laws

HOW YOU OPEN AN ACCOUNT 137

permitting an adult, acting as a custodian without court ap-
pointment, to handle investments for a child. Such a cus-
todian can buy stocks as a gift for a minor. He can sell them
for a minor and he can collect any dividends in the child's
name. With the New York Stock Exchange and the entire
brokerage fraternity plumping vigorously for the enactment
of such statutes, all 50 states had passed laws permitting gifts
of stock to minors by 1961. Subsequently, stock ownership
among minors increased at a faster rate than in any other age
group. In 1962, 450,000 minors owned stock. By 1970, the
number had increased to 2,221,000.

It has, of course, always been possible for parents or other
relatives to buy stock for children by setting up a trust fund,
They just had to get a court order appointing them as trustees
so they could legally buy or sell stock for the children. This is
an expensive and cumbersome procedure, however, although
it does permit wealthy people to realize important tax savings.
It is generally much simpler for parents or other relative or
friends to give stock to minors under the provisions of the
states' laws.

If you want to open a margin account instead of, or in
addition to, a regular cash account, so that you can buy
securities by paying only a portioo of their cost, the broker
will want to be especially sure of your financial solvency. After
all, when you pay only part of the cost, the broker has to pay
the balance, and that money may be on loan to you a long
time with interest payments coming due regularly.

Once you have opened an account  cash, joint, or
margin  you can buy or sell whatever you want simply by
phoning your representative  or by writing or wiring him.
Probably 90% of a broker's business comes to him by phone.

f,

If you live outside New York and give an order for a Big
Board stock to a registered representative in your local office,
that order is teletyped into the New York headquarters of the
firm. There it is either switched automatically to the booth on
t^-the exchange floor nearest the post where it will be executed,
t or it is phoned to that booth. In either case the order is
? executed as promptly as possible by the floor broker. Then
the floor broker gives his clerk in the booth a report on the
order and the price at which it was executed. This informa-
tion is then transmitted instantly back to your representative
 and then to you.

138 HOW TO BUY STOCKS

The entire operation can be accomplished literally while
you are still on the phone talking to your representative about
other matters. On a market order for immediate execution,
one involving an actively traded stock, the round trip from
California to the exchange and back again, including the
transaction on the floor, can be made in about one minute.
Actually five minutes is more like par for an average transac-
tion. If the stock you are buying is one that doesn't trade
frequently, or if the market is very active and your broker's
wires are flooded with traffic, it may take longer.

In any event, once your order is executed, your representa-
tive should report to you. But whether you get the informa-
tion by phone or not, you'll know within the next day or two
just what price you got on the order, because then you will
receive in the mail your broker's formal confirmation of the
transaction-
If you have bought stock, this will be your bill, unless you
have bought and paid for the stock in advance as you would
under the Monthly Investment Plan.

If you have sold stock, the confirmation will be a report on
how much money you realized from the sale. The proceeds
will automatically be credited to your account on the settle-
ment date, five business days after the transaction.

Instead of having the proceeds credited to your account,
you can, of course, ask that payment be made directly to
you by check. In very special circumstances, you might be
able to arrange for immediate payment, instead of waiting for
the settlement date. Brokers are extremely reluctant to make
such advance payments, however. After all, they don't get
their money from the other broker involved in the transaction
till settlement date. Furthermore, advance payment can open
the door to sharp practice by unscrupulous customers  a
practice known as free-riding.

A free-rider is a person who places a purchase order for a
stock with one broker and then, if the stock goes up before
he is forced to pay, sells the stock through another broker.
He then demands immediate payment for some ostensibly
good reason ("I can't get my wife out of the hospital till I pay
the bill"), and uses the proceeds of the sale to pay for his
original purchase. Thus he has realized a profit without put-
ting a cent of his own money at risk. He has had a free ride.
If the stock goes down, chances are he will attempt to re-


now YOU OPEN AN ACCOUNT     13Q

pudiate the original order ("I said sell  not buy") or simply
vanish and leave the broker holding the bag. This is one good
reason for the exchange rule that every broker must know
his customer.

Of course, if you sell stock in a regular cash account, you
must see that the stock is delivered to the broker. Since you
have an account with him, he will know what stocks you
own, and he will sell any of them for you on your instruction,
even if he does not have the certificates in hand. But he
expects you to deliver the certificates, properly endorsed, im-
mediately after a sale, because he in turn must settle within
five days with the broker who bought the stock.

Many security owners find it more convenient to leave
their stock certificates with their brokers. Then the certificates
are right there when the owner wants to sell. Such securities
are carried in the customer's account ]'ust as cash might be.
Every month he gets a statement showing exactly what se-
curities and what funds are credited to him.

On stocks that are left with him, the broker will collect all
the dividends and credit them as cash to the customer's ac-
count. Similarly, on bonds, he will see that the interest is
collected, and credit the payments to the customer's account.
Brokers will also mail to the customer the regular financial
reports of the companies he owns, as well as all proxies,
official notices of meetings, dividends, stock rights, and con-
version privileges, as those materials are supplied to him by
the individual companies.

When the customer leaves his securities with his broker,
the actual shares of stock are sometimes physically segre-
gated, much as they might be if he rented a safe-deposit box.
As a general rule, however, this kind of custodian account is
available only to those who own large amounts of securities.
In all other cases, when a customer leaves his securities with
his broker, they are held in street name. This means that all
the shares of a given security owned by all that broker's
customers are lumped together and held in the broker's name.
The broker keeps his own records of Just what each indi-
vidual customer owns. Thus, a broker might hold 100,000
shares of U.S. Steel for 2,000 or 3,000 individual customers.
The shares would be made out in the broker's name  not
the name of the individual stockholder unless he requested it.
But the broker would send each customer a monthly statement

140 HOW TO BUY STOCKS

showing just how many of those shares belonged to him.
Shares held in street name and those held in the stockholder's
own name must be kept separate, under federal law.

There is one big advantage to leaving your stocks with
your broker. If you want to sell any of them, all you have
to do is phone him and give him instructions. You don't have
to bother with delivering or endorsing the certificates.

But is it safe to leave your securities with your broker, as
you might leave cash with your banker?

The answer is that it's probably safer to leave them with a
broker than it is to try to take care of them yourself, unless
you rent a safe-deposit box. The broker handles all the safe-
keeping, storage, and insurance problems. When securities
are left with him, they can't be lost or misplaced, and the risk
of loss by Bre or theft is probably much less than it would be
if you kept them in your home or office.

Furthermore, the broker cannot borrow money on those
securities, nor can he sell or lend them except on your express
authorization. Those securities belong to you. The surprise
audits that are sprung on all member firms at different inter-
vals by the New York Stock Exchange further help to ensure
that brokers are faithful to their trust. Every single share of
stock held in street name and every dollar in customers' ac-
counts must be accounted for.

To ensure financial solvency the exchange insists that
member firms have substantial capital reserves. Thus, the
amount of money owed to a brokerage firm, principally on
margin accounts, can never be greater than 15 times a firm's
capital. The exchange may even require a member firm to
reduce its business if its net capital ratio should exceed 12 to
i. It may prohibit a member firm altogether from trying to
expand its business if the ratio exceeds 10 to i.

In 1970, the S.E.C. put the full weight of its authority
behind these capital requirement rules and undertook to see
that the i5-to-i ratio also applied to nonmember firms which
had previously operated on a ao-to-i standard.

But what if a broker goes under, despite all the regulations
of the stock exchange and the S.E.C.?

For years, an adequate answer to that was that brokers
simply didn't go bankrupt. Despite the debacle of 1929,
member firms of the New York Stock Exchange boasted a
solvency record over a go-year period that was around 99%

HOW YOU OPEN AN ACCOUNT 141

 better than the solvency record of state and national banks.

But in 1963, an event took place that shook the brokerage
fraternity's confidence in its financial stability to the very
foundations. In November of that year, one of Wall Street's
most respected houses, Ira Haupt & Company, went under to
die tune of almost $10 million. A second firm, J. R. Wflliston
& Beane, was bailed out only in the nick of time and ab-
sorbed by another firm.

The Haupt bankruptcy was brought on by the inability of
Anthony De Angelis, a big speculator in soybean oil, to meet
an obligation to the Haupt firm in the amount of $18 million.
Haupt's doom was sealed when it was discovered that ware-
house receipts De Angelis had given the firm as security were
fraudulent. The receipts were supposed to prove that millions
of gallons of soybean oil were stored in tanks in New Jersey.
But the tanks were empty.

Ironically, Haupt's relations with its securities customers
conformed impeccably to all requirements of the law and of
the exchange. These customers were the people  people in
no way involved in Haupt's commodity mess  who stood to
get hurt by Haupt's inability to meet its loans from the banks.

To save these customers in particular, and to preserve in-
vestor confidence in general, the exchange devised over one
critical weekend a plan that obligated all members to make
good Haupt's loss. After the liquidation of Haupt's assets, the
bill, which was shared by members in proportion to the
amount of their exchange business, came to $9.6 million.

But Wall Street's troubles were far from over. In fact, they
had barely begun.

First, the Street was engulfed by the great bull market of
1968, with volume soaring far above the historic highs of late
October 1929. Despite the advent of computers and other
forms of mechanized record keeping, many brokers and trans-
fer agents where unable to keep abreast of the operational
work load. "Fails to deliver," the inability of one broker to
settle his trades with another broker by delivering traded se-
curities, rose to a record high of $4. i billion.

For many brokers, 1968 was a year of profitless prosperity.
They were forced to hire more personnel to handle the vol-
ume, and to face the fact that they had failed to control costs
in many vital areas.

Then came 1969 and 1970. Stock prices went into a tail-

142 HOW TO BUY STOCKS

spin. Volume contracted sharply, falling to an average of
only 11,400,000 shares a day in 1969. This at a time when
the New York Stock Exchange was estimating that the break-
even point for its member firms was a daily average of
12,000,000 shares.

As prices fell, many firms that had invested their own
capital in stocks suffered such losses that they were unable to
meet the New York Stock Exchange's capital requirements.
Fifty Srms closed their doors while they were still solvent.
Sixty-five others arranged "shotgun" mergers with stronger
firms.

But there was no way to stave off the inevitable. Before the
storm abated the New York Stock Exchange had exhausted
the $25 million special trust fund it had set up after the
Haupt disaster. It had also pumped an additional $43 million
into its rescue operations  funds it raised by assessing its
hard-pressed members.

All told, the exchange intervened in the affairs of almost
200 brokerage houses. Despite its best efforts, however, fif-
teen firms went under, including such well-known names as
McDonneIl & Company, Orvis Brothers, Dempsey-Tegeler,
Blair & Company, and Hayden, Stone.

The desperate stopgap measures that the exchange had to
take to preserve the integrity of the brokerage business made
it dear that some far more reliable machinery was needed to
insure investors against any future loss caused by a firm's
financial failure. Hence, a proposal was made to create a
federal insurance system for investors comparable to that
provided by the Federal Deposit Insurance Corporation to
insure bank savings.

With Wall Street wreckage standing in plain and tragic
view. Congress moved with unaccustomed speed in the last
half of 1970 to establish the Securities Investor Protection
Corporation. Only then could the investor  and Wall Street,
too  breathe a sigh of relief. Of course investors could still
lose money in the market  and plenty of it in bear markets.
But at least they now knew they couldn't lose it because their
broker had gone broke.

The Securities Investor Protection Corporation, known as
S.I.P.C., will advance up to $500,000 per account in case of
the liquidation of any S.I.P.C. member. That includes every
member firm of every securities exchange and every non-

HOW YOU OPEN AN ACCOUNT     143

member securities dealer, excepting those who do only a mu-
tual fund business. Cash in an account is insured up to
$100,000.

S.I.P.C- is empowered to disburse up to $1 billion of fed-
eral funds to insure investors. The fund is built up primarily
from assessments on the securities business of S.I.P.C. mem-
bers. In 1979, a uniform member assessment of $25 per year
went into effect.

Quite obviously, the federal government could not be ex-
pected to insure investors against the collapse of securities
firms unless it had some definite say in how those firms were
operated. The S.E.C. is the agency that really exercises that
power, although theoretically S.I.P.C. writes its own rules.
One of the rules requires all securities firms to maintain ade-
quate cash reserves against their customers' credit balance
 the cash they have in their accounts. Another rule requires
brokers to keep separate all securities owned by customers
but held by the firm in street name.

S.I.P.C. is run by a seven-member board of directors. One
member is appointed by the Secretary of the Treasury, one by
the Federal Reserve Board, three represent the securities in-
dustry but are appointed by the President, two represent the
general public and are also appointed by the President. Origi-
nally, the industry fought to get a maiority of their represen-
tatives on this board. But it gave up without too much argu-
ment when it realized that, regardless of who was on the
board, the S.E.C intended to be the power behind the throne.
The industry soon resigned itself to the fact that the S.E.C,
was going to be an increasingly tough taskmaster in the years
ahead  as the Securities Reform of 1975 certainly gave it
the authority to be.

During the first four years of its life only one N.Y.S.E.
member firm went into S.I.P.C. liquidation, and this was
because of fraud. This record was all the more remarkable
considering that volume on the New York Stock Exchange
for much of the bear market of 1973-1974 was substantially
below the 17,000,000 to 18,000,000 shares per day member
firms needed to break even.

The federal insurance program, supplemented in many
cases by private insurance coverage, has obviously lifted a
tremendous weight off Wall Street's shoulders. Still, the in-
dustry knows that the long-range solution to the problem of

144 ^OW TO BUY STOCKS

financing its own business lies in attracting large chunks of
permanent new capital and in restoring investor confidence in
the financial community in general.

For generations the brokerage business thought of itself
as a business of individuals, or partnerships of individuals,
who exercised an almost fiduciary responsibility. This  the
old "family counselor" approach  was the way brokers jelt
customer confidence in the investment business could best be
built. But with the spread of public ownership of stocks, the
adoption of modem merchandising methods, and the arrival
of computers, the business rapidly outgrew this old concept
of itself. And the exchange membership had to recognize
that.

In 1953, the exchange took its first step toward liberalizing
its rules by permitting the voluntary incorporation of member
firms. One advantage of incorporation was that corporations
were subject to a maximum federal tax of 52%, while indi-
vidual partners in a firm might find themselves paying a con-
siderably higher income tax. By incorporating, a firm would be
able to retain a much higher proportion of its earnings as
capital.

More important, incorporation provided a much greater
permanence of capital. In a partnership, a partner can decide
to withdraw and take his capital with him. When a partner
dies, even if his heirs are willing to leave his capital in the
firm, a large part of it inevitably has to be withdrawn to pay
estate taxes. With incorporation, a firm can spread its owner-
ship among many more people by selling shares to hundreds
of key employees. This technique not only gives the employee
a piece of the action, and hence stimulates morale, it also
reduces the risk of having large hunks of capital precipitously
withdrawn.

In the decade following the exchange's abandonment of
partnership rule, more than a third of the member firms,
including most of the biggest firms, transformed themselves
from partnerships into corporations and thus strengthened
their financial positions.

In June 1969 the exchange took a second important step. It
authorized member firms to raise additional capital by issuing
bonds for sale to the public.

Then a few months later the aggressive young firm of
Donaldson, Lufkin & Jenrette, which specialized in institu-

HOW YOU OPEN AN ACCOUNT     145

tional business, forced the exchange's hand by applying to
the S.E.C. for registration and sale of an issue of its own
common stock. The exchange had no alternative. It had to
amend its rules to permit Donaldson, Lufkin & Jenrette and
all other member firms to "go public" if they wanted to.

It was inevitable that many member firms would do so. It
was the only way they could raise the capital they needed to
stay in business. In April 1971 the biggest firm of all, Merrill
Lynch. Pierce, Fenner & Smith, announced it would go pub-
lic. It has since been followed by almost all the major broker-
age firms in the country.

20

CHAPTER

What It Means to Speculate

SPECULATING is an inevitable part of the business of buy-
ing securities. But then speculating is an inevitable part of
just living.

Whenever you are confronted with an unavoidable risk 
as indeed you are in many circumstances every dayyou
must speculate. You must meet the risk; you must take your
chances. Often you are presented with a choice of risks.
When you make up your mind which one you will take,
weighing the good and the bad features of each, you arrive at
a speculative decision,

The businessman who must be in another city at a given
time often has the choice of flying or driving. He can figure
on getting there faster if he flies. But there's always the pos-
sibility of bad weather, mechanical failure, or other delays.
Those risks may be somewhat reduced if he drives. But then
he faces other hazards  breakdown, an accident, traffic tie-
ups. Faced with this kind of choice, the man must inevitably
speculate.

The manufacturer who must pick Jones or Smith for a key
job must speculate on which will be the more able man.

And the farmer's whole operation is one vast speculation.
When he puts the seed in the ground, he is speculating on his
ability to grow a crop and sell it at a profit despite bad
weather, pests, blight, and changing market prices.

When a man takes a risk he cannot avoid, he is speculat-
ing. But when he takes a risk that he doesn't have to take, he
gambles.

That is one distinction between speculation and gambling.
But there is another. Speculation involves an exercise of rea-
son, while gambling involves nothing but chance. The man
who speculates can make an intelligent forecast of the haz-
ards of his course. The gambler stands or falls on the flip of a
coin or the draw of a card.

146

WHAT IT MEANS TO SPECULATE  147

In the purchase of any stock or bond, even a government
bond, there is an element of speculation. The risk that it
might decline in value cannot be avoided. For that matter,
there is a risk just in holding money  the risk that it won't
buy as much in the future as it will today.

When a man buys securities however, he doesn't have to
operate exclusively on chance. He can make a fairly intelli-
gent estimate of how much risk he is assuming on the basis of
the record. And he has a wide range of risks to choose
from  all the way from a government bond to the penny
stocks of companies whose assets are made up principally of
hope.

The word investments is applied by many old-line investors
only to government bonds, municipal bonds, and first-quality
corporate bonds- To an ultraconservative buyer of securities
tor a bank or an insurance company, all stocks are too risky
to be classed as investments, despite the fact that some stocks
have proved safer than many corporate bonds over the long
term.

Because most preferred stocks and a good number of
common stocks have proven so stable, even the conservatives
refer to them nowadays as "investment-type" securities. These
are apt to be the stocks of utilities, food firms, banks, or
chain stores  industries that have shown themselves to be
comparatively steady earners, come boom or depression.

Of course, what is one man's speculation is very often
another man's investment. Below the level of topflight securi-
ties is a vast assortment of stocks that many men of sound
judgment consider good investments, primarily because of the
liberal dividends they pay.

Often these are stocks of companies whose fortunes rise
and fall sharply with the business cycle  companies in the
automobile, steel, construction, or clothing industries. When
business is good, they pay excellent dividends. When business
slumps, those dividends may be reduced or eliminated.

As a rough  very rough  rule of thumb, the degree of
risk which you assume in buying one of those "cyclical"
stocks can be measured by the liberality of its dividend. The
larger the dividend as a percentage of the selling price, the
greater the risk tends to be. This is because stocks that pay
high dividends are usually in demand. This demand is gen-
erally reflected in the high price of the stock. If the stock's

148 HOW TO BUY STOCKS

price is not high, this means the high dividend is not being
reflected in the price of the stock because some other negative
risk factor is acting as a deterrent to buyers.

There are other stocks  thousands of them  that must
be frankly classified as speculations. Even here, however,
there is a wide range of quality. At the top are those stocks
that might be described as "good growth situations." These
are stocks of companies, often paying little or no dividend,
that because of their future prospects are regarded as attrac-
tive to investors. Sixty years ago, many automobile and radio
stocks might have been so classified. More recently, electronic,
office equipment, cosmetic, computer, drug, and aerospace
stocks have been placed in this category. In recent years, these
glamorous growth stocks have been the darlings of the invest-
ing public. Such has been the demand for them that aggres-
sive investors have frequently been willing to buy them for
prices equal to 40 or 50 times their current annual earnings.

Some speculative securities are attractive not because their
future looks so promising but because it looks a lot better
than their past. A company may have had to pass some
dividends or miss interest payments during a difficult period
of reorganization. But once it starts to hit the comeback trail,
its securities are apt to take on new life. Many a sizable
fortune has been made by buying bonds that were severely
depressed because the company had to default on interest
payments temporarily. That's also been true of many pre-
ferred stocks on which dividend payments have accumulated
for a number of years before ultimately being paid off. Such
investments are strictly long shots and must be so regarded.

The most popular kind of speculative stock is the stock
issued by small aggressive companies in one of the growth
fields. Characteristically, these are over-the-counter stocks
selling at relatively modest prices, unseasoned securities is-
sued by companies that are so new they have no record of
consistent earnings. These companies are long on hopes, short
on cash. Rank speculations though they be, they attract inter-
est because everyone knows that Xerox, Polaroid, and IBM
 and Rod & Reel  were just such stocks not so many
years ago.

Finally, there are the outright penny stocks. A few of these
may be the listed securities of old-line companies that have
fallen on evu days. Their business has declined steadfly, and

WHAT IT MEANS TO SPECULATE  149

their stock seems virtually worthless. But a significant num-
ber of these low-priced stocks, selling at 50^, $i, $2, maybe
as high as $5, are the newly issued stocks of questionable oil
or mining companies. These are peddled by high-pressure
salesmen who expect to make as much as 50^ on every dol-
lar's worth of stock they sell. Often by direct mail and even
long-distance phone, the prospect is told that a block of 100
or 300 shares has been reserved in his name at a special
bargain price. But he must buy within 24 hours or lose his
chance of a lifetime. People who have charge accounts at
expensive stores and professional people are particular targets
for this kind of promotion. Their names and addresses are
bought from direct-mail firms.

Occasionally these glamorous sales stories have an element
of truth to them. The men who put their money in the oil
property "right next to our land" may actually have made
1,000% on their investment already. But the fact remains
that anyone who takes a flyer on this kind of deal is much
more apt to lose everything he puts into it than he is to make
a whopping profit.

Although there is an obvious difference between this kind
of rank speculation and the solid investment that a govern-
ment bond represents, it is also true that the distinction be-
tween investing and speculating frequently gets hazy as soon
as you move away from either of these two extremes. Actu-
ally, the difference between investing and speculating is not so
much a matter of the individual security's merit as it is the
motive for which that security was bought.

The investor is a man who puts his money in a company in
the expectation of earning a reasonable and regular return on
it over the long pull, both in dividends and price appreciation.
The speculator takes a short-term view. He is not interested
in dividends. He is interested in making a quick profit on his
money and selling out whenever he can get it. Often he takes
a big risk in the process. But if he hits it right, he stands to
make a lot of money.

Furthermore, under present federal tax laws he may be
able to keep more of that money than he would if he made
the same amount of money in dividends, salary, or other
income.

Risk capital  the money that a man puts at risk when he
buys or sells almost any kind of property  played such

150 HOW TO BUY STOCKS

an important role in building this country that Congress for
more than a quarter of a century has given favored tax treat-
ment to profits realized in such ventures. These are called
capital gains, and they include the profits realized on the
purchase and sale of securities.

For many years our federal tax law provided that a man
who made a profit by selling any security he had owned for
more than six monthsa long-term capital gainwould
not have to pay a tax of more than 25% of that profit. That
was the absolute maximum. Actually, the tax might be con-
siderably less, for instead of paying 25% on the entire gain,
he could, if he chose, pay a straight income tax on only half
the gain at whatever regular income tax applied in his case.
Thus, if a stockholder's maximum tax bracket was only 40%
on regular income, the effective rate he would pay on a long-
term capital gain would be only 2.0%.

In recent years the minimum amount of time a stock had
to be held to qualify as a long-term capital-gain candidate
was extended to one year. And the Economic Recovery Tax
Act of 1981 reduced the maximum tax on capital gains to
ao% for taxpayers in all brackets.

Short-term gains  those realized on securities owned for
less than one year  are taxed at full regular income tax
rates.

Furthermore, the government has always offered another
special advantage to investors or speculators. It permits them
to offset capital gains with capital losses. Thus, if a person
realizes capital gains of $5,000 and suffers capital losses of
$4,000 in a given tax year, he pays the capital-gains tax on
only $1,000.

Any tax reduction on capital gains, as opposed to ordinary
income, is favorable to investing. But many businessmen and
some economists argue that the present tax treatment is not
favorable enough. They contend that new-venture capital 
speculative capital  could be made more freely available to
business. This could be accomplished by reducing taxes on
long-term capital gains further or by permitting taxpayers to
classify profits as a long-term gain after a shorter period of
time. There are many who argue that the capital-gains tax
rate should be reduced as the holding period lengthens.

It obviously makes sense for a stockholder to consider the
matter of taxes on long-term and short-term capital gains (or

WHAT IT MEANS TO SPECULATE  Igl

losses) in deciding whether, and when, to sell his stock. Thus,
it would be ridiculous for a man in a high income tax bracket
 say 50%  to sell a stock on which he had a substantial
profit if he had owned that stock just a few days short of one
year. But waiting those few additional days he could establish
his profit as a long-term capital gain, and he would have to
pay considerably less tax than he would if he realized a short-
term capital gain and had to pay a tax of 50%. Only in the
most unusual circumstances would his risk of loss in those
few days outweigh the extra tax he incurred by selling his
stock early.

On the other hand, too great a concern about taxes on
capital gains can seriously warp investment judgment. Many
a stockowner has refused to sell and take a profit, because he
didn't want to pay even a long-term capital-gains tax. While
he complains about being "locked-in," his profit may dwindle
in a declining market. Stock market authorities call this taxa-
tion rigor mortis. It costs stockholders a lot more every year
than all the dubious new issues and other outright swindles
combined. The person with a 100% profit in a stock will
complain bitterly about his long-term capital-gains tax. He
forgets that when he bought the stock he would have been
more than satisfied with any profit whatsoever.

If you have a profit in a stock,'you might as well reconcile
yourself to paying a capital-gains tax on it. You can, of
course, hold on to the stock  and the profit, if you are
lucky  till you die. But then your executors and your heirs
will have to worry about inheritance taxes.

Of course, you can sidestep the tax by using a capital gain
to offset a capital loss. This provision has served to stimulate
a fair amount of speculation. A person with a capital gain
will often take a much greater measure of risk than he ordi-
narily would. If he loses. Uncle Sam will cover a part of the

\    losses,

The capital-gains tax constitutes the biggest paradox in the
stock market. It stimulates speculation because it offers the
high-income investor a chance to build up capital at bargain

i    rates. But it simultaneously deters speculation, particularly
among amateurs, because it is human nature to postpone the
payment of any tax as long as possible.

;      Curiously enough, the professional speculator does not so

|6    often try to make a profita capital gainby putting

152 HOW TO BUY STOCKS

money into a really speculative growth stock, as he does by
speculating in the 50 or 60 active stocks  many of them
topflight investments  that account for most of the transac-
tions on the Big Board.

There is a reason for this. At any given time the price of a
stock or the price of all stocks represents the combined judg-
ments of all the people who are buying and selling. Most
times a speculator is staking his judgment against the publfc
judgment.

He may study the stock of a company in minute detail, and
on the basis of that intensive analysis may feel that he knows
better than the public what it's really worthor, rather,
what the public will soon or later determine is its real worth.

Again, he may think that he has a better feel for the
market as a whole, knows better than the public whether
stock prices will advance steadily upward in a bull market, or
decline in a bear market. If he is right, the leading stocks 
those that enjoy the widest public following  will probably
provide the earliest conBnnation of his judgment. Hence,
they provide the best opportunity for a quick profit.

On the assumption that his judgment is right, the specu-
lator seeks to augment his profits  or protect them once
they are made  by using various techniques of trading.

He may buy on margin.

He may pyramid profits.

He may sell short.

He may buy puts or calls.

Let it be noted that none of these techniques, discussed in
the following chapters, constitutes in itself unfair or dishonest
manipulation of the market. On the contrary, all are legiti-
mate procedures and make for greater trading activity and a
more liquid market. Often, in fact, the average investor would
find it difficult to sell stock if the speculator were not willing
to assume the risk the investor wants to escape.

Periodically, there is public clamor about the ill-gotten
gains of market speculators. People are apt to say that "there
ought to be a law" to curb them. In 1905, Oliver Wendell
Holmes, Justice of the United States Supreme Court, deliv-
ered the definitive reply to all such critics. Said Justice
Holmes: "Speculation ... is the self-adjustment of society to
the probable. Its value is well known, as a means of avoiding
or mitigating catastrophes, equalizing prices and providing

WHAT FT MEANS TO SPECULATE lg3

for periods of want It is true that the success of the strong
induces imitation by the weak, and that incompetent persons
bring themselves to ruin by undertaking to speculate in their
turn. But legislatures and courts generally have recognized
that the natural evolutions of a complex society are to be
touched only with a very cautious hand...."

21

CHAPTER

How You Buy Stocks on Margin

ONCE a security buyer has assured a broker of his financial
responsibility and opened a margin account, he can buy
stocks  any of the stocks listed on a United States securities
exchange and some over-the-counter stocks approved for
margin transactions by the Federal Reserve Board  just by
making a down payment on them. How big that down pay-
ment must be is governed by a wide variety of rules.

First, the New York Stock Exchange says that no one can
open an account to buy its securities on margin unless the
down payment is at least $a,ooo in cash, or an equivalent in

securities.

Occasionally, the exchange may be concerned about the
market action of a particular stock because of sharp swings in
its price or in its trading volume. In such circumstances the
exchange may require those who buy or sell that stock to put
up extra margina higher down payment. The exchange
can also forbid all margin trading in such stocks and has
often done so, especially in periods of heavy speculative

activity.

In addition to the rules set by the various exchanges you
may encounter special margin requirements set by individual
brokers. Some, for instance, will not permit a customer to
buy any stock on margin unless that stock sells above $5 a
share. Other brokers require a larger down payment than the
exchange does.

Finally, the most important, there are the regulations of
the Federal Reserve Board, which has been empowered by
Congress to say, in effect, just what the minimum margin
requirements must be. Since 1934, when the board began to
exercise its authority, it has set that minimum by saying that
the down payment must represent a certain percentage of the
total value of the stock that is being bought on margin. The
percentage is changed from time to time, depending on the

154

HOW YOU BUY STOCKS ON MARGIN  Igg

availability of credit, how worried the board is about infla-
tion, and the amount of stock trading that is being done on
margin.

The lowest figure that the board has ever set is 40%. That
figure prevailed for eight years, from 1937 to 1945. The
highest figure has been ioo9E. While that was in effect, from
January 1946 to February 1947, nobody could buy on
margin.

In bull markets, the board will raise the rate because it is
concerned about overtrading and wants to cool down specula-
tive fever. Conversely, in bear markets, when volume has
dried up, the board is frequently willing to provide some
stimulus to the market by reducing the minimum margin
requirements.

To simplify the explanation of how margin works, suppose
the Federal Reserve Board margin requirement at a given
time is 50%. This means that you can buy $10,000 worth of
some marginable stock with $5,000. Your broker lends you
the other $5,000. Naturally, when he does that, he charges
you interest on the money he lends. How much interest de-
pends on how much interest he himself has to pay a bank 
whatever the prevailing interest rate is on brokers' loans 
for the $5,000 he borrows from them to lend to you. He'll
generally charge you the prevailing-interest rate plus, accord-
ing to stock exchange practice, at least %% to 1%, and
sometimes more, for himself.

With basic bank rates at historical highs, during the late
seventies and early eighties, brokers were concerned about
violating state usury laws. Some states exempt brokers from
their usury laws, but where they don't, brokers argued that
since their margin orders were executed in New York, the
usury law of New York should apply. In various cases, state
courts accepted this argument. However, short of a U.S. Su-
preme Court ruling, no one could be absolutely sure of its
validity.

If you think you can get a better deal from your bank than
you can from your broker on a margin account  you can
forget about it. Banks are not permitted to lend any more on
stock purchases than brokers can lend. It is true that you can
borrow a greater^roportion of the day payment, up to 90%,
from unregulated lenders. But you are not likely to get any
break there- Indeed, it is probable you will pay as much as

156 HOW TO BUY STOCKS

1% or 2% extra interest a month. And any broker or regis-
tered representative who helped you arrange such a loan
would run afoul of the S.E.C.

When a broker borrows money from a bank and lends it to
you so you can buy stocks on margin, he has to give the bank
some security on the loan. That loan security may be the very
stock you buy on margin. Hence, when you open a margin
account, you must agree to leave your margined stocks with
the broker and to let him hypothecate them, or pledge them
as security for whatever bank loan he may need in order to
carry margin accounts.

If you buy $10,000 worth of stock on margin, you natu-
rally pay commissions on the full $10,000 worth of stock.
But you are also entitled to all the dividends on those shares.
This alone is sufficient to interest some investors in buying
stocks on margin, especially when stocks are paying liberal
dividends and margin interest rates are low.

Still, virtually all margin customers are interested in mar-
gin not because of the extra dividends, but because of the
speculative profit they hope to make, for margin is the specu-
lator's number one tool.

Suppose that a man with $5,000 to invest has picked out a
stock selling at $50 a share which he thinks will go up. Under
a 50% margin rule, he can buy 200 shares of that stock,
instead of just 100 shares, with his $5,000. If it goes up five
points, he makes $1,000 instead of $500, a 20% profit in-
stead of 10%. Doubling a profit can make even a 20%
interest charge on a margin loan look cheap.

But suppose the stock goes down in price? There's the
rub.

It's then that the margin buyer may receive a margin caU
from his broker, a request to put up more margin  that is,
to increase the amount of his down payment. If he can't put
up more money, the broker has the right to sell his stock 
or as much of it as may be necessary  to raise the required
cash. This presents no logistical problem to the broker, be-
cause all margined stock must be left on deposit with him.

How much more money may a margin buyer have to put
up if his stocks decline? The answer to this is governed by the
margin maintenance rules of the New York Stock Exchange
and by those of the individual broker. The Federal Reserve
Board isn't in the picture at all after the original purchase. If

HOW YOU BUY STOCKS ON MABCtN  157

a buyer meets the board's original margin requirements 
^Yi or 5^ cash  he is never compelled by the board to
put up more margin, even if the board later raises its require-
ments to 75% or more.

Under New York Stock Exchange rules, however, a broker
must ask a customer for more margin whenever the amount
that customer would have left if he sold his stocks and paid
off the broker's loan is less than 25% of the current value of
the stocks. (Some brokers have margin maintenance require-
ments that are higher than the minimums set by the New
York Stock Exchange.)

To illustrate; suppose a margin customer bought 100
shares of a stock selling at $60 a share at a time when the
Federal Reserve Board required only 50% margin. In that
case he would put up $3,000 and he would borrow $3,000
from his broker. Now suppose the stock dropped from $60 to
$40 a share. If he were to sell out now, he would realize only
$4,000 on his holdings. After he paid his broker $3,000, he
would have only $1,000 left. This would be exactly 25%
of the current value ($4,000) of his stock.

If the stock fell below $40 in this instance, the broker
would have to ask for more margin money so that the 25%
ratio would be restored. Actually, he'd probably ask for a bit
more so that he wouldn't have to make another margin call
very soon if the stock continued to decline-
If a stock is bought on a 50% margin basis, it can drop a
full third in price  from 60 to 40, as in the example above
 before a broker must call for more margin. If the Federal
Reserve Board's initial margin requirement was 75% instead
of 50%, the stock could decline two-thirds in value and the
customer would still not have to put up more margin. Here's
how that works: The customer buys loo shares of stock at
$60 a share and puts up 75% margin, or $4,500. He borrows
only $1,500 from his broker. If the stock drops from $60 to
$20, his holdings are worth $2,000. At that point, he could
sell out, pay the broker $1,500, and still have $500 left. This
would represent 25% of the current market value of his
stocks ($2,000).

These examples have assumed that the customer bought
only a single stock on margin. Actually, most margin cus-
tomers have positions in a number of stocks in their margin
accounts. In such circumstances, the broker must compute

158 HOW TO BUY STOCKS

exactly how the customer stands on all of his stocks. He will
not send out a margin call on one stock that may have fallen
below the maintenance requirements if the customer shows
a surplus on his other holdings sufficient to offset the short-
ages. In short, the broker takes into account the customer's
overall position  the shortages and surpluses in each stock
 and sends out a margin call only when the customer falls
below the minimum maintenance requirements on his fblal
holdings-
Thanks to modern data processing and computing equip-
ment, which wasn't available during the 1929 crash, brokers
can compute the exact position of an active margin account
almost instantly in periods of rapidly falling prices. At other,
more normal times, weekly runs on all margin accounts are
sufficient to protect the broker.

Incidentally, when a customer gets a margin call, he
doesn't have to pony up cash if he has acceptable securities in
a regular or cash account that he can post as collateral.

A margin customer is also permitted to substitute one stock
for another in his margin account. But if the stock he buys is
higher in price than the one he sells, he will have to deposit
funds with his broker equal to the Federal Reserve's initial
margin requirement on the difference between the purchase
price of the one and the selling price of the other.

Conversely, if proceeds from a customer's sale exceed his
purchase cost, the amount that he can withdraw from his
account is the amount above the Federal Reserve's current
initial margin requirement, provided that his account is fully
margined (unrestricted). If his account is restricted (mar-
gined below the current initial federal margin requirement),
the customer can withdraw at least 30% of the difference
between the purchase cost and the sale proceeds.

The strictness of both the Federal Reserve Board's require-
ment governing the initial margin payment and the stock
exchange rule on maintenance of margin explain why
margin calls are comparatively infrequent today, except dur-
ing sharp market dips. In severe slumps the margin buyer can
be caught in a bad squeeze and forced to sell at a substantial
loss in order to meet a margin call. That's why no one should
trade on margin unless he has both the temperament and the
resources to enable him to accept his losses with reasonable

HOW YOU BUY STOCKS ON MARGIN  159

equanimity. You can't be a margin trader  nor should you
be  if you have only a widow's mite.

One other restriction on margin trading should be noted.
The exchange has put a brake on the heavy margin traders
who move in and out of a given stock several times during
one day's trading. Brokers are now required to see that such
day traders operating on margin, as most of them do, have
enough capital in their accounts to cover the initial margin
requirement on the maximum position they held at any time
during the day's trading  not just on their position at the
end of the day.

Not only have these regulations resulted in fewer margin
calls than at the time of the 1929 crash, but they have also
greatly reduced the proportion of margin accounts in relation
to all accounts. In 1929 it is estimated that margin customers
represented 40% of all customers. And these customers ac-
counted for a considerably larger proportion of total com-
mission business, just how large a proportion no one knows
exactly. But as the market boiled upward in the late twenties,
the margin customers were always the big buyers, the people
who kept pyramiding their paper profits and buying more and
more stock.

;    Here's how pyramiding worked in those days: suppose a
man bought 200 shares of a $50 stock. Under the lax margin
regulations that prevailed then, he might have had to put up
only $a,ooo of the $10,000 cost  maybe even less if he was
a favored customer.

i    Now let's assume that his stock advanced to $75 a share.
His total holdings would now be worth $15,000. If he sold at
that price and paid off the $8,000 loan from his broker, he
would have $7,000 cash. On a 20% margin basis, this would
enable him to buy $35,000 worth of stock. Actually, of
course, he didn't have to go through the mechanics of selling

\ out and buying afresh. The broker recognized the expanded
" value of his original holdings and accepted that added value
as collateral on additional margin purchases.

In this instance, the customer would have been able to own
$35,000 worth of securities on a cash margin of only $2,000,
all thanks to a 50% increase in the value of his original 200
shares. If he continued to be that lucky, he could run his
paper profits to a hundred thousand dollars, a half million

l6o HOW TO BUY STOCKS

dollars, a million dollars, many millions of dollars, all on Just
$2,000 cash.

In the twenties many people did exactly that. But when
prices started to decline and the margin calls came, many of
them couldn't raise even a few thousand dollars cash, except
by selling securities. And when they sold, that very act of
selling depressed prices further and resulted in more margin
calls. Again they had to sell. And so the vicious circle'kept
swirling downward into the great abyss.

There's nothing illegal about pyramiding, even today,
under the Federal Reserve Board rules. But it can't work very
effectively when you have to put up margin of 50%, 70%, or
90% instead of 20%. Then only a substantial increase in the
price of a speculator's stock will yield you big enough paper
profits to permit a significant increase in your holdings.

Current margin trading accounts for only 10% to 15% of
total trading on the New York Stock Exchange. However,
because they are apt to trade more frequently and in larger
amounts, margin customers today probably account for 30%
to 40% of brokers' total commission income. Margin ac-
counts are so well protected today that even if there were a
serious decline in the market it is unlikely that it could ever
be turned into the kind of rout that made 1929 the debacle it
was,

22

CHAPTER

What It Means to Sell Short

WHEN an investor opens a margin account with a broker, he
is asked to sign an agreement giving the broker authority to
lend his marginable stocks to others. It is this lending or
hypothecation agreement that makes it possible for other cus-
tomers to sell stocks short.

Short selling normally accounts for only 6% to 8% of all
the transactions on the New York Stock Exchange, Yet prob-
ably no other market technique excites so much public in-
terest  or is so widely misunderstood.

A short sale is nothing but the reverse of the usual market
transaction. Instead of buying a stock and then selling it, the
short trader first sells a stock he has borrowed, then buys it
back at what he hopes will be a lower price.

If it is legitimate to buy a stock because you think it's
going to go up, why isn't it just as legitimate to sell it because
you think it's going to go down?"Why shouldn't you be able
to try to make a profit in either direction? It can be fairly
argued that the right of a bear to sell, or go short, is Just as
vital to a completely free market as the right of a bull to buy
stocks, or go long.

Regardless of the logic of the situation, most people think
it just isn't morally right to sell something you don't have.

What about the magazine publisher who sells you a three-
year advance subscription to his publication?

What about the fanner who sells his whole crop to a grain
elevator when the seed hasn't even sprouted yet?

Both of them sell something they haven't got just on the
strength of a promise to deliver. That's all a short seller does.

Furthermore, it isn't really true that the short seller sells
something he doesn't have. He has to borrow the stock that
he sells, and he has to give it back. This he hopes to be able
to do by covering, or buying it back at a price less than he
sold it for.

161

l6a HOW TO BUY STOCKS

Where does he borrow his stock? From his broker.

Where does the broker get the stock to lend? Usually from
his other margin customers, who signed the lending agree-
ment when they opened their accounts. If a broker doesn't
have among all his margin accounts the particular stock a
customer wants to sell short, he will borrow it from another
broker, or from some individual stockowner who makes a
business of lending stock. But the broker cannot borrow
stock from the account of any of his regular cash customers
without speciBc authorization.

Why should one broker lend stock to another? Because he
gets paid for it by the borrowing broker, who retains all the
proceeds of his customer's short sale until the transaction is
closed out by an offsetting purchase. Sometimes, if the stock
is in heavy demand and is difficult to borrow, the broker wfll
even pay a premium to borrow it. Any such premium pay-
ment is, of course, charged to the short seller. If the price of
a stock on loan increases significantly, the lending broker will
expect to receive more money for lending it. If the price
drops, the borrowing broker will expect a proportionate re-
fund of the money he has paid. (Sometimes a lending broker
will demand return of the shares. If the borrowing broker
can't locate them elsewhere, he is forced to buy them back
from the customer and close out the short position whether
the customer likes it or not.)

A short seller operates under essentially die same rules as a
margin buyer. If the Federal Reserve Board has a 50% mar-
gin rule in effect, the seller must put up cash equal to 50% of
the market value of the stock that he borrows and sells.
Under stock exchange rules, the minimum margin cannot be
less than $2,000.

Suppose an investor wanted to go short 100 shares of a
stock selling at 60. If the Federal Reserve Board margin
requirement was 50% at the time, he would have to put up
$3,000 cash. If the stock dropped at 50, he could buy it back.
cover his short position by returning the stock, and make a
proBt of $10 a share, or $1,000, less taxes and commis-
sions.

But perhaps when the stock hit 50 he thought it would go
lower. He could make more money if it did, but he wouldn't
want to lose the profit he already had. In such a situation, he
might place a stop order to buy at 52, and thus protect

WHAT IT MEANS TO SELL SHORT  163

himself against a rising market. If the stock does go up to 52,
his stop order to buy becomes a market order to buy at
once.

If he buys back in at that price, he will still have a profit of
$800, exclusive of all brokerage commissions and taxes. Ad-
ditionally, he will be liable for whatever dividends have ac-
crued on the stock during the operation, because the lender
was entitled to get them during the time his stock was on
loan.

There is one important difference between the amount of
margin required for margin buyers and short sellers. The
minimum requirement of the New York Stock Exchange for
maintenance-of-margin is 25% for the long position. But when
a customer uses margin  as he must  for going short, the
minimum is increased to 30%, or $5 a share, whichever is
greater. (If the stock itself is selling below $5 a share, the
minimum requirement is 100% of the market value, or $2.50
a share, whichever is greater.)

That 30% maintenance-of-margin requirement on short
sales means that the broker will call for more money when-
ever the amount of the margin that the short seller would
have left if he bought the stock back and covered his short
position is only 30% of its current market price.

Suppose a man sells short 100 snares of a stock at 60. If
the initial margin requirement was 50%, he would have to
put up $3,000. Now, instead of declining to 50, suppose the
price of the stock goes up to 70. If he were to cover at that
point, he would owe $7,000, or $1,000 more than he sold the
stock for originally. That means he would have only $2,000
margin left in his account ($3,000 minus $1,000), or a little
less than 30% of the current value of the stock ($7,000 times
.30 equals $2,100). At that point, unless he decided to take
his loss and close out the transaction, he would receive a
maintenance call to deposit at least $100 additional mar-
gin.

Sometimes a short sale can be prudently used to protect a
profit in a stock at a time when the buyer doesn't want to sell
it and take his capital gain. Suppose, for instance, you had
bought 100 shares of a stock in Augusta straight cash
transaction  and that it ran up 20 points by the next July.
If you were to sell before the one-year time period passed and
take your $2,000 profit, you would have to pay a short-term

164 HOW TO BUY STOCKS

capital-gains tax on that profit at the full tax rate applying
to ordinary income. If you were in a 50% tax bracket, you
would have to pay out $1,000 in taxes. So you might want to
hold on for Just another month until your capital gain can be
reported as long-term.

But suppose the stock were to drop during that month
waiting period and you were to lose a substantial part of your
$a,ooo profit? You don't want that to happen. And you're
willing to forgo the prospect of further price appreciation, a
bigger profit, just to protect yourself against the risk of loss.
A short sale of 100 shares of the same stock you own offers
you just that kind of insurance. When you are both long and
short the same number of shares of the stock, your position is
stabilized. If the stock rises, you make money on your long
position and lose an equal amount on your short position. If
it goes down, you make money on the short side and lose an
offsetting amount on the long side. Your capital gains and
losses cancel each other out.

When you stabilize this way, you don't change the tax
status of your profit. You simply defer taking your gain and
avoid paying the tax on it as if it were a short-term gain. All
you lose are the additional commission, taxes, and interest
you pay on the short sale. (It should be noted that under
federal tax regulations a short sale cannot be used within a
single tax year to convert a short-term into a long-term capi-
tal gain in order to reduce the tax. It can be used only when
the carryover is from one year to the succeeding year.)

Another good thing about this kind of transaction, known
as selling short against the box, is that the maintenance-of-
margin requirement is reduced from 30% to 10%. This is
because when the margin customer is "long stock" in his cash
account in an amount that precisely offsets the number of
shares he is short in his margin account, any chance of loss is
eliminated, regardless of how the market moves.

While it is obvious that there is a legitimate place for short
selling in a free and orderly securities market, it cannot be
denied that short selling has often been used for illegitimate
purposes. Such abuses have frequently led to demands that
short selling be outlawed. From the time 350 years ago when
buyers and sellers first began to trade in the stock of the
Dutch East India Company, the history of short selling has
not been a pretty one. It contributed some gaudy chapters to

WHAT FT MEANS TO SELL SHORT  165

the history of the New York Stock Exchange, particularly in
the nineteenth century, when short selling was a favorite tool
of such famous market manipulators as Commodore Vander-
bilt, Daniel Drew, Jay Gould, and Jim Fisk.

These men frequently tried to catch each other in market
corners. A market corner is created when one man or group
succeeds in getting such complete control of a particular
stock that others who may have sold it short cannot cover
their purchases by buying the stock back, as they eventually
have to do, except on terms dictated by the controlling group.

One of the classic comers is the one that involved the old
Harlem Railroad, a predecessor of the New York Central.
Vanderbilt got control of the Harlem and then proceeded to
extend the road down Manhattan Island. Drew, who was also
a stockholder in the road and had realized a handsome profit
as the stock advanced in price, now saw an opportunity to
make a much larger profit. He induced the New York City
Council to repeal the franchise that had been granted for the
extension of the road, on the assumption that this bad news
would depress the price of the stock. Simultaneously, he sold
the stock short.

His maneuver succeeded in driving the price of the stock
down, but as Drew sold, the Commodore bought. In the end,
Drew and some of the members' of the City Council who
were associated with him in this notorious exploit found that
they had sold short more stock than actually existed. They
could not cover their short positions except on terms dictated
by Vanderbilt  and the terms were ruinous. That is perhaps
when the famous couplet, credited to Drew, came into our
literature; "He who sells what isn't his'n/Must buy it back or
go to pris'n"

Even when nothing so titanic as an attempted comer was
involved, short selling often praved an effective manipulative
device for pool operators, who would Join forces to bid the
price of a stock up and then drive it back down again with
short selling to make a big speculative profit.

Often such pool operators risked very little of their own
capital in the operation. They would stimulate public interest
in a particular stock by adroit publicity and creation of con-
siderable activity in the market for that stock. That activity
was usually more apparent than real, because it would be
generated by wash sales. A. wash sale, now outlawed by the

1,66  HOW TO BUY STOCKS

S.E.C., simply involved the simultaneous purchase and sale
of large blocks, say 1,000 or 10,000 shares. Such big volume
would attract the public, which inevitably seems to buy
whenever there is a lot of activity in a stock. As the public
bought and forced the price up, pool operators would wait
for the strategic moment when they thought the stock was
about as high as it could get, then begin selling it short,
hammering the price down to a level where they could buy it
back at a handsome profit.

One of the most important reforms introduced by the Se-
curities and Exchange Commission was the regulation that
effectively prevented abuse of the right to sell short. The
S.E.C. accomplished this objective in February 1938 by a
ruling that a stock can be sold short only in a rising market,
however temporary that rise may be.

The rule, generally referred to as the one-eighth rule,
works this way: if a customer places an order to sell short,
that order, as it goes to the floor, must be clearly marked as a
short sale- The floor broker is forbidden to execute that order
except at what is, in effect, a higher price. Thus, if a stock
were last sold at 50, the broker could not sell that stock short
except at a price of 50% or higher. In this case he would be
selling on an up tick.

There is one exception to this rule. The broker may sell the
stock at 50, the same price that prevailed on the last sale,
provided the last previous change in the price had been up-
ward. In other words, there might have been one or two or
six transactions that had taken place at the same price of 50,
but a short sale could still be made at 50, provided the last
different price had been 49% or lower. This is called selling
on an even tick.

With the debut of the consolidated tape in June 1975, the
S.E.C. had some new problems to solve connected with short
selling. The commission wanted to prohibit any short sale at
a price that was lower than the last sale reported on the
consolidated tape, regardless of where that sale was made.
Further, the commission wanted to prohibit a short sale on
an even tick and to impose short selling restrictions on all
over-the-counter transactions in listed securities.

Such stringent regulations posed serious problems for the
exchange specialists, who are responsible for maintaining a
fluid auction market in the stocks they handle. So the S.E.C.

WHAT IT MEANS TO SELL SHORT  167

relaxed its rule, providing that short sales could be made by
specialists regardless of the tick, as long as they were made at
the last sale price reported on the consolidated tape. Still, the
specialists were not satisfied. They argued that the consoli-
dated tape might lag significantly behind the actual market in
a given stock, that a price change that might appear on the
tape to be a down tick might actually be an up tick in their
own market.

So the S.E.C. made another concession, which became
effective on April 30, 1976. It gave the exchange the choice
of basing short sales on prices that prevailed on the big
board, or of using those that appeared on the consolidated
tape. The N.Y.S.E., of course, adhered firmly to its own
prices.

Most of the short selling that is presently done comes not
from the public but from members of the exchange. Does this
mean that brokers are up to their old tricks? Not at all,

The specialists account for 55% to 60% of all short selling
on the New York Stock Exchange. They often have to make
these sales if they are to fulfill their obligation to maintain
orderly and continuous markets in the stocks assigned to
them. Thus, if a broker wants to execute a market buy order
for a customer but there are no near offers to sell, except
perhaps at a price that is wholly out of line, the specialist is
expected to offer the stock at a better or lower price. He
must do this even if he doesn't have that stock in his inven-
tory and has to go short in order to complete the transaction.

Registered floor traders frequently engage in short selling
for their personal accounts. When they do, it is not because
they are trading on inside knowledge. Often it's because they
are cynical about the public's perpetual bullishness. Then too,
these traders customarily make fast and frequent trades on
both sides of the market, long and short, seeking to make a
small profit, even if that profit is only a fraction of a point.
They can afford to trade for minuscule profits because they
pay no brokerage commission by reason of their Big Board
membership. Such rapid-fire operations are very closely
scrutinized.

Short selling has been strictly regulated by the S.E.C., but
it still remains an important trading tool. As evidence of that,
the total number of shares sold short on the New York Stock
Exchange, the so-called short interest, is reported monthly by

l68 HOW TO BUT STOCKS

the exchange, and continues to reach consecutive highs, each
succeeding year.

Paradoxical as it may seem, a big short interest is generally
regarded as bullish. This is because as the short interest
grows, so does the potential volume of buying orders. Be-
cause ultimately every one of those short sellers is going to
have to buy back the stock he previously sold short in order
to make delivery of the shares. Hence, the short interest
represents a cushion of upcoming buying orders, which helps
sustain the market.

It is a truism that the public always wants die market to go
up and generally believes that it will. Most investors act ac-
cordingly. In the light of such perpetual bullishness, who
could deny an old bear the right to sell short on the assump-
tion that the public is wrong again?

2'?

CHAPTER  ^^J

OptionsPlain and Fancy

IN addition to margin trading, pyramiding profits, and selling
short, the speculator can execute still another market ma-
neuver that has become increasingly popular in recent years:

buying and selling options.

If you think a certain stock is likely to increase in price
over the next three months, for example, you can buy a caU
on that stock. This call gives you the right at any time within
the three-month period to buy 100 shares of that stock at the
price specified in the call contract. Whether or not you exer-
cise that option is wholly up to you. Whether you do or don't
depends on the market action of the stock. If its price ad-
vances and its increase is greater than the cost of the option
that you bought, it can be of advantage to you to exercise
your option and buy the 100 shares at the option price. Or
you might decide to sell your option, which you can do at
any time before the expiration date, and take your profit on
it.

Thus, if Rod & Reel was selling at $50 a share on August
i, you might want to buy an October call on Rod & Reel at
50. This would entitle you to buy the stock at the same $50
price, at any time from August i until the last option trading
day in October.

What would it cost you to buy such a call?

That depends on a variety of factors  what the outlook is
for the market as a whole, how stable the price of Rod & Reel
has been in the past, what its earnings prospects are, et cetera.
But, typically, a three-month option on 100 shares of a $50
stock  a round lot is the standard unit of trading  will
cost you $500, plus a commission of about $25. At $500,
your option on 100 shares would obviously cost you $5 a
share. That is the premium you pay. Unless Rod & Reel
advances by the amount of the premium  from 50 to 55 

i69

1/0 HOW TO BUY STOCKS

within that three-month option period, you will lose money.
Anything over 55 will represent a proBt to you, because you
have the right to buy 100 shares of Rod & Reel at 50. At 55,
you break even. That's called parity. At 57, you would be $2
a share ahead of the game.

At that point you could sell your contract in the options
market and net a profit of $200, minus commission on both
the purchase and sale of your option contract, a commissions
that might total $50. But you would have made $150 on a
$500 speculation, or 30% on your money.

Now suppose Rod & Reel never goes higher than 53 and
you conclude it never will before your option expires. Then
you might decide to sell the contract, even if it means losing
$2 a share or $200, plus $50 in commissions  a total loss of

$250.

The comforting thing about buying an option is that you
can never lose more than the amount of your original cost.
Maybe Rod & Reel goes up above your option price of 50.
But maybe it goes down to 48 or 47 or even lower. Obvi-
ously, at such prices, nobody is going to be much interested
in buying your call on the stock at 50, assuming that the
contract is also about to expire. So your call is worthless, and
you end up losing the $500, plus the $25 commission you
paid for the option. That's the most you can lose, no matter
how low Rod & Reel sinks.

And therein lies the great attraction of options. If you buy
one, you can't lose more than the contract cost you. But your
profit potential is open-ended. You might make 40% or
100%, or even more  all on just a $500 speculation. In
contrast, if you owned 100 shares of Rod & Reel outright at
$50 a share and it moved from 50 to 57, you could sell these
shares and make a profit of $700, or only 14%. But if you
had bought a $500 option at 50 and the price rose to 57 or
two points beyond your break-even point, you would make a
40% profit. You would also have put at risk only one-tenth
as much of your capital. Of course, you would have to as-
sume the risk that Rod & Reel would advance at least four
points in order to make money  a risk the man who owns
the stock outright never has to take.

In all these examples, it is assumed that the value of your
option moves up or down exactly the same amount as the
price of the stock. But that isn't always the case. Obviously,

OPTIONS  PLAIN AND FANCY 171

the price at which an option is traded is always going to be
influenced primarily by the price movement of the underlying
stock. But, after all, options are traded in a separate market
from that in which stocks are traded. And options traders
may not have the same idea about the future for any given
stock as those who buy and sell the stock itself. As a general
rule, when options are selling below parity, the price at which
purchases can break even, price swings are not as big, either
up or down, for the stock itself. But once an option reaches
parity, its price is likely to move up or down by exactly the
same amount as the stock itself.

If you have a profit in an option contract, you can sell it in
the options market, take your profit, and get out. But an
option contract gives you the right to buy that stock at a
specified price, and this is a right you might decide to exercise
if you think prospects look good for the stock. Thus, if you
bought an option on Rod & Reel at 50 (plus $5 per share
premium cost) and if Rod & Reel went to 58 during the life
of your contract, you might decide to exercise your right to
buy the stock outright at 50. In that case, your costs would
add up like this: $500 for the option contract, plus $25
commission, plus $5,000 for 100 shares of Rod & Reel at
50, plus approximately $40 commission on that purchase 
a total of $5,565 for stock then worth $5,800. So you come
out $235 ahead.

Even if you couldn't show a profit on your option deal you
might, if you liked the stock, decide to exercise the option
anyway and cut your losses. Thus, if you had paid $525 for
the right to buy a round lot of Rod & Reel at 50, you might
decide to exercise the option when Rod & Reel was selling
at 53. Your total cost would, of course, be the same $5,565.
But your stock would be worth only $5,300, resulting in a
loss to you of $265. But a loss of $265 is better than a loss of
$525, which is what you would be out of pocket if Rod &
Reel dropped to 50 or below.

There is nothing new about buying calls. You could have
bought a call on any number of popular stocks in the over-
the-counter market for many years. Or you might have
bought a put in the same market. A put is the opposite of a
call and gives you the right to sell a stock at a specified price
within a given time period on the assumption that the stock
named in the contract will decline.

HOW TO BUY STOCKS

172

What made trading in options so popular was the establish-
ment in April 1973 of the Chicago Board Options Exchange
for the sole purpose of providing an organized market for
trading in calls. In 1975, the American Stock Exchange also
initiated option trading, featuring a different list of Big Board
stocks. The Philadelphia and Pacific stock exchanges have
since followed suit. The exchanges have been doing a thriving
business. Although option trading was restricted originally to
calls, trading was extended to puts on all tour exchanges in
June 1977.

Meanwhile, in the old over-the-counter market, the old-line
options dealers still offer a wide variety of puts and calls on
assorted stocks, options of various durations that might ex-
pire on any one of the 250 trading days in the stock market
year.

On the exchanges, order has been brought out of this
chaos. Options are offered there for three-, six-, or nine-
month periods  just those and nothing else. Furthermore,
options contracts expire on a set date, usually on the Satur-
day following the third Friday of every month. But there are
three different time cycles. Some options operate on a January,
April, July, and October cycle. Some terminate in February,
May, August, and November. Still others expire on March,
June, September, and December. Hence, there are only twelve
terminal dates a year when contracts are closed out.

Finally, the prices at which options are offered have been
standardized. If a stock sells for under 100, prices are quoted
in five-dollar steps, except that options on some stocks that sell
tor more than $100 are quoted in $10 steps. These steps are
closely related to the price at which the stock itself is selling.
Thus, if Rod & Reel were selling at 30, you might, at any
given time, be able to buy or sell Rod & Reel options at 25,
30, 35, ant^ 4- N market would exist for option contracts
that were farther away than that from the actual price of Rod
& Reel. After all, no one would be interested in buying or
selling a contract at 50 or 55 for a stock currently selling at 30,
because it would not be realistic to expect such a stock to trade
in such a high price range soon.

Options on stocks that have rapid price movements, either
up or down, usually cost more than contracts on stocks
whose price performance is more stable. Typically, on these
more stable stocks you might pay 5% or 10% of the market

OPTIONS  PLAIN AND FANCY  173

price for an option, while on a real swinging stock, you might
expect to pay as much as 15%.

The value of the option as a speculative tool is clearly
apparent. Anyone can take a flyer in the option market by
risking just a few hundred dollars. He doesn't have nearly as
much money tied up in the operation as he would if he traded
on margin, even when margin is as low as 40% or 50%.
With terminal dates on option contracts often forcing the
buyer to take his losses, out-of-pocket costs may be higher for
option trading than margin trading. But if there is a signifi-
cant price advance in the stock, the profit may make this cost
look incidental.

The value of using options for protection is not always so
clear. But if you had a substantial profit in a stock and you
wanted to be sure that that profit was protected against any
possible loss for three, six, or nine months, you could buy a
put on that stock at the prevailing price. This would guaran-
tee that somebody else would eventually pay you the present
price for the stock, no matter how much it had fallen subse-
quently.

For instance, suppose you had bought 100 shares of Rod &
Reel at $20, and the price has risen to $40- You would have a
paper profit of $2,000. Now let's assume that this was money
you knew you were going to need a few months hence to help
pay for your children's tuition at college. You don't want to
sell Rod & Reel right then and take your $2,000 profit, be-
cause you think there's a good chance that Rod & Reel might
run up to $50, maybe even higher. Nevertheless, you can't
afford to lose that $2,000 profit you have in hand. To insure
yourself against loss, you might buy a six-month put. The
cost of the put would depend on the degree of volatility of
Rod & Reel, its price at that time, where it was traded, and its
previous history.

If the market then took a tumble and Rod & Reel declined
to, say, $32, you could exercise your right before the option
expired to "put" the stock to the seller of the option and force
the seller to accept delivery at $40 a share. You would still be
out the cost of the put, not counting commissions, but that's
better than being out $800, as you would have been if you
hadn't bought the contract. In protecting yourself this way
you have achieved the same objective as would a margin
trader who sold short against the box.

174 How TO BUY STOCKS

Of course, if the market rose and Rod & Reel kept going
up, perhaps to $47 or $48, you would lose the cost of the put
option. But you would be comforted by the $700 or $800
increase in the value of your holdings. In such cases, you
might consider the cost of the put a cheap form of insurance.

Instead of buying a put, you could also protect yourself by
selling you 100 shares of Rod & Reel at $40 and buying a call
on it at $40. If Rod & Reel dropped, the most you could lose
would be the cost of the call. But if it continued rising, you
would be in exactly the same position as if you still owned
the stock, except for the cost of the call.

A speculator who has sold Rod & Reel short could also use
options to hedge his position. But he would use them in
precisely the reverse fashion. Instead of buying a put to pro-
tect himself against a falling market, he would buy a call to
protect against a rising market.

Of course, you could accomplish the same objective by
placing a stop order to sell with your broker  the short
seller would conversely place a stop order to buy  but many
people dislike using stop orders to protect a profit because
such orders have no elasticity, no "give," to them. For in-
stance, suppose that you had bought Rod & Reel at $20 and it
now stands at $40. Being willing to concede some of this
twenty-point profit, you place a stop order to sell at $37. Now
suppose there was a brisk sell-off in the market on a given
day because of some worrisome piece of news and Rod &
Reel suddenly dropped to $37. Your stop order would be-
come a market order and you would be sold out immediately.
Then, in a few days, when the market had recovered from its
temporary shock. Rod & Reel might bound back to $40. But
you wouldn't own the stock any longer.

In addition to providing protection against loss, puts and
calls can also be effectively used to convert a short-term
capital gain into a long-term one, thus effecting a tax saving.
Suppose you owned 500 shares of Rod & Reel and there had
been a 5-point run-up in its price. You might be quite content
to take a $2,500 profit and get out. But if you had owned the
stock for anything less than one year, and if you were to sell
then, you would have to pay the full tax rate applying to your
income bracket on that capital gain. If you could only hold
the stock until the one-year mark had passed, your capital

OPTIONS  PLAIN AND FANCY   1.75^

gain would be taxed at the much lower long-term rate. But
because Rod & Reel might decline in those two months, you
wonder if you really should sell then, even if it did mean
paying a higher tax rate.

Options may offer you a solution. Instead of selling your
shares you could consider selling five three-month call options
on your five hundred shares of Rod & Reel. The call option
gives the buyer the right to purchase your five hundred shares
at a specified price within the three month period.

If the price of the stock declines, the call would not be
exercised but you would be protected by the amount of the
premium you received for the call. The premium, however,
would be taxed as a short-term gain.

If the stock goes up, the call will probably be exercised.
If at that time your holdings have reached long-term status,
you can fulfill the call with your holdings, and the premium
received for the call when you sold it will be added to the
selling price of your Rod & Reel shares, increasing your long-
term gain. It the call is exercised before then, you can buy
\. new stock to fulfill it and incur a short-term capital loss. You
" may be able to avoid exercise by buying in your options for

more than you received for them which would also result in
> short-term loss.

Purchasing a put would not serve you well in this case. If

 a put is purchased to protect a stock position that has not
reached long-term status, the holding period on the stock is

'. terminated. In other words, the long-term dial returns to zero

""and does not start again until the put is exercised or sold or

\.until it expires.

While many individuals buy options on one of the ex-
changes for trading purposes without exercising their right
stipulated in the contract, the bulk of options is sold, or "writ-

. ten," by private individuals or large institutions with sub-

 stantial capital. Does this mean that these people who sell
'^Calls are primarily bearish on the market? Not at all. They
Me willing to assume the risk they take for several very good
reasons: (i) they are well paid for that risk by the premium
they receive for the options they write; (2) when they sell
an option they have instant use of this money; (3) since they
usually own the stock against which they write the option,
they collect all dividends on that stock in the interim; and

176 HOW TO BUY STOCKS

(4) the contracts they write often represent "hedge" in-
surance against wide price fluctuations in stocks held in their
portfolios.

Since an active option writer deals in dozens of different
stocks, he can count on the law of averages to absorb a good
measure of his risk. Stocks simply do not move in identical
price patterns. He will lose on some and win on others. Con-
sidering all these factors, the trained and knowledgeable op-
tion writer does not carry as large a burden of risk as might
appear on the surface. After all, sellers of calls always have
that premium working for them. A stock has to advance by
more than the amount of the premium before the seller loses
any money.

Sometimes a trader will buy both a put and a call simul-
taneously on the same stock. This is called a straddlea
double stock option contract, each for 100 shares and with
identical exercise prices. Both options are written at the same
price.

The trader's purpose in buying a straddle is usually to try
to take advantage of anticipated large fluctuations in the price
of the underlying stock, without having to pinpoint either the
time or direction of such fluctuations. Thus, a stock might
rise sharply in price to a point where it became profitable for
him to exercise his call and then drop drastically, enabling
him to make a profit on die put.

Options are obviously very volatile, with a high leverage
factor  the chance to make a lot of money by placing only
a comparatively small amount at stake  while the size of the
loss is limited just to the size of the investor's stake.

So popular has option trading become in just a few short
years that options on several hundred stocks can now be
bought on the exchanges. And they are substantial stocks,
because the exchanges where options are traded have set cer-
tain requirements that a stock must meet before it becomes

eligible for trading;

(1) There must be at least 7,000,000 shares in public hands.

(2) There must be at least 6,000 shareholders of beneficial interest.

(3) Trading volume must have been at least 2,400,000 shares
during the previous twelve months.

(4) The price per share must have been at least $10 during the
three preceding calendar months. The underlying company

OPTIONS  PLAIN AND FANCY  177

must have made after-tax profits of at least $1 million during
the preceding eight quarters.

(5) The corporation that issues the stock must also meet certain
requirements, quite similar to those that govern the original
listing of the stock.

The central market system that the options exchanges have
designed for options trading is a microcosm of the central
market that the S.E.C. has designed for securities. It includes
a consolidated tape for reporting price and volume data, a
consolidated quotation system for publicizing the prices at
which competing brokers will buy and sell options, and a
central clearing system for processing all trades. These and
other time- and laborsaving innovations have reduced the
many variables formerly associated with options trading to
one basic factor; the price of the option.

The computer, too. has been created to estimate an op-
tion's value, based on its life span and the degree of risk in
the underlying stock. These programs produce a value es-
timate, which is compared with the price at which the option
sells in the marketplace in order to determine if the option is
overvalued or undervalued. Additional programs are then
employed to establish buying and seUing strategies.

The juggling of these various speculative devices  margin
trading, short selling, puts, and calls  weighing the risks
and the costs of each against the other, makes the business of
professional speculation a highly complicated one. This alone
, can explain why it is probably true that among people who
speculate, more lose money than make it.

But an even more important reason lies in the inclination
of speculators to act on the basis of a tip or hunch, their
wiwilhngness to study thoroughly all the tacts about a com-
pany before buying or selling its stock. Bernard M. Baruch,
probably America's most successful speculator, made it an
inviolable rule never to become involved in a speculative ven-
ture until he had mastered all the facts concerning it. As he
once explained, successful speculation demands not only
courage, persistence, and a judgment unclouded by emotion,
but above all it requires an infinite capacity for taking pains
 the pains to analyze all the available facts.

24

CHAPTER

How to Tell What the Market Is Doing

WHEN most people buy securities for the first time, they are
likely to do so for the wrong reasons. They will buy a stock
because they've heard other people, their friends or business
associates, talk about it.

It seems to be human nature to "believe that the other
fellow always knows a good thing, that he has reliable inside
information on how a company is doing.

Is there such a thing as inside information?

Of course there is.

The officers and directors of a company know more about
that firm and ifs prospects than anybody else could possibly
know. And they have relatives and friends with whom they
discuss their company's situation. In effect, these people do
have what appears to be privileged information  the real
"inside." And because they do, the S-E.C. has long kept close
watch on the stock-trading operations of company executives
and other insiders. The commission wants no recurrence of
the pre-igag situation when many company officials con-
sidered the privilege of trading in their company's stock on
the basis of inside information simply part of their compen-
sation.

Today, any such insider is required to report to the S-E.C.
every purchase or sale he makes of his own company's stock.
A list of such transactions is published monthly. An insider is
never permitted to sell his own company's stock short. Fur-
ther, if an insider realizes any profit from buying or selling
his company's stock within a six-month period,'that profit is
recoverable by the company, whether or not it can be dem-
onstrated that inside information was used. And it it can be
shown that he masked his transaction in the name of his wife
or some other relative or friend, he is just as liable as if he
had traded in his own name.

178

HOW TO TELL WHAT THE MARKET IS DOING   179

Inside information is, of course, no longer inside when it
has been made public. But when can such information be
said to have become public? This was the key question in a
test case initiated by the S.E.C. in May 1966. The case in-
volved a dozen directors and officials of the Texas Gulf Sul-
phur Company, which in 1963 discovered valuable deposits
of lead, zinc, and copper on its property at Timmins, Ontario.
The company acquired adjacent properties and resumed drill-
ing operations in March 1964. On April 16, 1964, Texas Gulf
announced its discoveries at a press conference.

The S.E.C. in its suit alleged that various officials profited
from their inside knowledge by buying stock in the company
before the ore discoveries became public knowledge. It even
went so far as to charge one director with a violation, al-
though his purchase of 3,000 shares was not made until an
hour after news services in virtually every major bank and
brokerage office in the country reported it. This particular
charge was dismissed when the first verdict was returned in a
federal district court, and all but two of the defendants were
exonerated. But American industry was put on notice that the
S.E.C. intended to be more vigilant than ever in supervising
transactions by company officials and other insiders,

If there was any need for emphasis, the S.E.C. underlined
its point in September 1968 when it brought an action against
, Men-ill Lynch, Pierce, Fenner & Smith, charging that the firm
had permitted a dozen of its large institutional customers to
^benefit from inside information that it had obtained in the
, course of working on a proposed underwriting for the Doug-
las Aircraft Company. Specifically, the firm was charged with
passing along a report that Douglas earnings for the first six
months of 1966 were going to be sharply lower than those
reported just a little earlier for the first five months. On the
basis of that information it was alleged that a dozen of Mer-
rill Lynch's institutional customers had gone short a total of
190,000 shares of Douglas stock a day or two before Doug-
las's first-half earnings forecast was made public. Because the
firm felt that there would be little profit to it in helping the
S.E.C. define more precisely what did and didn't constitute
inside information, it accepted the S.E.C.'s minimal penalties
and did not contest the action. But some of its institutional
customers who were also charged with violating the antifraud
provisions of the Securities Exchange Act of 1934 persisted

l8o HOW TO BUY STOCKS

in fighting the case. All but one  the Dreyfus Fund  were
convicted.

In 1974, a case was brought before a United States Court
of Appeals that involved a dispute about whether a brokerage
firm could function as investment banker tor a company,
while operating simultaneously as broker-dealer in that com-
pany's securities, without running afoul of insider leading
regulations.

Shearson Hammill & Co., a large stock exchange member
firm involved in the case, contended that it maintained a
"Chinese Wall" between its retail sales and investment bank-
ing departments. The plaintiffs asserted that, wall or no wall,
the firm's investment department transmitted to its sales force
on at least four occasions bullish information about Tidal
Marine Co., despite the fact that it also had bearish informa-
tion about the company that was not released to salesmen or
the public. However, Shearson maintained that its investment
department did not possess this bearish information until sev-
eral weeks after the plaintiffs had concluded their purchases
of Tidal Marine.

Regardless of the ultimate outcome of the Skew-son
"Chinese WoH" Case, as it has come to be called, Wall Street
houses then took strenuous steps to sever all lines of com-
munication between their investment banking departments
and their retail salesmen. They were hoping thereby to avoid
any charge of violating the S.E.C.'s rules on insider trading.
However, the S.E.C. rather tartly suggested that a better way
to avoid such problems would be for firms to prohibit their
salesmen from recommending the securities of any of the
companies with which that firm had an underwriting rela-
tionship.

On the basis of these cases, you may rightfully assume that
there is, indeed, such a thing as inside information about a
company. But you should also realize that the really impor-
tant inside information is usually so closely guarded that
neither you nor any other investor is likely to hear it until it
becomes generally available to all investors,

All publicly owned companies are obligated to reveal
promptly to the public any and all information that may
influence the price of their stock or any investment decision
about it. The news, whether favorable or unfavorable, must
be disseminated. The stock exchanges maintain strict and

HOW TO TELL WHAT THE MAIUOET IS DOING  l8l

detailed policies about disclosure, particularly anything that
might be considered inside information. Leaks of reliable in-
formation are rare indeed, and that's why anyone who invests
his money on what he believes to be an inside tip is apt to be
seriously misled.

How, then, should a person set about investing?
If he doesn't know anything at all about the market or the
stocks of various companies, where can he turn for in-
formation?

Probably the first and most obvious answer to that is the
newspaper  one of the big metropolitan daily newspapers
that carry complete stock market quotations and comprehen-
sive coverage of financial news, or one of the regional edi-
tions of The Wall Street Journal.

If an investor is not already familiar with the stock tables,
, probably his first step should be to study them regularly for a
>: period of time. If he reads a morning paper, he will find the
( stocks traded during the preceding day on the various ex-
; changes listed in alphabetical order under those exchanges'
^ individual headings. The late edition of the evening paper
i provides similar information for the stocks traded during that

| day.

In their consolidated stock tables, some papers provide
.much more complete information than others. But it our Rod

& Reel were sold on an exchange, or over-the-counter, and if
.yovx paper published complete consolidated stock tables, an

entry for one day, with the appropriate column heads, might

look like this;

Ym to Date    StocK?    P-E   Salw                      Nel
High   Low   Dividend   Ratio in IOO* High Low Clow Change

42%   389i Rod&Red2   12    17   40% 39% 40%   +%

The column headings make much of the information self-
explanatory. Obviously, the stock has been traded in a fairly
narrow range, having fluctuated only between a low of 38%
and a high of 42^ all year. A comparison of this price range
with the range recorded by other stocks will give you some
general idea of whether Rod & Reel might be classified as an
: investor-type stock or a speculation stock. As a very rough
'- rule of thumb, the greater the price fluctuation, the lower the
? investment caliber of the stock.

l8a HOW TO BUY STOCKS

The dividend figure immediately following the name of the
stock gives you another clue to the quality of the stock,
With an annual dividend rate of $a and a current price of
$40, Rod & Reel is yielding exactly 5%. Very often after the
dividend figure there will appear a small letter, which will
refer to a footnote. These footnotes can be very important,
because they may indicate that the dividend figure includes
extra dividends, or that this was the dividend paid last year,
or that it represents only the total paid so far this year for a
stock not on a regular dividend basis, or any of a number of
other dividend payout variations.

The P-E ratio  price-earnings ratio  of the stock is
computed by dividing the market price by its indicated or
actual earnings per share. Thus, if Rod & Reel sells at 40^4
with estimated earnings of $3.50 per share, it has a price-
earnings ratio of 11.5 ($40.25 divided by $3.50). This would
be rounded out to 12 for reporting purposes.

The figure for the number of shares traded simply shows
how Rod & Reel stacks up that day alongside other stocks as
far as market interest is concerned. Sales volume of a stock in
which there is considerable speculative interest will very often
exceed that of some of the better-grade market leaders.

The high, low, and close figures give you a bird's-eye pic-
ture of how Rod & Reel moved during the trading day. On
any given day, the pattern of price movement will not be the
same for all stocks. But this profile of Rod & Reel will show
you whether its market performance is generally in line with
that of other stocks and of the market as a whole. If Rod &
Reel closed at its high for the day, as it did, and if the market
as a whole had declined that day, you could conclude that
because Rod & Reel ran counter to the downward trend of
the general market the stock had demonstrated strength.

On the consolidated tape, which covers all markets, the
volume figures and closing prices published in the newspaper
are those that prevailed at 5:30 P.M., E.S.T. That is when
trading terminates on the West Coast market, one and a half
hours after the Big Board shuts down.

The net change figure (+%) shows the difference between
the closing price that day (40%) and the closing price the
preceding day (which thus had to be 39^).

Occasionally you may notice that the price of a stock is
down from the preceding day, but the net change figure

HOW TO TELL WHAT THE MARKET IS DOING   183

doesn't show a corresponding drop. That's because the stock
is being sold ex-dividend,

Suppose Rod & Reel pays its quarterly dividend of 50^ to
stockholders who are on its books as of the close of business
on Friday, September 15. Beginning the previous Monday,
September 11, and running through Friday, the stock will be
worth 5o<i less, because anyone who buys it during that
period will not be eligible for the dividend. This is because
',five business days are allowed to make delivery of stock on a
Sell order, and only those people who own the stock as of the
close of the markets on Friday, September 8, will be on the

company's records on Friday, September 15. On any day on
': which a stock is sold ex-dividend (in this case Monday,
^ September 11), its price is expected to decline by the amount
1" of the dividend. It that is exactly what happens, the net
: change figure will show no gain or loss. Sometimes, however,
 a stock may show outstanding strength and "make up" the
;; amount of the dividend, thus, in this case, closing with a net
gi change of +Vi, even though the price is exactly what it was

before the stock went ex-dividend,

'.  This five-day interval is also important when a stock goes
; ex-rights. Thus, a company with a new issue of additional
stock might announce that stockholders as of Friday, Sep-
tember 15, would have the right to buy-new stock in propor-
tion to their present holdings at a price somewhat below the
market. But obviously only those people who bought the
, stock on or before Friday, September 8, would appear on the
' company's records five business days or one week later. Any-
body who bought the stock after that date wouldn't get the
rights. When a stock goes ex-rights, it usually sells at a price
'that is lower by an amount roughly equal to the value of the
rights. During the time when the rights can be exercised, they

 are bought and sold separately and often quoted separately in
the stock tables- They fluctuate up or down, generally reflect-
ing strength or weakness in the parent stock.

Obviously, it would be a mistake to draw any positive
conclusions about a stock on the basis of one day's trading
pattern- But if you watch a stock over a period of time and
compare it closely with a dozen or so others, particularly with

j those in the same field, you will begin to get an idea of how
that stock is regarded by the thousands of people whose daily

' transactions make the market.

184 HOW TO BUY STOCKS

Not all newspapers publish anything like complete quota-
tions of Big Board stocks. Nor do many of them use the
tables compiled from the consolidated tape. Some of them
continue to cover just the transactions on the New York
Stock Exchange, ignoring what might have taken place in the
over-the-counter market or on regional exchanges and what
might have happened to prices on the Pacific Coast after the
Big Board closed. In smaller cities, the daily newspapers may
list only 100 or so stocks with no details except the closing
price and the net change from the preceding day. In big
cities, the former practice of publishing the bid-and-asked
quotations on listed stocks that did not trade during the day
has been abandoned.

The American Stock Exchange stocks don't get nearly as
much play in the papers as those of the Big Board, and stocks
listed on the regional exchanges are likely to get press notice
only in the areas where the parent companies operate and
where there is some public interest in their stocks. Much the
same standard determines how many unlisted stocks are
quoted daily from the national and regional lists supplied by
the National Association of Securities Dealers through
NASDAQ. Big city newspapers usually publish the full
N.A.S.D. national list.

Prices reported in the newspapers for bonds are apt to be a
little confusing. Although bonds are usually sold in thousand-
dollar units, their prices are quoted as though they had a
hundred-dollar denomination. Thus, a quotation of 98 would
indicate an actual price of $980. One of 98% would be
$983-75-

Since government bonds sold on the open market are
traded not in eighths or quarters but in thirty-seconds, a
special price-reporting formula has been developed for them.
For example, a printed quotation of 99.16 actually means a
price of $995. Here's how you arrive at that: the point in the
quote isn't a decimal point; it is only a device for separating
the round figure from the fraction. Hence the quotation really
stands for 991%2, or 99%, or $995. Sometimes Treasuries
are sold on a price change of just %< rather than ^2. If a
plus sign appears after the published quotation for a govern-
ment bond, this means that Vw should be added to the pub-
lished price.

Almost every daily paper publishes, in addition to prices on

HOW TO TELL WHAT THE MARKET IS DOING   185

individual security issues, some report on the average move-
ment of New York Stock Exchange prices.

There are a number of these averages that are supposed to
serve as barometers of the business. The best known of them
is the Dow Jones average.

Actually, the Dow Jones average isn't one average but
four  one for industrial stocks, one for transportation stocks,
one for utilities, and a composite one that reflects the status
of the other three. These averages are computed constantly
and are instantaneously available on desk-model quotation
machines. They are officially announced by Dow Jones at
half-hour intervals throughout the trading day.

The utility index is an average of prices for fifteen utilities;

the transportation index covers twenty railroads, airlines, and
trucking companies; the industrial average is based on the
stocks of 30 leading manufacturers and distributors. The
composite index includes all 65.

Over the years, these averages (which date back to 1897,
except for the utilities index, which was first computed in
1929) have come to be accepted as the Bible of the business.
This is partly because Dow Jones & Company. Inc., which
originated them, publishes the country's leading financial
newspaper, the Wall Street Journal, It also operates the ticker
news service, known as the board tape, which can be found in
virtually every major bank and brokerage office, often pro-
jected on a large electronic screen.

But in recent years the suspicion has grown that this Bible
is not divinely inspired, that the Dow Jones averages are not
an infallible measure of the market. This criticism has been
aimed especially at the Dow Jones industrial average, the
most important indicator of them all, and is based on two

counts.

In the first place, it is argued that the 30 stocks that make
up the Dow Jones industrial average are not truly represen-
tative of all the industrials listed on the Big Board. Too many
of them classify as "blue chips"  stocks such as General
Motors, Exxon, du Font, Procter & Gamble, American Can,
Eastman Kodak, General Electric, General Foods, U.S. Steel,
and Sears, Roebuck. Moreover, one of its components, Ameri-
can Telephone, is really a utility and not an industrial stock
at all.

In the second place, over the years many of these stocks

l86 HOW TO BUY STOCKS

have been split several times, and with each split the price of
the stock has dropped proportionately. Thus, if the split were
two for one, the price of the stock could be expected to
decline about 50%. On a four-for-one split it would decline
about 75%.

In order to correct these occasional distortions and to
maintain the continuity of the averages, Dow Jones intro-
duced a new system of computation in 1928. Instead of divid-
ing the total of the daily closing prices of stocks used in each
average by the number of stocks in the average, the revised
system is based upon an artiEcial divisor, which remains un-
changed until a stock is split, its price is reduced substantially
by a stock dividend, or another stock is substituted. When
any of these changes occur, Dow Jones computes a new
divisor, which is intended to compensate for the change.

The inadequacy of the system, its lack of mathematical
precision, is evident from the fact that it is possible for the
Dow Jones industrial average to go up while the aggregate
value of all the stocks that comprise the average goes down.
For instance, on one particular day the Dow Jones average
showed an increase of about % of 1%. But on that same day
the actual value of all the shares of the 30 companies in the
average dropped from $26.5 to $25.5 billion. The apparent
gain in the average was accounted for by a rise in the price of
a comparatively few stocks that didn't have nearly as many
shares outstanding as those companies whose stocks declined.

In recent years, the premier position of the Dow Jones
industrial average has been seriously challenged by the 500-
stock index of Standard & Poor Corporation, the nation's
largest securities research organization. For many years,
Standard & Poor had published other indexes  a go-stock
daily index and a 48o-stock weekly indexbut it wasn't
unt" ^Sy. when high-speed computers made more compre-
hensive indexes possible on an hourly basis, that Standard &
Poor decided to lock horns decisively with Dow Jones,

Its 500-stock index, covering stocks that account for 86%
of the total value of all Big Board stocks, is unquestionably a
more scientifically constructed index than the Dow, and pro-
vides a much more accurate picture of what is happening in
the market. This is true because the Standard & Poor index is
computed by multiplying the price of each stock in it by the
number of shares outstanding, thus giving proper weight to

HOW TO TELL WHAT THE MARKET IS DOING  187

the bigger and more influential companies like A.T.&T. and
General Motors  and IBM, which isn't even included in the
Dow Jones average.

Despite the fact that the Dow Jones industrial average has
statistical shortcomings and the Standard & Poor 500-stock
index is definitely more scientific, the two indexes do move
together with surprisingly little disparity. It is unusual when
one ends up showing a plus and the other a minus. This
happens only on days when the market has had no clear-cut
movement in either direction. On major swings, they move
pretty much together, although one or the other may boast
that its index gave the first indication of such a move. On
balance, the Dow Jones is apt to be more sensitive to short-
term movements, while the 500-stock index provides a more
reliable long-term perspective.

Although Standard & Poor is proud that its index is used by
the Federal Reserve Board and the Department of Com-
merce, as well as many other federal officials and business
economists, Dow Jones  by virtue of its age and its popu-
larity with financial editors of press, radio, and TV
continues to have an iron-bound grip on the public mind,
particularly that public that frequents brokerage offices.

There is one significant difference between the two indexes,
and that lies in the magnitude of the numbers they use. When
the Dow Jones industrial stands at 975, the 500-stock index
stands at about 100, and that relationship holds pretty true
nght up and down the line. The Dow figure is about ten times
greater than Standard & Poor's. This results from the calcu-
lated effort by Standard & Poor to devise an index figure
more nearly comparable to the average dollar price of all
stocks traded on the New York Stock Exchange than the

inflated Dow figures are.

For years the New York Stock Exchange attempted to
persuade Dow Jones to divide its index by 10 or devise an-
other formula that would yield an index figure only a fraction
of the present level. But Dow Jones, which regards its aver-
ages as sacrosanct, despite the many changes brought about
by substituting one company for another over the years, has
turned a deaf ear to all such suggestions.

The reason why the exchange would like to see the Dow
Jones average fractioned is perfectly obvious. The exchange
worries about the effect on the public of front-page headlines

l88 HOW TO BUY STOCKS

proclaiming that the stock market dropped 25 points, as it
has often done in a single day. It isn't much happier when the
headlines say that the market went up 25 points. The big
figures, up or down, give the public an incorrect impression
of the volatility of the market.

No matter how you attempt to explain the situation, people
will go on confusing Dow Jones points with actual dollars,
despite the fact there is no relationship between the two. On a
day when the Dow might move 15 points  say from 900 to
915  the aggregate dollar value of all stocks listed on the
exchange would increase only about t%.

Dissatisfaction with the Dow Jones average was certainly
one of the key reasons why the New York Stock Exchange
decided in 1966 to begin publishing its own official composite
index, as well as four group indexes: industrial, transporta-
tion, utility, and Bnancial. The composite index covers all
1,532 common stocks on the exchange, and is computed
continuously and publicly announced on the exchange ticker
every half hour. No one was surprised to learn that the com-
putation process used in this "official" index yielded a figure
close to the $50 average price of all shares then on the
exchange. To be sure that the exchange is never embarrassed
by its own index, it plans to keep the index in line either by
splitting it or by changing the base period whenever necessary.

Another new index made its debut in 1966: the first index
of American Stock Exchange securities. But this so-called
Price Change Index was replaced in 1973 by the index cur-
rently in use  Market Value Index, which aligns the Ameri-
can Stock Exchange more closely with other market value
indicators in the industry. The NASDAQ Composite Index
was introduced on February 5, 1971.

CHAPTER

How to Read the Financial News

ONCE a person starts following stock prices and averages, it
isn't long before he or she begins reading the rest of the
financial section of the newspaper.

Here, obviously, will be found much important informa-
tion both about business in general and about individual
companies  their plans for expansion, their new products,
their sales and earnings records. Some of these news stories
dealing with individual companies may be a little on the
optimistic side, since they are often based on publicity re-
leases furnished by the companies themselves- But every
responsible newspaper today makes an effort to be as objec-
tive as possible in the handling of financial news.

A standard feature of the financial section of every big-city
newspaper is the daily column in which the action of the
stock market is reported and often analyzed in terms of vari-
ous technical factors  the primary trend, the secondary
movement, resistance levels, and so on.

While there are technical factors in the market that may
indicate its direction over short periods of time  the volume
of short sales, the ratio of odd-lot transactions to round lots,
whether odd-lot customers buy or sell on balance, the number
of stocks hitting new highs and the number falling to new
lows, et ceterathese are factors that are apt to be of far
greater importance to the professional trader or speculator
than to the average investor. This is especially true for the
newcomer, who may be understandably confused by refer-
ences to the "double top" or "head and shoulders," chart
configurations so dear to the hearts of point-and-figure and
bar-and-line technicians.

Nevertheless, all market columns can make interesting
reading after one gets used to the jargon. Soon even the
neophyte finds himself acquiring some familiarity with such

189

1QO HOW TO BUY STOCKS

phrases as "technically strong' or "technically weofc," the
"short interest" and the "Dow Theory."

The phrases technically strong and technically weak have
fairly precise meanings. Suppose stock prices have been mov-
ing more or less steadily upward over a long period of time,
Inevitably, in such a bull market movement, there are price
advances and price reactions, ups and downs in the market.. If
the volume of sales is heavy when stocks go up and light
when they go down during such a bull movement, the market
can be described as technically strong. Conversely, if volume
is heavy on the down side and light on the rallies, the market
is technically weak. This interpretation is based on the theory
that the amount of volume usually identifies the dominant
trend.

The term short interest refers, of course, to the total num-
ber of shares of Big Board stocks that all sellers are short 
shares they have sold but must buy back at some future date
to cover their positions. Many stock market commentators
are fascinated by the short interest figures and take them to
be a primary index of the technical strength or weakness of
the market. Its fluctuations, often very sharp, are interpreted
by many technicians to be bullish or bearish signals. But it is
worth remembering that even when the short interest rose to
a record high above 89,000,000 shares in December 1981,
that figure stfll represented less than 1% of all shares listed
on the Big Board. You might well ask if so small a tail can
really wag so big a dog. On the other hand, it's the big
operators who account for the short selling, and they are the
people who are supposed to be most knowledgeable about the
market.

The Dow Theory is at once the most celebrated, compli-
cated, and least understood interpretation of market action.
This is probably because neither Charles Dow, who founded
Dow Jones & Company, nor any of his various disciples has
ever adequately defined the theory.

In essence, the Dow theorists hold that three movements of
the Dow Jones averages are simultaneously under way at any
given time. There is the primary movement  broad upward
or downward trends which may last for several years (the
great bull or bear markets). There is the secondary move-
ment  a significant decline in a primary bull market, or a
strong recovery in a primary bear market, generally lasting

HOW TO READ THE FINANCIAL NEWS  1Q1

from three weeks to three months. Finally, there is the ter-
tiary movement  day-to-day price fluctuations, which are
usually relatively unimportant.

The crux of the theory is that reliable conclusions cannot
be drawn about the trend of the stock market until it has
been ascertained that the industrial average, consisting of 30
stocks, and the transportation average, consisting of twenty
stocks (known as the "rail average" until January 1970, when
nine airline and trucking company stocks were substituted for
nine railroad issues), are moving upward or downward "in
gear." When that happens, the averages are said to be "con-
finning" one another in whatever direction they are headed.

Forecasts based on the movement of one average, if un-
confirmed by the other, are generally wrong  according to
the theorists. When successive rallies by both averages exceed
previous high levels, and when ensuing declines hold above
preceding low levels, the inference is bullish. The averages are
then said to be charting a pattern of "higher highs." Con-
versely, when rallies fail to carry above the old highs and
subsequent declines penetrate the previous lows, the implica-
tion is bearish  a pattern of 'lower lows."

Dow theorists contend that by their somewhat occult for-
mula they have been able to forecast almost every significant
movement in the market for many years. Other analysts,
looking at the same set of tacts, dispute the Dow Theory's
record. They say it can be made to look good only when the
forecasting has become history. Nevertheless, many financial
editors continue to expound the Dow Theory, and various
Dow disciples appear in the advertising columns from time to
time, offering letter services to explain the market action in
terms of their interpretation of the Dow Theory and the Dow

averages.

Very often in reading the newspaper the new investor will
encounter what appears to be a striking contradiction be-
tween the news and the market reaction to that news. For
example, a company may announce some good news, such as
an increase in its dividend  and its stock drops in price. A
prime example of this occurred on January 10, 1962, when
Ford Motor stock opened at i^ points lower and then closed
down 4 points on the day, after a two-for-one split and an
increase in the dividend were declared  announcements one
would expect might have given the stock a sizable boost.

1Q2 HOW TO BUY STOCKS

Again, news may break that Congress expects to enact a new
tax bill lightening the tax burden on business  and that day
stocks sell off right across the board.

There is one simple explanation for these paradoxes. The
stock market has "discounted" the news before it happened.
The big traders, the people supposedly in the know, were sure
that a dividend increase was coming at Ford, because profits
had been increasing spectacularly. As for the tax legislation
favorable to business, these same big traders would have been
surprised if Congress hadn't moved to enact it. They had
already bought or sold the stock affected by this news in
expectation of such developments. When the actual news
broke and attracted public interest in the market, the profes-
sionals seized their opportunity to realize profitsto sell
while others were buying on the basis of the newly published
news.

Some people consider the market an infallible barometer of
general business. They say that you can tell what's going to
happen to business in the near future by the way the stock
market acts over a period of time. Even government econ-
omists classify stock market action as a key economic in-
dicator.

Actually, the stock market is far from being an infallible
business barometer. Consider just a few of the most glaring
exceptions.

For instance, business conditions began to look a little less
than rosy in the late spring of 1929. But it was not until late
October of that year that the market hit the big slide, with
some popular stocks slumping 100 points or more in four
successive trading sessions.

More recently the stock market has performed very little
better as a guide to our economic health. Since the end of
World War II, it has missed the boat on several important
turns in business.

Thus. in 1945, business was retarded by the necessity of
reconverting from war to peace. But the stock market gener-
ally continued its upward course until mid-1946. Then it
declined 21% in five months when business had already
begun to improve. The economy continued steadily on the
upgrade for several years. But the market didn't catch up
with this postwar boom until early 1949.

HOW TO READ THE FINANCIAL NEWS  193

The market did turn down before general business in late
1948, early 1953, and mid-1957. But it gave an utterly fal-
lacious signal in the first six months of 1962, when stocks
sold off 25% while business generally continued to boom
merrily along, unperturbed by the Wall Street Cassandras.
Again, in 1966, the market missed the boat. It declined 25%
from February to October while business continued on its
steady course with only an insignificant drop of 2% in pro-
duction. The slow but generally steady growth of American
business during the 197&1982 period has been reflected in
the Dow-Jones average, which has fluctuated in die 800-
i.ooo range. However, like the perennial question "Which
comes first, the chicken or the egg?" the question of whether
the stock market leads business or business leads the stock
market is one that probably can never have an unequivocal
answer.

But if the stock market doesn't faithfully anticipate busi-
ness, it must sooner or later fall into step with the basic
business trends, because in the end stock values are deter-
mined by our economic health. That's why the investor is
well advised to keep an eye on some of the more basic in-
dexes of business  such as the Federal Reserve index of
industrial production and various, statistics tabulating em-
ployment, steel output, electric power production, construc-
tion, carloadings, retail sales, unfilled orders and prices, as
well as data on credit, bank deposits, and interest rates. These
statistics will tell how much America is producing, how rap-
idly this output is moving into the channels of distribution,
what kind of consumer demand there is for it, and the avail-
ability and cost of money and credit. In the long run, these
are the vital factors that will determine the real values of the
stock that you own in any company  how much the com-
pany is likely to earn and what kind of dividend it can pay.

But how is the individual investor to keep apprised of all
the financial news that affects the economy in general and his
specific stock investments in particular? The answer is by
reading one or a number of the various newspapers and mag-
azines that specialize in economic journalism, reporting in
depth on all the news that might affect the outcome of any
individual investment.

The following are the most widely read general business/

194 HOW TO BUY STOCKS

investment periodicals. They are the most useful sources of
dear, concise economic reporting for any investor  begin-
ner or expert.

Daily

The WaU Street Journal: every business day the "Journal
contains more market tables, more company news, more in-
dications of industry and economic trends, and more analysis
of current market conditions and the future market directions
than any other periodical published anywhere. It is also Justly
renowned for the scope and quality of its general reportage.
Many Journalists consider the Journal not only an indis-
pensable tool for all investors and businessmen, but also one
of the best daily newspapers of any kind in America. Truly
die Bible of the investment community.

The New York Times: for those investors who have nei-
ther the time nor the patience to wade through the 40-plus
pages of economic news and analysis The Wall Street Journal
produces every business day, the good gray Times provides a
more modest serving from the same basic menu. In the late
seventies the Times began devoting an entire ten-to-twelve-
page section of the paper to business news Monday through
Friday, augmenting its justly renowned Sunday business sec-
tion. Now Section D, known as "Business Day," presents the
most comprehensive array of market quotes, economic news,
and investment analysis this side of The Wall Street Journal.
It is surely as much information as the average investor needs
to keep abreast of current developments. And it is far and
away the best economic/investment coverage provided by any
daily newspaper in America today.

Weekly

Barrens National Business 6- Financial Weekly: put out by
the Dow Jones Company, which also publishes The Wall
Street Journal, Barrens is a weekly tabloid that contains an
encyclopedically comprehensive history of the week's transac-
tions in a wide variety of financial markets, including a range
of minute details even the Journal does not bother to record.

HOW TO BEAD THE FINANCIAL NEWS  195

Barrens also contains numerous feature articles, the iconoclas-
tic commentary of its acerbic editor Alan Abelson in his front-
page "Up and Down Wall Street" column, weekly chronicles
of the various doings in the real estate, commodities, and
options markets, hard-hitting profiles of specific companies,
and the largest imaginable selection of advertising for con-
cerns offering assorted investment expertise.

Business Week looks like Time and Newsweek; it delivers
its weekly amalgam of "hard" economic news featurss and
soft investment analysis in much the same sort of slick, pithy
fashion. B.W, is not specifically aimed at investors, although
it does have a very valuable weekly-performance financial
section. It is meant to be more of a digest of national and
international business and economic developments aimed at
the average businessman and the marginally sophisticated
layman. But the implications many of its stories have for
every investor are obvious. As a readable and comprehensive
source of general business news it is without peer.

World Business Weekly: published by the Financial Times
of London, W.B.W. is a global version of Business Week.
Done up in a similarly slick format, it reports on inter-
national economic Developments as well as specific foreign
investment opportunities. With the world growing smaller
every day and national business enterprises becoming increas-
ingly dependent on international financial opportunities, even
the casual investor can't afford to ignore the implications of
the kinds of story World Business Week presents so clearly
and concisely.

Twice Monthly

Forbes is the most comprehensive of general magazines for
the moderately sophisticated investor. It covers all the mar-
kets and the men who make them. Its specialty is the short,
punchy profile of changing companies and the dispassionate
look at new investment gimmicks- Forbes's stable of in-house
columnists  Ben Weberman, Heinz H. Biel, John Train,
Stanley Angrist, Srully Blotnick, and David Dreman  is
among the most realistic in the business. The magazine is well
edited and entertainingly written.

Financial World: a smaller version of Forbes, F.W.'s scope

196 HOW TO BUY STOCKS

is less comprehensive than its crosstown New York rival, but
its stories tend to treat their subjects in greater depth, com-
plete with detailed explanations of their implications for the
slightly less sophisticated investor.

Monthly                                                /

Dun's Monthly: until 1981 Dun's was almost a carbon copy
of Financial World, with very much the same format, style,
and editorial concerns. Late that year, however, the editors
transformed the magazine from a semimonthly to a monthly,
in the process adjusting both its substance and its personality
to reflect its new twelve-issue-a-year schedule. Now Dun's
looks like a cross between Forbes and F.W., as it attempts to
cut out a niche for itself in the investment journalism mar-
ketplace by combining the best features of both those excep-
tional magazines.

Fortune is the most prestigious of the general business
magazines. Famous as the arbiter of bigness in American
commerce with its renowned "Fortune 500" listings, a com-
prehensive ranking of the largest companies in the country,
Fortune tends to take the long view of things, with massive in-
depth looks at significant economic issues and business devel-
opments. Its coverage of personal investment decisions is
minimal But the weight of its opinions and the implication of
its researches are things any investor ignores at his peril.

Money: published by Time, Inc, Fortune's parent com-
pany, Money is the financial journalism success story of the
eighties. It tailors its editorial policies to deal with the com-
plete financial/investment needs of the average middle-class
American family  from stock selection advice to tax shel-
ter, vacation home buying, and franchised business investing
tips. Money differs from the other general-interest investment
magazines in that it concentrates as much as the changing
needs of the individual who makes the investments as it does
on the specific characteristics of the vehicle he or she is
investing in. In doing so it has scored by far the greatest
increase in readership among investment magazines during
the past decade.

Changing Times: traditionally less an investment magazine
than an editorial advisory service geared to the consumer

HOW TO READ THE FINANCIAL NEWS  197

needs of the average American, Changing Times has found
itself writing more about municipal bonds and less about can
openers of late as the investment awareness of the common
man increases dramatically. It has adopted these new duties
with its traditional thoroughness and dispassion.

Television

"Wall Street Week" (Friday, 8:30 P.M., PBS): nowhere is
the increasing hunger of Middle America for a broad range
of investment information more apparent than in the in-
vestment-advice community's increasing presence on the na-
tion's television screens. "Wall Street Week" is the grand-
daddy of all televised investment roundups. Every Friday
night on Public Broadcasting channels across the country,
host Louis Rukeyser spends a half-hour summarizing the
week's general economic news and specific investment hap-
penings, drilling his assorted panelists on their interpretation
of the current scene, and interviewing one guest expert on his
or her assessment of stocks, bonds, or any of a wealth of
other investment vehicles. It's a one-stop video quick fix on
the current market picture, which has deservedly become one
of public television's most popular weeUy fixtures.

"The Business Report" (daily, 6:30 P.M., PBS): the latest
entry into the economic video marketplace, this Miami-based,
three-anchor-person broadcast looks just like the other three
networks' seven o'clock news, except that it concentrates ex-
clusively on business and investment topics. Attempting to be
a sort of abbreviated television version of The WaU Street
Journal, "The Business Report" delivers a nightly roundup of
the day's financial activities and market results to its growing
audience of viewers, both veteran and beginning investors
alike.

All of these publications and shows are extremely useful
resources of detailed economic and investment information.
But in the final analysis, they leave the investor to work out
his own destiny by himself. They give him basic information,
but they can't tell him precisely what he should do about
it

26

CHAPTER.

Financial Adviceat a Price

DO you want more specific help with you investment prob-
lems: information, advice, recommendations?

You can get it  at a price. Whether it's worth the price
you pay is something else again.

Maybe you want something more than advice. Maybe you
don't want to worry about your investment problems at all. If
that's the case  and if you have at least $100,000 to invest,
preferably a good ideal more  you can turn your entire in-
vestment problem over to an investment counselor. His sole
business is guiding the investment destiny of his clients 
making all the buying and selling decisions for them, and
seeing that they are properly executed by a brokerage firm. In
New York City alone there are hundreds of these counseling
firms. They spend their full time investing other people's
money  for a sizable fee, of course. This fee is tax-deducti-
ble. There are many other such firms in all the other major
cities, from coast to coast.

In the main, these investment counselors do a sound job
for their clients, which include many institutions. But their
services are obviously beyond the reach of the average in-
vestor.

Many big-city banks will be glad to take your investment
problems off your hands. But again, they wfll do this only at
a price that most investors can't afford. One service such
banks offer is the investment advisory account, for which
they charge an annual management fee, usually % of 1%.
That may not sound like much. But the minimum annual fee
is at least $500, often much more. So again, unless you have
at least $100,000 to invest, or unless some unusual circum-
stance, such as a long-term absence from the country, jus-
tifies payment of the bank's supervision fee, such a service
may not be for you.

Under another type of bank service the depositor agrees to

198

FINANCIAL ADVICE  AT A PMCE  199

let the bank withdraw a fixed amount of money from his
checking account each month to buy shares or fractional
shares of stock in a company, or companies, selected from a
list prepared by the bank. The bank then combines the funds
allocated by all its customers for specific stocks and makes
bulk purchases, thus saving a good deal on commission costs.

Apart from investment counselors and banks, where else
might the average investor turn for help?

The answer is that there are dozens and dozens of invest-
ment adivsory services, all of them only too willing to help,
regardless of how competent they are. They offer the investor
a bewildering array of publications and services. Some are
simply compilations of statistical information. Some under-
take to review business conditions as they affect the invest-
ment outlook. Some provide recommendations about hun-
dreds of different securities  what to buy, what to sell, what
to hold.

Some are perennially bearish, but the majority are usually
bullish. Some, believing that good investment advice can't be
turned out on a mass-production basis, undertake to provide
a kind of tailor-made service. They offer to answer specific
investor inquiries and to permit occasional consultation with
their experts. Some even offer a- reasonably well-rounded
counseling service at a negotiated fee to the smaller investor,
perhaps the man with only $25,000 to invest.

Some of the financial advisory organizations sell many of
these different kinds of services. Others offer only one kind.

Most controversial of all are those services that undertake
to give advice about the general "market," usually in a weekly
letter sold on a subscription basis. Many of these publications
offer the subscriber their own rating service, covering hun-
dreds of different stocks. These publications tell the sub-
scriber whether to buy or sell, and most of them maintain
supervised lists of those investments that they consider par-
ticularly attractive. In effect, these supervised lists represent
model investment programs.

Many of these services are more concerned with the short-
term outlook  what the market is likely to do in the next
couple of months  than they are with the problem of long-
term investment. A few of them even limit themselves ex-
clusively to a discussion of technical factors affecting the
market.

200 HOW TO BUY STOCKS

Regardless of their different approaches to the investment
problem, these services generally share one common charac-
teristic; they will tell you how successful they've been in
calling the turns in past markets and in recommending good
buys and good sells at just the strategic moment.

The S.E.C. has the authority to compel investment advisers
to conform with strict and detailed standards of advertising.
Failure to meet these standards is considered fraudulent con-
duct in violation of the antifraud provisions of the Investment
Advisers Act of 1940. But there are those who feel this is an
area in which the S.E.C has not yet done the policing Job it
might.

In trying to bring these services to heel, the commission
has been admittedly handicapped by not having an industry
organization like the New York Stock Exchange with which
to share the regulatory responsibility. It has tried to induce
the advisory services to form some kind of an organization,
but the services, realizing how much easier it would then be
for the S.E.C. to bring pressure to bear on them, have turned
a deaf ear. Then too, such highly ethical and responsible
organizations as Standard & Poor's and Moody's Investors
Service have an understandable reluctance to be associated,
on any basis whatsoever, with the obvious quacks in the
business.

In the absence of an industry organization that could pur-
sue a program of self-regulation, the S.E.C. has accomplished
most of its housedeaning ]'ob on a piecemeal basis by bring-
ing legal action against palpable offenders. This course has
been time-consuming and expensive. But the commission has
won some landmark decisions in the courts and has brought a
number of the services sharply to heel.

The first and most important action was that brought
against the Capital Gains Research Bureau. The S.E.C.
charged that officers of this advisory service were guilty of
price manipulation by buying stock, touting it in their service,
then selling out when the price advanced. The U.S. Supreme
Court held that such scalping practices were a "fraud and
deceit upon any client or prospective client." It said that the
S.E.C. could enforce compliance with the Investment Ad-
visers Act by obtaining an injunction to halt such practices.

Under this act, designed "to protect the public and in-

FINANCIAL ADVICE  AT A PRICE  201

vestors against malpractices by persons paid for advising
others about securities," all investment advisers who receive
compensation in any form for their service must register with
the S.E.C. They must state the name and form of the organi-
zation, names and addresses of the principal officers, their
education and business affiliations for the past ten years, the
exact nature of the business, the form of compensation for
their services, et cetera.

In addition, the services must keep accounts, correspon-
dence, memorandums, papers, books, and other records and
furnish copies of them to their clients or to the S.E.C. at any
time upon request. Banks, lawyers, accountants, engineers,
teachers, newspapers, and magazines are exempt from this
registration  an exemption not entirely satisfactory to the
S.E.C.

Brokers are also exempt, as their advisory service is pre-
sumed to be incidental to their execution of orders, for which
they receive only commissions. However, brokers who per-
form an advisory service for which they are paid by clients
are not exempt.

It is the S.E.C.'s responsibility to see that there is no con-
flict of interest in the service that investment advisers offer the
public. In other words, an adviser cannot offer advice about a
stock if there is any possibility of his making money from
what he reports, unless he reveals that this is the case.

Significantly, it is not the S.E.C.'s responsibility under the
Investment Advisers Act to guarantee the competence of any
adviser or the quality of his service. Of course, the original
Securities Exchange Act does prohibit "any person" from
distributing information that is false or misleading. But it's
not as easy for the S.E.C. to prove a case against an invest-
ment adviser under this board but somewhat nebulous grant
of power as it is to establish a case of fraud or deceit.

The S.E.C. has proposed legislation that would increase
sharply its authority over investment advisers and make them
subject to the types of professional and responsibility stan-
dard that apply to brokers and dealers.

The S.E.C. has been so shorthanded, and the field it must
supervise has become so vast, that many publishers of market
letters have been plying their trade with little interference
from regulatory authorities. However, in 1972 the S.E.C. es-

202 HOW TO BUY STOCKS

tablished an Advisory Committee on Enforcement Policy and
Practices, which recommended that the S.E.C. double the size
of its staff. The S.E.C. accordingly was granted about $45
million more in 1975 in order to augment its staff by some
385 people in the succeeding three years.

How good is the advice that investment services provide?
There's no answer to that, because there is no way ac-
curately to compute and compare all their batting averages.
Some make flat-footed recommendations. Others hedge their
suggestions with all kinds of qualification. However, one
stock market analyst who did keep check on sixteen services
for a period of years found that if an investor had followed
all their 7,500 different recommendations during that period,
he would have ended up Just 1.43% worse than the market
averages.

Here are some of the most reputable companies whose
investment services are in no way to be compared to the
many market letters with their "get-rich-quick" recommenda-
tions.

Companies Rendering A Comprehensive Research
And Advisory Service

The biggest firms in the financial research business are Stan-
dard & Poor Corporation, 25 Broadway, New York, NY
10004, and Moody's Investors Service, 99 Church Street,
New York, NY 10007.

Known primarily as publishers of financial data, these two
firms supply the entire investment business, including all the
other advisory services, with the basic facts and figures on all
securities sold in the public market and on the companies that
issue them. Many of their publications, such as those dealing
exclusively with bonds, are too specialized to be of signifi-
cance to the average investor, but both investor and broker
would be utterly lost if it were not for the complete and
detailed information that these organizations supply on
stocks, both listed and unlisted.

Much of the research material supplied by one firm is also
supplied by the other, but they use different methods of or-
ganizing and publishing it.

FINANCIAL ADVICE  AT A PBICE  203

Most fundamental of all the reference books are Standard
& Poor's Corporation Records and Moody's Manuals. In
these massive volumes, running into tens of thousands of
pages, you'll find a brief history of virtually every publicly
owned company in the United States and full financial data
running from the present back over a period of years  the
figures on assets, income, earnings, dividends, and stock
prices.

Standard & Poor's Corporation Records consist of six loose-
leaf volumes in which reports on over 7,500 individual com-
panies are arranged in alphabetical order. These reports, pro-
viding all the basic financial data, are revised whenever a
i    company issues new reports or other important developments
1,    alter a company's prospects; supplements are issued every two
i]    months summarizing news bulletins on a company-by-
f    company basis. Standard & Poor's also has a special service
^    reviewing conditions by industry, called Industry Surveys. It
^    provides economic and investment analysis of 65 leading U.S.
I,    industries and 1,500 individual companies. For each industry
^    group an annual basic survey is published, supplemented by
f    current surveys updating the basic information.

I.'      Moody's presents its financial information on publicly
'^    owned securities in six publications covering municipal
''    bonds, banks and finance, industrials, public utilities, and
^    transportation. It also publishes weekly news reports on over-
the-counter industrial stocks. Subscribers to each of the pub-

TJ                                                                                                                        l.

t    lications receive an annual bound volume containing basic
f.    descriptions of these companies and investment situations at
no extra cost. Moody's is also the publisher of the authorita-
tive twice-weekly Dividend Record.

Standard & Poor's subsidiary, Daily Stock Price Record
Services, provides a broad spectrum of computerized financial
and corporate data relied upon by security analysts, research-
ers, and corporate financial executives.

These services, keeping abreast of all corporate facts and
figures, are far too costly for most individuals. Nor is it
necessary for an investor to spend several hundred dollars a
year on them, since they can usually be referred to in a public
library or broker's office. A registered representative can also
get the information for the client.

Even more condensed information is provided in the Stock

204 HOW TO BUY STOCKS

Guide, a pocket-size manual published by Standard & Poor.
Here, in tabular form, the investor can find the high-and-low
prices over the past few years, current data on assets, earn-
ings, and dividends, figures on institutional holdings, and
Standard & Poor's own quality ratings for 5,100 common and
preferred stocks, listed and unlisted. A new edition of the
Stock Guide, complete with lists of stocks recommended far
different objectives, is issued monthly.

For the individual investor, both Standard & Poor and
Moody's have special services and letters that comment on
business developments as they affect the outlook for indi-
vidual stocks and industries.

Chart and Statististical Services

M. C. Horsey & Co., Inc., P.O. Box H, Salisbury. MD 21801,
issues The Stock Picture bimonthly, which provides price
charts on more than 1,900 stocks for periods of time ranging
from five to fifteen years. Charts show earnings, dividends,
and present capitalization. Sample pages are sent upon re-
quest.

Trendline, 25 Broadway, New York, NY 10004, which is
owned by Standard & Poor, publishes three major stock mar-
ket services. Daily Action Stock Charts, covering 754 com-
panies and 14 market indicators, is published weekly. Each
company chart shows the daily high, low, dose, and volume
and the 200-day moving average (for the previous seven
months), as well as the yearly range for ten years. Earnings
figures, with comparisons for eight quarters, dividends, and
capitalization data, are also provided- There is also a monthly
edition. Trial subscriptions are available. Current Market
Perspectives, published monthly, includes charts of 1,476 in-
dividual companies, showing the weekly high, low, close, and
volume for the last four years, along with historical price-
earnings ratios. A three-week trial subscription is available.
Trendline also publishes the bimonthly OTC Chart Manual,
which includes charts of 840 leading over-the-counter stocks.
Each chart includes weekly high, low, and closing bid prices,
and volume for up to three years, annual price ranges for
eight years, and an earnings-dividend record for six years.

American Institute for Economic Research (AIER), P.O.

FINANCIAL ADVICE  AT A PRICE  ZOg

Box 567, 50 Stockbridge Road, Great Barrington, MA
01230, is an independent scientific and educational organiza-
tion conducting economic research and publishing the results
of that research whenever it considers that the public interest
would thus be served.

AIER publishes a weekly bulletin entitled Research Re-
ports. The issues analyze current economic developments.
Important factors such as industrial activity, prices, and
money-credit trends are depicted in an unusual series of
charts.

It also publishes monthly Economic Education Bulletins,
which are studies of such basic topics as property problems,
financial relationships, insurance, investment trusts, taxes,
estate problems, business cycles, commercial banking, and
the role of gold. Its publications are sent free to all sustaining
members.

In order to retain its tax exemption, in 1963 AIER trans-
ferred its investment advisory activities to American Institute
Counselors, Incorporated, which contributes all of its income
after taxes to AIER. This service publishes a semimonthly
report entitled Investment Bulletin, which covers business and
monetary developments and analyzes their significance for
investors.

The bulletins do not advise on margin trading and do not
attempt to forecast short swings or technical movements of
the stock market. They are intended primarily to assist those
who wish to follow long-term investment programs.

Babson's Reports Inc., Wellesley Hills, MA 02181: the
Babson organization, founded in 1904 by Roger W. Babson,
offers investors four different advisory services  an annual
consultation service, an investment advisory (with super-
visory option), a quarterly appraisal and review service of the
client's portfolio, and a complete investment management
service. The company's Investment and Barometer Letter is
supplied as a supplement to all three services.

Published by a subsidiary of the company that publishes
Forbes magazine, Forbes Special Situation Survey, 60 Fifth
Avenue, New York, NY 10011, is for the more sophisticated
investor interested in "high-potential" situations and willing
to assume the risk. The subscriber receives twelve recom-
mendations a year. Each recommendation covers a stock that
the service believes has a potential to perform substantially

206 HOW TO BUY STOCKS

better than the market in a period of roughly one to two
years. Subscribers are kept informed by periodic reviews and,
where necessary, suggestions are made about when to get out
of stocks previously recommended.

United Business and Investment Service, 120 Newbury
Street, Boston, MA 02116: each issue of its comprehensive
Weekly Report contains a review of the business outlook, a
report on Washington developments, a forecast of commodity
prices, an appraisal of the stock market, and specific recom-
mendations for buying or selling different stocks. Regular
reports are made on all stocks that are kept on supervised
lists. Periodic features include analysis of individual stocks
and groups of stocks, a report on bonds, various statistical
indexes of business and a summary of opinions and recom-
mendations of other leading advisory services.

Chartcraft, Inc., i West Avenue, Larchmont, NY 10538,
publisher of the Chartcraft Weekly Service, Chartcraft
Weekly Option Service, Chartcraft Weekly Commodity Ser-
vice, Chartcraft Technical Indicator Review, and the Chart-
craft Monthly Point and Figure Chart Book, offers services
devoted to point-and-figure charting and analysis. The Weekly
Service and the Monthly Chart Book cover every stock on the
New York and American stock exchanges. The Technical
Indicator Review deals with point-and-figure analysis of mar-
ket trends.

Dow Theory Forecasts, Inc., 7412 Calumet Avenue,
Hammond, IN 46325: general market projections are based
upon the Dow Theory, which this service has undertaken to
interpret and apply since 1946. The Dow Theory does not
deal with the selection of individual stocks, but seeks to de-
termine and project overall market trends. However, this ser-
vice does provide monthly buy-sell-hold advice on more than
700 issues. Clients may call at any time for speciBc advice on
their individual problems; unlimited consultation privileges
are provided. Its publication appears weekly, 52 times a year.

Value Line, 711 Third Avenue, New York, NY 10017,
publishes three comprehensive analytical services. The Value
Line Investment Survey reports on, and evaluates systemati-
cally, on a preset schedule, about 1,700 stocks in 92 different
industries. Each report analyzes how the company's business
is progressing and how the stock's future is perceived by
Value Line analysts. Each stock's prospects are objectively

FINANCIAL ADVICE  AT A PMCE  207

forecast in terms of timeliness and safety. The Value Line
OTC Special Situations Service (twice monthly) pinpoints
emerging stocks with above-average potential for growth-
oriented investors willing to undertake some financial risk in
the hope of realizing exceptional capital gains. Value Line
Options and Convertibles (first four Mondays of each month)
is an all-in-one service concentrating on listed options, conver-
tibles, and warrants.

In addition to these comprehensive analytical services there
exists a number of publications whose primary function is to
either reprint or distill in digest form the current thinking of
the world's foremost financial advisers. Chief among these are
the following.

The Wall Street Transcript, 120 Wall Street, New York,
NY 10005, is an enormous tabloid-style newspaper which
reprints verbatim the weekly market and technical letters of a
wide variety of Wall Street brokerage firms, as well as
numerous brokers' analyses of various industries and recom-
mendations of specific stocks. The Transcript also reprints
corporate news, publishes lengthy round-table discussions of
various industries and their stocks, written by analysts of
those industries, profiles investment professionals and their
current stock selections, and contains weekly options and
collectible columns. It is an indispensable tool for investors
interested in a wide variety of original market research and
specific stock recommendations.

Newsletter Digest, 2335 Pansy Street, Huntsville, AL
35801, provides capsulized versions of current comments by
a wide variety of analysts in a broad range of investment
fields  stocks, bonds, gold, commodities, real estate, interest
rates  and the general economic picture. It also comments
on some of these opinions from its own editorial perspective
and appears semimonthly.

Market Consensus Letter, Suite 383, 9333 North Meridian
Street, Indianapolis, IN 46260, provides a meaningful selec-
tion of current quotes from a wide variety of market analysts,
but differs from Newsletter Digest in that it concentrates
solely on stocks and offers a considerable amount of its own
opinion, including the recommending of specific stocks for
capital appreciation. It, too, appears semimonthly.

208 HOW TO BUY STOCKS

WaU Street Digest, 120 Wall Street. New York, NY 10005,
provides a monthly digest of excerpts from the current opin-
ions of the world's leading financial advisers. WSD also gives
its own precise investment recommendations for the stock
and bond markets, gold, silver, the best money market funds,
plus a comprehensive general economic survey.

The Hulbert Financial Digest, 8 East Street SE, Washing-
ton, DC 20003, is the only monitor of investment advisories
that generates no opinions or recommendations of its own. It
exists solely to track the advisory records of the various news-
letters it surveys. In addition to providing a healthy smatter-
ing of opinion on a wide range of investment vehicles from
the various advisories it monitors every week, Hulbert pro-
vides an objective performance of its subjects' recommenda-
tions. Hypothetical model portfolios are constructed accord-
ing to each letter's advice, and each issue reports on the
values of those portfolios as it goes to press. It comes out
monthly.

And, finally, of course, we have the specific stock market
advisory newsletters themselves. Most major brokerage
houses issue periodic investment summaries, which comment
on general economic conditions and particular stocks they are
currently recommending for purchase. These brokers will be
more than happy to send you copies of their letters if you
request them. But, in addition, a number of independent
market letters, written and published by a wide range of
market "gurus" using a confusing array of forecasting tech-
niques, have sprung up in recent years. Many have become so
popular that they have come to wield a strong influence on
the performance of the very market they have set out to
predict. Among the most widely read are the following.

The Granville Market Letter, Drawer 0, Holly Hill, FL
32017, is the most widely known financial newsletter in the
world. "Joe" Granville is a pure technician who interprets the
"tale of the tape" to tell his many subscribers when to buy
and sell. Critics charge that he is as often off target as on, but
he goes blithely on making dramatic predictions that are
watched by analysts as much for the effect they have on the
market as for the accuracy of their prognostications. The
letter appears semimonthly.

The Zweig Forecast, 747 Third Avenue, New York, NY

FINANCIAL ADVICE  AT A PRICE  209

looly: a regular panelist on the "Wall Street Week" televi-
sion program, Martin Zweig topped the Hulbert Financial
Digest 1981 stock market advisory survey with a 36.3% gain
for his model portfolio versus a 1.2% decline for the broadly
based Standard & Poor 500-stock average. Zweig screens over
2,000 stocks in an effort to select the potential top performers
according to insider trading, yields, price earnings ratios, and
a wide array of more obscure technical measurements. The
Forecast appears every three weeks.

The Professional Tape Reader, Redcap, Inc., P.O. Box
2407, Hollywood, FL 33022, is a technical stock market
letter that uses 46 indicators to forecast both the short-term
and long-term market trends and recommend specific indi-
vidual stocks. It comes out semimonthly.

Personal Finance  The Inflation Survival Letter, Kephart
Communications, Inc., 901 North Washington Street, Alex-
andria, VA 22314, emphasizes hard money and alternative
investments, and covers gold, silver, hard currencies, foreign
bank accounts, real estate, collectibles, commodities, strategic
metals, precious gems, foreign stocks, insurance, money mar-
ket funds, barter, and financial privacy matters. It generates
its own articles and quotes from a wide array of varied expert
opinion. It appears semimonthly.

Harry Broume's Special Reports, Box 5586, Austin, TX
78763: the best-selling author of How You Can Profit from
the Coming Devaluation and Inflation Proofing Your Invest-
ments offers sage advice on the current state of a wide range
of investment topics from money market funds to Swiss bank
accounts.

The Wellington Letter, Suite 1812, 745 Fort Street, Hono-
lulu, HI 96813, analyzes and forecasts for the sophisticated
investor, all the major financial markets, with particular
emphasis on interest rates, commodities, and the stock mar-
ket. It is a monthly.

International MoneyUne, 25 Broad Street, New York, NY
10004, writes commentary and provides general strategy and
'1.'   specific buy and sell recommendations on stocks and cur-

!rency. It appears twice monthly.

Market Logic, The Institute for Econometric Research,
\   3471 North Federal Highway, Fort Lauderdale, FL 33306,
4   publishes general stock market tuning advice and specific

210 HOW TO BUY STOCKS

equity purchase recommendations based on econometric fore-
casting models. Market Logic also includes a review of market
indicators, mutual fund recommendations, option timing, and
a digest of other advisories' commentary. Norman G. Fosback,
the editor, and Glen King Parker, the publisher, produce two
other innovative newsletters: The Insiders, which rates and
recommends all listed stocks based on recent sales and pur-
chases by corporate officials of the companies in question,
and New Issues, which gives analysis and buy recommenda-
tions on pending initial public stock offerings. The Insider is
published twice monthly. New Issues and Market Logic are
published monthly.

The Professional Investor, Lynatrace Inc., 2593 SE Ninth
Street, P.O. Box 2144, Pompano Beach, FL 33061, monitors
55 stock market indicators and 100 market letters to arrive at
a composite forecast. It appears twice monthly.

The Cabot Market Letter, Cabot Heritage Corp., P.O. Box
1013, Salem, MA 01970, features the Cabot Model Portfolio,
an actual working portfolio with stocks of twelve smaller
companies possessing high potential for rapid long-term
growth. Stock selection and monitoring are based on Momen-
tum Analysis, a unique approach that evaluates stocks' rela-
tive strength. The Letter comes out twice monthly.

Ruff Times, Target Publishers Inc., 1451 Danville Boule-
vard, P.O. Box aooo, San Ramon, CA 94853: the charis-
matic author of How to Prosper during the Coming Bad
Years offers advice on stocks, hard money, real estate, and
inflation. It appears twice monthly.

The Holt Investment Advisory, T. J. Holt & Company, 290
Post Road West, Box 909, Westport, CT 06881, provides a
complete analysis of the economy and the stock market, sup-
ported by numerous charts detailing trends in precious met-
als, money, credit, and the leading economic indicators. It
includes specific recommendations and follow-up reports. It
appears twice monthly.

Most investment advisory newsletters will send a sample
copy (usually a back issue) of their publication to prospec-
tive subscribers who request one.

The most complete listing of investment newsletters, re-
porting services, and journals available is The National Direc-
tory of Investment Newsletters. The 1982 edition cost $12

FINANCIAL ADVICE  AT A PMCE 211

plus (3 postage and handling. It lists hundreds of advisories
and newsletters, giving a brief description of their aims and
methodology, along with addresses, subscription rates, and
frequency of publication. The Directory is available from
Idea Publishing Corporation, 55 East Afton Avenue, Yardley,
PA 19067.

27

CHAPTER

How Your Broker Can Help You

IN the last analysis, the best answer that any investor can
End to the question of what stocks to buy is likely to be what
he works out for himself through study and investigation.

But where, you ask, can the average investor who is willing
to do his own investigating turn for the information he needs?
The answer to that is  his broker, preferably a member firm
of the New York Stock Exchange.

Perhaps you think this is dubious advice. After all, isn't a
broker interested in selling securities? Yes, a broker is a sales-
man. But that doesn't mean that your interests and his are
completely opposed. Quite the contrary. Any salesman of any
product wants his customer to be satisfied, because that's the
best way of building his own business. That's especially true
of the broker.

Then, too, there's an important difference between brokers
and other salesmen. The automobile salesman wants to sell
you a particular make of car. The insurance salesman wants
to sell you a policy in his company. The salesman for a
financial advisory service wants to sell you that service and
nothing else.

The broker, as a general rule, doesn't care which stocks
you buy. Professionally he has no ax to grind. He stands to
make about the same commission on the same total invest-
ment no matter how that investment is appointed. When it
comes to over-the-counter stocks, admittedly, he could have
an ax to grind if his firm makes a market in a particular
stock, but most securities dealers realize that such a self-serv-
ing policy can be bad business in the long run.

All this is not intended to imply that the brokerage busi-
ness is wholly without sin. Any business has a certain number
of sinners in it. And if that business involves the handling of
large sums of money, as the brokerage business certainly

HOW YOUB BROKEB CAN HELP YOU 213

does, it is likely to have an even greater than average number
of sinners, despite all efforts to exorcise them.

Over the years, the brokerage business has done a good job
of policing itself, of trying to rid itself of all unprincipled
elements. In recent years it has redoubled its efforts. That
increased effort can be traced directly to the publication in

1963 of the S.E.C/s final report to Congress on its study of
the securities business. This report led to the enactment of the

1964 Amendment Acts, and to the even more sweeping revi-
sions and regulations imposed by the Securities Reform Act

of 1975-

The S.E.C. has made it unmistakably dear with each pass-
ing year that it intends to supervise strictly and thoroughly all
member firms all over the country and every man in every
office. Furthermore, the commission has made it equally clear
that unless the New York Stock Exchange, which it has al-
ways accused of treating disciplinary matters too tenderly, did
a more competent policing job, it would hold the exchange
and its member firms responsible.

As a result the exchange has increased the efficiency of its
own police force. This force schedules surprise calls on
branch offices of member firms all across the country, check-
ing customer trading records and the character and per-
formance of the registered representatives. And the member
firms have followed suit. Some initiated policing of (heir own
offices as early as 1965 to forestall trouble with the S.E.C-
and customer lawsuits.

What are these policemen  or compliance officers, as
they are euphemistically calledlooking for? In general,
they are looking for any abuses of public confidence.

In particular, they are looking for evidence of churning,
the overstimulation of customer's trading in order to build
commission revenues.

They are looking for high-pressure salesmanshiptele-
phone calls at night, undue persuasion of widows, attempts to
prey on the unsophisticated and the unsuspecting.

They are looking for misrepresentation. "The stock is bound
to go up ... you can't miss,"

They are looking for abuses of the discretionary authority
that a customer may give a broker to manage an account, to
buy or sell whatever and whenever he thinks best.

They are looking for margin trading by customers who

214 HOW TO BUY STOCKS

plainly lack the resources to undertake the risks involved.

They are looking for the flagrant incompetence or the will-
ful malfeasance that could result in the recommendation of a
clearly unsuitable investment  a highly speculative penny
stock for a retired couple to whom safety of capital is para-
mount.

They are looking for situations in which securities firms, w
even individual partners or salesmen, seek to further their
own undisclosed interest in a stock by promoting its sale in
order to enhance the value of their own holdings.

In summary, they are looking for any abuse of what is
known in Wall Street as the S.E.C. "shingle theory"the
theory that when a broker hangs out his shingle he guarantees
to the world that he will deal fairly and honestly with his
customers.

The S.E.C. holds the home-office executives of member
firms wholly responsible for supervising their branch offices.
If there ever was any doubt about this, it vanished quickly in
the mid-sixties, when the S.E.C. and the N.A.S.D. empha-
sized their intent by instituting action against several leading
firms. Those actions resulted not only in the expulsion of
individual employees and branch office managers, but in fines
and suspensions levied against the firms' top officials.

The public furor stirred up by these headline cases was
actually disproportionate to the problem involved. Admit-
tedly, there were some sharp operators, utterly lacking in
moral scruples, among the 25,000 registered representatives
then employed. Admittedly, also, top management among the
member firms had been lax in exercising supervisory re-
sponsibility. And, admittedly, the exchange had been less
than stem in its disciplinary actions.

Still the fact remains that the securities business as a whole
adheres to a standard of ethics and a concern for the public
good that few other businesses can match.

And the fact also remains that the vast majority of regis-
tered representatives are honest, scrupulous, and sincerely
concerned with the welfare of their customers.

But even if the reliability of your broker can be taken for
granted, what about his ability? How competent is he likely
to be when it comes to giving you sound advice about your
money and how to invest it?

Obviously, that's a question to which there is no absolute

HOW YOUB BROKER CAN HELP YOU    215

answer. Nobody could possibly contend that all the thou-
sands of brokers in the securities business are preeminently
well qualified to give investment help. Some are and some
aren't. But thanks to the training programs that many leading
brokerage firms have been operating for years, the standards
of professional ability have been steadily raised. Most of
these programs last six months, with half that time spent in
the classroom, eight hours a day. Graduates can be consid-
ered to be pretty knowledgeable about the investment busi-
ness, even before they start to work in it.

Certainly this much can be said: as a general rule there
isn't anybody who is apt to be as well qualified to advise you
about your investments as your broker. After all, the regis-
tered representative works at the job of investing at least eight
hours a day, five days a week. And he has been doing it for
years. He has facts, figures, and information at his fingertips
that nobody else can easily lay hold of. He has easy access to
the basic reference works  Standard & Poor's Corporation
Records or Moody's Manuals  and he can get detailed data
on almost any publicly owned company in the United States.

"Investigate before you invest" is still one of the soundest
pieces of advice anyone can give you. And you might start
your investigating by thumbing Jthrough either Standard &
Poor's monthly Srocfc Summary or the Monthly Stock Digest,
published by Data Digests, Inc. Either of these two publica-
tions will give you an idea of the kind of information you
should have about any stock before you buy it,

If your preliminary investigation leads you to develop an
interest in several specific stocks, most brokers can supply
you  within reason, of course  with reports on these com-
panies. They buy these reports from accepted research ser-
vices or they are prepared by their own research departments
and often made available to customers without charge.

Research has become vitally important in the brokerage
business, and its quality can give a firm a genuine competitive
advantage. No member firm can buy a listed stock for you
for a cheaper price than another firm. They all must pay the
same price for a given stock on the exchange at any given
moment. But not all firms can give you the same well-quali-
fied advice about how good a particular stock may be for you
in your particular circumstances and with your particular
investment objective.

2l6 HOW TO BUY STOCKS

This, plus variable commission rates and service charges,
makes a decision about which brokerage Brm to use almost as
important as deciding which stock to buy. How can you form
an opinion about which broker might best be able to help
you? Well, you might visit three or four different ones and
ask them about the same stock. That would give you some
idea of how well informed each one was, what kind of ce-
search service each one provided, and the cost, if any.

If brokers charge for research advice they'll tell you. Then
you can decide whether you want to pay the fee or not. On
the basis of the replies you get from the brokers you contact,
you can make a reasonably informed judgment about the
quality of their research  provided, of course, that you have
leveled with them about how much money you have to invest,
what your financial situation is, and what you want most out
of your investments; safety of capital, dividend income, near-
term price appreciation, or long-term growth. The more com-
plete the information you provide about your circumstances,
the more pertinent the broker's recommendations are apt to
be,

And you need not feel that you are imposing on a broker
for this service. After all, that's part of the job for which
he and his firm get paid  by you. Many brokerage houses
advertise their willingness to set up a program for the new
investor, or to review the holdings of present shareowners,
making suggestions about what to buy or what to sell  and
why.

A good research department is staffed with analysts, who
spend all their time following developments in certain as-
signed industries. By reading countless business and industrial
publications and some of the more reliable financial advisory
services, an analyst keeps up with the published information
on his industries, including the reports of competing brokers,
He also tries to establish and maintain contact with key offi-
cials in all the major companies he covers, and visits them as
often as possible. This is one way in which a brokerage house
analyst determines the quality of a company's management,
the key factor, after all is said and done, in determining a
company's success.

Over the years, officials in companies covered by such re-
search have come to respect the qualified securities analysts.
Still they are likely to maintain strict silence about anything

HOW YOUB BROKER CAN HELP YOU    217

that could possibly be construed as inside information.

Publicly owned companies are obligated to reveal promptly
to the public any information that may influence the price of
their stock. The news may be favorable or unfavorable. It still
must be disseminated. But it definitely should not be dis-
seminated through the medium of a securities analyst who
telephones a company executive to inquire if an earnings esti-
mate of so much per share is "in the ball park." Casting
around for information in this manner has become generally
outmoded anyway; not only by much tighter and more rigidly
enforced disclosure regulations, but by the increasing unwill-
ingness of executives to cooperate. As a result, when trying to
estimate earnings, many analysts depend more these days on
what is known as the mosaic theory.

By his intimate knowledge of a company's past record, its
balance sheet, and the performance of its stock, an analyst
today can come pretty close to making a reliable earnings
estimate by piecing together the myriad parts of a corporate
mosaicsize of inventories, labor conditions, plant cost,
capacity, new product development, order backlog, quality of
management, and other related data.

Yet the analyst at any given time may still lack one vital
piece of information  perhaps the. status of a labor contract
or facts about inventory  that would complete the mosaic.
If he could obtain that, he would be much more confident
about his earnings projection. In such circumstances, he has
absolutely no qualms about calling his closest contact in the
corporation and asking for the information. And the official
normally doesn't have to worry about answering the question,
since it doesn't really constitute inside information.

In addition to contacting the company itself, an analyst
can usually pick up valuable information to complete his
mosaic by checking that company's principal competitors.
Very often he might even get from the competitor an earn-
ings estimate he can compare to his own.

It is the analyst's responsibility at all times to see that his
firm's registered representatives are fully informed about all
important developments affecting the companies he follows.
Periodically he prepares reports on these companies for dis-
tribution to the firm's customers and the public. Many firms
also prepare much longer and more detailed reports for their
institutional clients.

2l8 HOW TO BUY STOCKS

These research reports are a far cry from the old "broker's
letter," a catch-as-catch-can commentary on the stock mar-
ket, liberally interspersed with tips on what to buy or what to
sell. Today, the typical research report on a company, pre-
pared and distributed by a member firm, is a substantial piece
of factual and honest work. So that the customer may allow
for any possible bias, many firms go so far as to disclose in
such reports any special interest the firm or its owners might
have in the stock in question as a result of their own hold-
ings, representation on the company's board of directors, or a
long-standing underwriting relationship.

In recent years securities analysts have found a valuable
new tool to aid them in their complicated studies, the high-
speed computer. Since the early sixties, Standard & Poor has
made available to them, as well as to banks, mutual funds,
and other big financial institutions, its Compustot service.
This service consists of reels of magnetic tape on which are
recorded virtually all the essential accounting data that an
analyst needs. These Compustat tapes include millions of fig-
ures from the financial reports of thousands of corporations
listed on the major exchanges for each company. The tapes
provide annual data back twenty years on 60 different items
that can be vital in measuring a company's wealth. Quarterly
data for the past years is available on 40 of these items. Even
brokers who cannot afford the tremendous expense involved
in installing their own data processing systems can have ac-
cess through time-sharing to vital data such as that provided
by the Compustat tapes. This is an arrangement that permits
brokers to submit specific problems or questions to a central
computer and get an answer back by telephone or-teletype.

As a consequence, securities analysts no longer have to
work endless hours digging the figures they need out of old
corporate reports to arrive at a reliable statistical analysis of a
company's performance as compared with its competitors.
The computer does much of their work for them, and it does
it instantly.

Although. computer-oriented research is still relatively
young, brokerage firms have found data processing machines
useful in several other areas: information retrieval, security
screening and selection, and basic research into the nature of
securities prices and price movements.

It is in the field of portfolio management and evaluation

HOW YOUR BROKER CAN HELP YOU     219

that computers have made their most significant contribution
in recent years. This development was spurred by the enact-
ment on Labor Day 1974 of the Employee Retirement In-
come Security Act, one of whose primary requirements is
that pension fund trustees evaluate the performance of their
fund managers. Several major brokerage firms have created
highly sophisticated computerized techniques for the diag-
nostic evaluation of fund performance. These programs not
only calculate the rates of return earned on the assets under
management; they also determine the amount of risk taken,
the degree of diversification, and the impact of the fund man-
ager's attempts at stock selection and timing.

Finally, each pension fund that is evaluated is compared
with hundreds of other professionally managed portfolios, so
that the relative performance of the fund manager can also be
gauged. Several thousand pension funds are now evaluated by
these computer-based performance measurement systems. A
continuing record of their investment results is stored in the
computer's memory. Other computer programs verify that
custodians of securities have paid required interest and divi-
dends into the appropriate account and determine whether
each trade occurred between the high and low prices for the

day.

Several large firms have computer systems that give branch-
office representatives direct wire access to the main-office
computer, allowing them to retrieve instantly the latest opin-
ion of the firm's research department on several thousand
different stocks. The individual registered representative could
not be expected to have valid information on anything like
that many stocks to satisfy a customer who wants to know
what he thinks about this company or that one. Now, if he
works for a firm with a computer-operated retrieval system,
all he has to do is punch a few keys and instantly, no matter
how far away he is, he gets a printout of the analyst's latest
thinking about the stock, complete with his projections for
earnings, dividends, and future price range. It is, of course,
the responsibility of the research department at headquarters
to see that the information file in the computer is kept con-
stantly up to date.

In the area of security selection, the vast capacity of the
computer makes it possible to screen rapidly an almost unlim-
ited number of securities in order to find those that will

030 HOW TO BUY STOCKS

match some predetermined set of standardsstocks that
have shown consistent growth of earnings over some specified
period, or stocks whose price performance has exceeded some
established yardstick, or stocks that match some particular
standard for dividend payout in relation to earnings. In using
computers in this fashion, the analyst establishes the criteria
and lets the machine survey the field to find those that meet
his standards. The ultimate objective of this kind of computer
research is to find stocks that are undervalued or overvalued
in relation to the market as a whole or to any specified
segment of it.

Portfolio management by computer is really only a further
development of the techniques used in stock selection, al-
though it is infinitely more complicated because the computer
must be asked to deal with a wide variety of criteria. Stocks
must be chosen not only to satisfy the individual investor's
circumstances  cash available for investment, income re-
quirements, tax considerations, and the like  but also to
keep the degree of risk that the investor assumes in reason-
able relationship to his investment objective. Computers can
apply new analytical methods to differentiate between that
element of risk in a given portfolio attributable to general
market action and that portion inherent in the specific securi-
ties included in the portfolio. In tailoring a portfolio to an
individual investor's needs (he computer is used to review a
vast number of alternative investments  a far greater num-
ber than an individual analyst could review in months or
years. Because of the computer's high speed, the job can be
done in a matter of minutes.

The technical market analyst who is interested' in trying to
predict long- or short-term swings in the market on the basis
of such factors as the volume of sho-t selling, the ratio of odd-
lot to round-lot transactions, cyclical and random variations
in price movements, and other esoteric data finds in the
computer the answer to an infinity of mathematical problems
he has wrestled with for years. In addition, with the improve-
ments in data communication and the development of video
screens, a technical analyst can command the computer to
create instantly at his desk a wide variety of charts  trend
lines, moving averages, volume data, and high-low-close
figuresto help him in his predictions for the market as a
whole or for individual stocks.

HOW YOUR BROKER CAN HELP YOU 221

The computer has had one interesting effect on the analyst
himself. Accustomed over the years to generalizations about
the probable price action of a stock  "although short-term
prospects are not promising, there is appreciable potential for
long-term growth"  the analyst now finds it necessary to
express his opinion in specific figures if his projections are to
be used in a computer program. He must say, for instance,
that over the next three months he expects no more than a
1% increase in the price of a given stock, while over a five-
year period he anticipates a 12% price appreciation. The
necessity of replacing qualitative judgments with quantitative
predictions has had the salutary effect of sharpening the
analysts' evaluations and even improving their accuracy.

How much you lean on your broker for help is up to you.
In special circumstances you may wish to open a discretion-
ary account and give the broker power of attorney to make
all buying and selling decisions for you. Most brokers are
loath to accept such complete responsibility for an account
because losses, no matter how small or infrequent, breed
trouble and discontent. Most brokers prefer to act on your
specific instructions. Some won't even accept discretionary
accounts. One thing you can be sure of: lacking concrete
instructions to do so, no reputable broker, no member firm of
the New York Stock Exchange, is going to "put you into"
some stock or "sell you out" of it. As a general rule, the
registered representative today wants you to assume re-
sponsibility for managing your own investments  with his
help.

Your broker will provide you with the facts and figures
you need to make specific investment decisions and to help
you to interpret them, but he prefers that the decisions about
what to buy and what to sell be yours. Not only will you be
less inclined to blame the broker for whatever might go
wrong if you determine your own investment course, but,
more important, in the long run you will be a better and more
successful investor if you make your own decisions. YouTI
have a greater interest in the problem, and you'll be more
willing to work at the job of investing.

Many investors have already learned the ropes in the in-
vestment business on a cooperative basis through the medium
of an investment club. Typically, an investment club will be

222 HOW TO BUY STOCKS

composed of a dozen or more neighbors, business associates,
fellow commuters, or social organization members who meet
together once a month, put ten or twenty dollars apiece into a
common pool, and spend an hour or two discussing the best
possible investment for their money. These are serious ses-
sions in which the pros and cons of various stocks are ar-
dently debated.

Despite the bookkeeping problems and the occasional legal
complications such club business creates, most brokers* repre-
sentatives are more than willing to provide the clubs with
company reports and meet with them to answer questions and
guide the discussions. The commission return for the time
and work involved is negligible. But the opportunity for valu-
able missionary work, for educating dub members in the
techniques of investing, is tremendous. And many a worth-
while individual brokerage account has been generated by
participation in an investment dub.

Information on how to start an investment club is available
from the National Association of Investment Clubs (1515
East Eleven Mfle Road, Royal Oak, MI 48067).

One thing is sure: investment dub members get a good
grounding in die investment facts of life. They learn, as every
investor must, that difference of opinion is what makes the
market.

If you as an investor can arrive at buying or selling deci-
sions that are better grounded in fact than other individual's,
you are going to be right more often than he is. It's just that
simple  and that complex.

28

CHAPTER

Can You ^Beat the Market"?

ISNT there any system to "beat the market," any system that
will protect you against price fluctuations and virtually guar-
antee you a proBt over the long pull?

Yes, there are such systems, and some of them work pretty
well. They are far from foolproof, but at least they do point
out some important lessons about successful investing. They
are called dollar cost averaging and formula investing.

Dollar cost averaging simply involves putting the same
amount of money$aoo, $500, $1,000into the same
stock, regardless of its price movement, at regular intervals 
say, every month or every six months  over a long period
of time. The Monthly Investment Plan is built on precisely
this basis.

Following a system of investing a fixed sum of money in
the same stock at regular intervals? you could have made a
profit on 90% of the stocks listed on the New York Stock
Exchange over almost any period of four or five years you
might want to pick in the last quarter-century.

Dollar cost averaging works simply because you buy more
shares of a stock with your fixed amount of money when the
stock is low in price than you do when it is comparatively
high. When the stock rises again, you have a profit on the
greater number of shares you got at low cost.

Suppose you bought $500 worth of a particular stock when
it was selling at $10 a share, another $500 worth three
months later when it was $9, another $500 worth at $8, and
so on, while the stock fell to $5. Suppose it then rose to $15,
and settled back to $10. If you then sold out, you would be
able to show a profit of about 10%, ignoring both dividends
and commission costs, despite the fact that you had paid an
average price of $10 and sold out at exactly that same price.
You don't believe it?

223

224 HOW TO BUY STOCKS



	Number of		Number of	Cumulative	Totof
Price per	Shares	Cost of	Sham	Cwtsof	Value of
Shwe	Purchased	Sham	Owned	Shores	SAW
(10	SO	$500	50	$ 500	( 500
e	56	504	106	1004	954
8	03	504	169	1508	1352
7	71	497	240	200C	1680
6	83	498	333	2503	1938
S	100	500	423	3003	2115
6	83	498	506	3501	3036
7	71	497	577	3998	4039
8	63	504	40	4502	5120
9	56	504	096	5006	0264
10	50	500	746	5506	7460
11	45	495	791	6006	8701
12	42	504	833	6505	QCKMUUUU
13	38	494	871	6999	11323
14	36	504	907	7503	12896
15	33	495	940	7908	14100
14	36	504	976	8502	13664
13	38	494	1014	ROOMowWf	13182
12	42	504	1056	9500	18671
12	45	485	1101	99u5	12111
10	50	500	1151	2W95	11510

Don't bother to Bgure it out, because the proof is in the
table above.

To avoid the complication of fractional shares of stock, it is
assumed that at every different price level the buyer pur-
chased whatever number of whole shares would cost the
amount nearest $500,

All told, you paid $10,495, and your holdings would be
worth $11,510, a gain of $1,015, or almost 10%. Exactly the
same results  again exclusive of all dividends and purchase
costs  would be achieved if the stock first rose steadily from
$10 to $15, then dropped to $5, then came back to $10, The
table on page 225 shows the figures on that.

There's only one significant difference between the two
tables. Note that you are considerably better off all the way
along the line until the very end if your stock drops first and
then comes back. Thus, in the first table, after the stock had
fallen to $5 and recovered to $10, you could have sold out

CAN YOU "BEAT THE MARKET"? 225



	Number of		Number of	Cumulative	Total
frier IW	Shares	Cottof	Shares	Costs of	Vahusof
Share	Purchased	Shares	Owned	Shaw	Shares
10	SO	9SOO	50	 500	$ 500
11	45	495	95	995	1045
12	42	504	137	1499	1644
13	38	494	175	1993	2275
14	36	504	211	2497	2954
15	33	495	244	2992	3660
14	36	504	280	3496	3920
13	38	494	318	3990	4134
12	42	504	360	4494	4320
11	45	495	405	4989	4455
10	50	500	455	5489	4550
9	56	504	511	UWvJ	4599
8	63	504	574	6497	4992
7	71	497	645	6994	4515
6	83	498	728	7492	4368
5	100	500	828	7992	4140
6	83	496	911	8490	5466
7	71	497	982	8987	6874
8	63	504	1045	9491	8360
9	56	504	U01	9995	IrtXAJ
10	50	500	1151	10495	11510

and made a profit of $1,954, or about 35%, on your money.

So if the stock you buy drops in price and you have the
confidence to believe that it wfll come back, as stocks in
general always have, you would do well to continue buying it
as it slides on down. This is called averaging down. Is a
technique the investor worried about the decline in price of
some stock he owns should keep in mind.

While no stock is likely to follow the precise patterns set
forth in the tables, these examples do serve to demonstrate
the validity of the dollar cost averaging principle.

There's only one big catch to this system of beating the
market. You've got to have the cash and the courage to buy
the same dollar amount of your stock at whatever interval of
time you've fixed on, be it every month, every three months,
or every year.

And if it drops, you've got to keep right on buying, in
order to pick up the low-cost shares on which you can later

226 HOW TO BUY STOCKS

make your profit. Unfortunately, when the stock market is
down, the average person's bank account is likely to be down
too. So he often can't afford to buy at just the time he should.
If instead of buying he should have to sell at such a time,
he might even have to take a loss. This will always be true if
a person has to sell at a price lower than the average cost of
the shares he owns. In such circumstances, the dollar cost
averaging technique will have provided no protection. Most
times, however, dollar cost averaging works over the long pull
because the long-term trend of the stock market has been
upward.

The stock of the RCA Corporation offers a dramatic ex-
ample of the way dollar cost averaging works most of the
time to the advantage of the investor. Let's assume that back
at the beginning of 1929 you had a lump sum of $23,000 and
you decided to invest it all in RCA stock- RCA was a popular
stock then, highly regarded for its growth possibilities. It was
selling early in 1929 in the price range of $375 to $380 per
share. So for your $23,000 you would have been able to buy
about 61 shares. Over the years, thanks to splits in the stock,
those shares would have increased in number to 1,087 and
you would have received a total of over $16,700 in dividend
payments. But 46 years later, at the end of 1974, when we
will assume you had to sell, your stock would have been
worth only $11.685 because of the 72% drop in price that
RCA sustained during the bear market of 1973-1974- Th^
means that, together with your dividends, you would have
had a net gain of only $5,400 on your $23,000 investment
after 46 years.

That's pretty bad, especially considering the fact that if you
had sold only two years earlier, at the end of 1972, you
would have had a net gain of $33,800 on your $23,000,
counting both dividends and price appreciation.

Now consider how much more you would have made if
you had followed the dollar cost averaging plan and put that
same $23,000 into RCA stock at the rate of about $500 a
year over the same 46 years. Here it is assumed that the
number of shares purchased (at the opening of the market
each year) was that number that you could have bought for
an amount closest to $500  sometimes a fraction of a share
less, sometimes a fraction more.

CAN YOU "BEAT THE MABKETT"?  227

At the end of 1974 you would have owned 5,476 shares of
RCA, figuring in splits, and you would have had a net gain,
after payment of all brokerage commissions on your pur-
chases, of more than $121,000this despite selling out at
the end of 1974. Of this sum, the $85,000 you would have
collected in dividends would have been more than three and a
half times the total cost of your investment. This is an im-
pressive record, and it could have been achieved only because
of the opportunity you would have had to pick up RCA
shares at bargain levels during the half-dozen severe market
slumps that occurred in that 46-year period.

However, we would have an entirely different story to tell
if we had taken 1933 as our starting date instead of 1929.
Then it would have been decidedly more advantageous to
have made a big lump-sum purchase of RCA than to have
acquired RCA stock in units of $500 a year over the 41-year
period 1933-1974-

If you had put $20,500 into RCA at the beginning of 1933
(the equivalent of $500 a year tor 41 years) your investment
would have been worth almost $372,000 at the end of 1974,
counting both price appreciation and dividends. It you had
bought the stock at the rate of $500 a year throughout that
41-year period, on the other hand; you would have realized
just a little more than 36% of that figure  a bit over
$136,000.

Because few people have large sums they can put into a
stock at any one time, and because most stocks fluctuate
quite widely from time to time, it is generally more prudent
and more profitable for an investor to follow the dollar cost
averaging plan. It's a plan that makes it possible to capitalize
on price fluctuations, rather than to take one big plunge.

The table on page 229 shows how you would have made
out by June 1975 if, beginning in 1929, you had put roughly
$500 a year into RCA and nineteen other stocks that proved
especially popular with M.I.P. investors.

Of course, this is history, and no one can guarantee it is
the kind of history that will repeat itself, but it does provide a
convincing demonstration of the value of accumulating
shares on a dollar cost averaging basis over a period of time.
This accumulation feature is one of the most persuasive
aspects of the Monthly Investment Plan, which makes it pos-

2fl8 HOW TO BUY STOCKS

sible for the small investor to follow precisely this course in
buying most of the stocks listed on the New York Stock
Exchange.

Formula investing is not so much a system for beating the
market as it is a mechanical means of enforcing prudence and
caution. There are many different formula plans  almost
every expert has his own. Stripped of their technicalities,
however, all of them hold that an investment fund should be
balanced between stocks and bonds, and the ratio of one kind
of security to the other should be changed as the market rises
and falls. You buy bonds and sell stocks when the stock
market rises  on the assumption that the market becomes
increasingly vulnerable as prices advance. You reverse the
procedure when the market drops.

Even if it is granted that the premise is basically sound, the
theory is one that the average investor can't apply very effec-
tively. His investment fund is rarely large enough for a for-
mula plan to operate without distortion. This is because all
formula plans assume that that portion of the fund which is
invested in stocks will perform as the market average does.
Obviously, the fewer stocks you can afford to own, the less
likely they are to perform in line with the general market.
Again, the only bonds a small investor can generally afford
are government savings bonds. He can't expect to achieve the
same interest return on these bonds as he might earn on other
government or corporate bonds, particularly since the return
on savings bonds is measurably less in the early years. Sav-
ings bank deposits can, of course, be substituted for bonds.

Basically, there are three kinds of formula plans  the
constant dollar plan, the constant ratio plan, and the variable
ratio plan. The constant dollar plan assumes that a fixed
dollar amount of stocks will be held at all times. Thus, if
you had $20,000, you might decide to keep $10,000no
more and no less  invested in stocks. If the dollar value of
your stock portfolio rose  say, to $11,000  you would sell
$1,000 of stocks and put the proceeds into bonds. If your
stocks declined $1,000, you would sell $1,000 of bonds and
buy stocks. One objection to the plan is that over any long
period of time stock prices are likely to advance  at least
they have advanced historically. If your stock investments are
frozen at any specified level, you won't keep up with the
parade.

CAN YOU "BEAT THE MABDIT"? 229

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230 HOW TO BUY STOCKS

The constant ratio plan works like the constant dollar plan
except that you determine to keep 50% of your investment
fund in stocks at all times and 50% in bonds. You don't use
fixed dollar amounts. The constant ratio plan is obviously
more Sexible, can be adapted more readily to the shirting
cycles of the stock market, and assures you of at'least partial
participation in the long-term growth of common-stock
values.

The variable ratio plan operates like the constant ratio
plan, except that you decide to vary the ratio invested in
common stocks as the market rises or falls. Thus, you might
start out on a 50-50 basis, but decide to keep only 40% of
your funds in common stocks whenever the market, as mea-
sured by one of the accepted averages, moved up 25%. When
the market advanced 50% you would cut back your common
stock holdings to 30% of your total funds. If it went up
75%, you would have only 20% invested in stocks. If the
market fell, you would reverse the operation, buying stocks at
the designated market levels and selling bonds. There are
dozens and dozens of variations on the variable ratio theme,
many of them involving complicated mathematical formulas
and using a variety of economic indexes as well as the market
averages. They are designed to permit the investor to take
maximum advantage of interim fluctuations in the market
while simultaneously protecting his long-term position.

But these formulas don't always work as well as they
might. Thus, anyone investing on a formula plan which
called for reducing his commitments in commoir stocks as the
market advanced would have lost out on the big bull market
in most stocks that began in 1950 and has continued with
only occasional short-lived slumps until today. That's why
even many big, conservative institutions have either aban-
doned or modiBed extensively the formula plans they initiated
twenty or 30 years ago. Of course, a shift into bonds, such
as these formula plans would have dictated at bull market
peaks, would have paid off handsomely during all subsequent
corrective phases.

While the average investor may not be able to apply any
neatly devised mathematical formula to his own situation, he
can profit by paying heed to the one basic precept of all these
formulas. Keep an eye on the market averages and, as they
rise, let them act as a brake on your buying enthusiasm.

CAN YOU "BEAT THE MABKET"? 231

Remember, no bull market lasts forever. And neither, for that
matter, does a bear market, although it wasn't until 1954, a
quarter of a century after the great crash, that the Dow
industrial average and Standard & Poor's 500-stock price
index surpassed their 1929 highs of 381.17 and 31.92 respec-
tively.

29

CHAPTER

Should You Buy a Mutual Fund?

THINKING is always hard work. Thinking about an invest-
ment problem is doubly hard because it frequently involves
dealing with words and ideas that are somewhat strange, so
it's understandable that you might want to let somebody else
do your investment thinking for you. That's just what more
and more new investors are doing all the time. They are turn-
ing to the investment trust  especially the mutual fund  as
the answer to their investment problems.

There's no special magic about an investment trust  nor
anything mysterious about its operation. Suppose you and
some of your friends  twenty of you, all told  each have
$1,000 to spare. Instead of investing the money individually,
you might decide to pool it. Then instead of forming an
investment club and arriving at collective investment deci-
sions, you turn the whole sum over to one individual, or
manager, to invest for you.

In that situation, the twenty of you would constitute an
investment trust, or investment company, in miniature.

Now let's assume you're lucky and that at the end of the
first year the manager of your trust is able to report that he
has made money for you. The value of the stocks that the
trust owns has risen from $ao,ooo to $22,000. Each of your
shares in that trust is now worth $1,100 ($22,000 divided by
20).

You've been so successful, as a matter of fact, that some of
your other friends would like to join your little trust. The
twenty of you must now make one of two decisions.

You may decide that you're going to restrict the trust to
just the original members and their original capital, thereby
creating a closed-end trust. There will be no new members or
shareholders in your company, unless, of course, one of the
original twenty wants to sell his share to somebody else for
whatever he can get for it, a right every member has.

232

SHOULD YOU BUY A MUTUAL FUND? 233

The alternative plan would involve a decision to expand
your trust and take in new members. Since your own shares
are now worth $1,100 apiece, you decide to allow others to
buy in on that basis$1,100 a share. That $1,100 would
represent the net asset value per share at that time  a figure
determined by taking the current market value of all the
shares held in your trust or fund and dividing it by the
number of shares outstanding. Net asset value per share is a
constantly changing figure for two reasons: (i) the total
value of your fund's holdings fluctuates as the prices of the
stocks that it owns change in the stock market; (2) the
number of shares outstanding changes, too, as additional
shares are sold to new or present participants in the fund and
as the fund redeems shares for those who want to sell.

If you decide that your fund should be operated in this man-
ner, you will have transformed your company into an open-end
trust, or what is known more popularly as a mutual fund.

This, in theory, is the essential difference between the
closed-end and open-end trusts. In actuality, there are other
differences.

Closed-end trusts are stock companies whose shares are
bought and sold just like other stocks. The business of these
trusts is investing, instead of manufacturing or merchandis-
ing. But they are operated just like any other company by
officers and directors responsible to the shareholders. These
shareholders stand to make or lose money as the value of the
stocks owned by the trust goes up or down and as the divi-
dend paid on those shares increases or decreases.

Some of these companies, like Lehman Corporation and
Tri-Continental Corporation, are listed on the New York
Stock Exchange. Anything from one share to hundreds ot
shares of their stock can be purchased through a member
firm, at the commission rate that firm charges. The stocks of
some smaller, less well-known closed-end trusts are sold over-
the-counter,

Sometimes the stock of a closed-end investment trust will
sell at a premium price, a price greater than its net asset value
per share. Other times it will sell at a discount or below that
value figure, particularly during a bear market. Closed-end
trusts usually compute and publish their net asset value per
share just once a quarter.

In contrast, shares of an open-end trust, or mutual fund,

234 HOW TO BUY STOCKS

are always bought and sold on the basis of their exact net
asset value. Mutual funds usually compute and announce the
net asset value o( their shares every day. This value deter-
mines the price dealers will charge a buyer, or what the
owner will get if he sells.

Mutual funds pay dividends, if earned, and these are taxed
at regular income tax rates. They also distribute long-term
capital gains when they are realized on the sale of their hold-
ings. Since these distributions of capital gains constitute a re-
turn on capital, the individual owner of mutual shares pays a
tax on such distributions in accordance with his own individual
tax situation, just as he would on any other long-term capital
gain. Fund shareholders can generally elect to have dividends
and capital distributions reinvested if they wish.

The two kinds of trust do much the same type of business.
But the difference in their setup makes for a difference in
their operation. A closed-end trust cannot increase its original
capital at will. An open-end trust not only can, but usually
wants to. The more shares that are sold, the more the trust
grows, and the more its salesmen and investment advisers
stand to profit.

There were more than 675 mutual funds in existence at the
end of 1981. It is these funds, not the almost-forgotten closed-
end trusts, that have been getting all the play in recent years.

Their growth has been little short of phenomenal  from a
half-billion dollars in 1941 to nearly $250 billion in 1981.
The half-dozen market slumps since 1941 have naturally been
rough on the mutual funds. In these periods their net asset
value declined to about the same extent as stock prices gener-
ally. But over the long haul they have managed to maintain a
fairly steady and impressive growth record. Some funds have
grown to gigantic size. Currently, there are seven funds with
assets of more than a billion dollars each, sixteen top the half-
billion figure, and 112 funds boast assests exceeding $100
million.

This growth has meant that a lot of new shareholders have
been created by the mutual funds, people who never had
previously ventured into the stock market. As a matter of
fact, mutual funds must attract a lot of new shareholders
every year to offset those who sell their shares. In bad years.
they are often called upon to redeem more than they sell. The
same situation prevails sometimes even in good years.

SHOULD YOU BUY A MUTUAL FUND? 235

In recent years, however, many large institutional investors
have turned to mutual funds because the funds relieve insti-
tutional managers of responsibility for managing the institu-
tions' investment portfolios. These big investors now hold
37.7% of the total assets of all mutual funds, and they ac-
count for a major portion of the big-unit sales. Sales to
employee pension funds and to corporation treasurers, who
must employ a company's idle funds, are also fast-growing
areas of the mutual fund business.

Why have mutual funds enjoyed such spectacular growth?
One answer is that the mutual fund has obvious appeal to the
person who seeks a ready-made answer to investment prob-
lems. It is easier to trust another individual's judgment about
the market, especially one who is supposed to be an expert,
than it is to make up your own mind about whether to buy
stock X or stock Y, whether to sell A or B.

Mutual fund salespeople are paid commissions that can be
substantial. It was the big commission that attracted a lot of
"moonlighters" into the business many years ago, but in re-
cent years, as the business became more professional, moon-
lighters have been replaced by the registered representatives
of member firms, salespeople tor over-the-counter houses,
and, to some extent, by the mutuah funds' own trained sales
forces.

An individual buying one type of mutual fund typically
pays a commission or, as it is more commonly known in the
fund business, a loading charge, of around 5.6% or the price
of the fund. The rates are set by the funds themselves, and
some charge up to 8V2%, the maximum permitted by law.

To realize just how great a sales incentive the loading
charge is, look at the situation from the point of view of a
brokerage firm which is a member of the New York Stock
Exchange. Suppose one of its sales representatives sells a
$5,000 investment in a mutual fund. An 82% loading
charge (the maximum) on such a sale would amount to $425.
Since the loading charge is deducted first, that means that
only $4,575 of the $5,000 would actually be invested in the
fund's shares. Thus, as far as the purchaser is concerned,
he is really being charged a sales commission of 9.3%  not
8Ms%  on the amount of money actually invested. Of the
$425 loading charge that the brokerage firm collected, it
would typically be permitted to keep 75%, or $317. The bal-

336 HOW TO BUY STOCKS

ance would go to the fund itself to cover operating costs.

But if the same brokerage firm sales representative sold his
customer $5,000 worth of a stock listed on the New York
Stock Exchange, the commission the firm would realize
would be considerably less. How much less would depend, of
course, on that firm's rate schedule. But before Mayday 1975,
when rates were fixed, the commission on 100 shares of a $50
stock was ]'ust $71.50.

Mutual funds, as a general rule, make no charge when the
customer redeems or sells his shares, so the broker doesn't
stand to make anything more than his original $317 commis-
sion on the mutual fund transaction. In contrast, the cus-
tomer who buys the listed stock may sell it someday, giving
the broker a chance to make a second commission. Still, even
the commission on a round-trip trade  the purchase and the
safe  would be distinctly less than the mutual fund loading
charge. And anyway, a commission in hand is worth two in
the bush.

While the average investor in a mutual fund might pay
5.6% on a $5,000 order, big orders do get big concessions,
Thus, on orders of $100,000 the rate might be only 1%. On
million-share orders, the loading charge might be as little as
% of 1%. But then, the big institutions also pay much lower
commission rates on their big volume exchange orders.

During the sixties, the most aggressively promoted and
rapidly growing mutual funds were the front-end load funds.
The buyer of such a fund agrees to make uniform periodic
payments to the fund, usually over a ten-to-fifteen-year
period, and in exchange acquires whatever number of fund
shares such payments will cover. When a salesman sells such
a front-end load fund he collects 50% of everything the
purchaser puts into the fund the first year. Thus, if the cus-
tomer signed up for a $5o-a-month plan and paid in $600 the
first year, $300 would be paid out immediately as a commis-
sion to the salesman. Only $300 of the customer's payment
would actually be invested for him. With a sales incentive like
that is it any wonder that sales of front-end load funds
zoomed in the sixties, while the number of such funds grew
from ten to more than 70?

Over the life of a front-end contract, the sales cost may
average out to a 5%-6% loading charge. But the advantage
to the salesman of such a fund is that he gets the lion's share

SHOULD YOU BUY A MUTUAL FUND? 237

of the total commission right away. He doesn't have to worry
that the buyer might cancel his contract in a couple of

years,

If the buyer of a front-end load fund wants to cancel his
contract and redeem his shares, he can't normally expect to
recover the sales cost and break even until he has been in
the plan for about three years, unless, of course, there's been
a spectacular increase in the value of the fund's shares. If the
stock market is slumping, it might be five or six years before
he can break even. Maybe he never will. Meanwhile, the
salesman has his take, all tidily sewed up.

In contrast, the buyer of a noncontractual or level load
mutual fund might put the same amount of money into the
fund and pay the same 5%-6% commission. But he would
never be in the hole, assuming the value of his fund shares
didn't decline. He wouldn't have to keep buying in order to
recover a whopping big commission paid in advance. He
could quit when he wanted to.

In 1966, the S.E.C, asked Congress for legislation to curb
many mutual fund selling practices. Specifically, it wanted an
outright ban on front-end load contracts. In defense of such
contracts the funds argued that investors needed some form
of compulsion  such as the threal-of loss if they backed out
of a contract in its early years to keep them saving and
investing regularly. But the S.E-C. pointed to its studies,
which showed that 20% of all those who bought front-end
contracts were forced to sell at a loss because they couldn't
keep up the payments. In general, these were the investors,
buying plans at ten or twenty dollars a month, who could
least afford such a loss.

When Congress finally passed the Investment Company
Amendments Acts of 1970, the industry heaved a sigh of
relief. The front-end contractual plan had survived, even if
subjected to new restrictions. Under the 1970 law such funds
may still pay a sales commission equal to 50% of the buyer's
first-year payments. But the law stipulates that the buyer can
cancel his contract any time in the first 45 days and get l^ack
the full commission paid. It further holds diat any time in the
first eighteen months the buyer can cancel the contract and
get back 85% of the commission  plus, of course, the value
of the shares at that time.

The law further provides that the buyer shall receive a

238 HOW TO BUY STOCKS

statement at the time of purchase setting forth the commis-
sions that will be deducted from the purchase price and in-
forming him of his right to withdraw from the fund and
obtain a refund. And if the buyer misses three payments in
the first fifteen months or one payment from the fifteenth to
the eighteenth month, the fund is obligated to notify him
again of his right to withdraw and the terms of the with-
drawal.

If a front-load fund wants to escape these specific provi-
sions governing the purchaser's right to withdraw, it can do
so only by limiting its sales commission to a maximum of
20% in any one year and 64% in the aggregate for the first
four years.

Apart from the commission, mutual funds offer brokers
still another incentive to push fund sales. As the funds grow,
they are constantly buying additional stock, big blocks of
stock. Furthermore, they keep changing their portfolios, sell-
ing 5,000 or 10,000 shares of this stock and buying 5,000 or
10,000 shares of that one. The funds obviously tend to give
this highly lucrative block business to those brokers who do
the best job of selling their shares.

AH through the sixties and very early seventies the in-and-
out trading activity of the funds grew apace, as competition
forced them to become increasingly "performance-oriented."
Sometimes, in striving for speculative gains in a rising mar-
ket, a fund would turn over half of its entire portfolio in a
year or less.

Since the funds themselves are not permitted to be mem-
bers of the big exchanges, they execute their orders for listed
stocks through established member firms. In the halcyon days
of the late sixties bull market, when the funds were setting a
feverish trading pace, member firms competed vigorously for
this big-ticket business. Reciprocity reigned. "You scratch my
back, and 111 scratch yours" was the order of the day. Brok-
ers and dealers intensified their fund-selling efforts in order to
get more of the fund's commission business.

With the abandonment of fixed commission rates in 1975,
however, reciprocity faded measurably. What now became
important to the funds was not what a broker's record was on
fund sales, but how much he would cut his commission to get
the fund's block business.

While mutual funds may be aggressively sold, that does not

SHOULD YOU BUY A MUTUAL FUND?     239

mean that they are not good things to buy. Quite the con-
trary. One great investment virtue all investment trusts, close-
end and open-end alike, have is their diversified holdings in
many different companies and industries. There is obviously
less risk (but less hope of making a killing, too) in owning an
interest in 50 or 150 different companies than in owning
stock in j'ust one company.

This is the argument, the protection provided by diversifi-
cation, that mutual fund salesmen stress. It's an argument
with significant merit. However, the importance of diversifi-
cation as a protective device is minimized or magnified by
your choice of a specific mutual fund. And there are many
different kinds of funds.

The most popular type of fund is the common stock fund,
a fund whose assets are wholly invested in a diversified list of
common stocks. Most put no more than 10% of their assets in
any given industry. But even so, there is a wide diversity of in-
vestment policy among them. Some accent income. Some aim
at the twin objectives of growth and income. And some, prob-
ably the greatest number, emphasize long-term capital growth.

Still other common stock funds take an opposite tack.
They invest all their assets in the securities of companies in a
single industry; chemicals, drugs, electronics, et cetera. Some
of these special purpose funds concentrate their investments
in specific geographical areas. Still others seek to cater to a
particular class or type of investor, such as farmers, airline
pilots, even cemetery owners.

Then there are the "go-go" funds, whose assets are totally
invested in aggressive growth situations, and the hedge funds,
which operate still farther out in a speculative orbit all their
own.

Originally, hedge funds were comprised of groups of
wealthy men who operated their funds as private partner-
ships. But as speculative fever rose and the market boiled to
its peak in 1973, many of these privately owned and privately
operated hedge funds were offered to the general public. If
you wanted to become a partner in such a fund, it didn't
matter whether or not you could afford to speculate. And
hedge funds are nothing if not speculative. They buy on
margin and sell short  trading techniques forbidden to regu-
lar mutual funds. They deal in warrants and options. They
put money into "special situations," even buying the stocks of

240 "OW TO BUY STOCKS

companies so small or so new that their stock does not enjoy
a public market.

In addition to the all-common-stock fund, there are the
balanced funds, whose assets are divided among common
stocks, preferreds, and bonds. Most of these highly conserva-
tive funds operate on some kind of a formula investing plan.
As common stocks rise into high ground, more and more of
the assets of such funds are shifted into preferred stocks and
bonds to protect against a break in the stock market. In a
faDing stock market, they sell bonds and begin buying stocks
in anticipation of an upturn there.

In addition to these various types of mutual funds, there is
one wholly different species  the no-load fund. Your broker
is not apt to be interested in arranging for you to buy such a
fund direct from the management company of the fund, be-
cause he doesn't make a penny on the deal. He'd prefer to sell
you a fund that yields him a good commission.

All mutual funds employ the services of a professional
management firm to direct and guide their investment policy.
One of the proudest boasts of fund salesmen is that such
management can invest your money for you better than you
can yourself. That's the way mutual funds justify the man-
agement fee, usually ^ of 1%, that they uniformly charge the
buyer.

Very often the men who comprise the management com-
pany are the same men who guide its sales destiny. Since they
wear two hats they collect two incomes  often very sub-
stantial incomes. The law does provide, with some exceptions,
that no more than 60% of a mutual fund's directors can be
connected with its advisory or management company. But
there are still quite a few mutual fund executives who take a
double dip out of a fund's earnings.

IS professional management is worthwhile, if it's worth %
of 1% a year, it might seem logical to assume that mutual
funds would show a performance record over the years su-
perior to the average action of the market.

Have the funds beaten the average?

There can be no clear-cut, categorical answer to that ques-
tion. The answer depends on what period of time you are
measuring and what kind of fund you are talking about out
of the many different types that exist.

In a sense the meteoric growth of the mutual fund industry

SHOULD WO BUY A MUTUAL FUND? 24!

can be traced to an inadvertent mistake the S.E.C. made
when the original Investment Company Act of 1940 was
passed. At that time mutual funds were almost unknown. In
approaching Congress with a request for legislation in the
investment company field, the S.E.C. sought a law that would
enable it to regulate the closed-end investment trusts that had
boomed as the market roared to its 1929 high.

In those days many of the trusts played fast and loose with
investors' money. Trust fund managers paid themselves large
fees and bonuses for their somewhat questionable services.
They split commissions with accountants and lawyers. Enjoy-
ing almost complete freedom to invest trust funds as they saw
fit, the managers placed themselves too willingly at the service
of investment bankers anxious to market new and dubious
stock issues. They resorted to all kinds of speculative prac-
tices. They bought on margin. They pyramided paper profits.
And they used the trusts to obtain control of whole industrial
empires, often with only a paltry outlay of actual cash 
cash furnished, of course, by investors in the fund. When the
crash came in 1909, 700 trusts collapsed with virtually no
show of assets.

The 1940 law was drafted to prohibit such practices, re-
quire full and open disclosure, and drive the manipulators
from business. But it also sanctioned, however unintention-
ally, all the selling practices that permitted mutual funds to
prosper. Specifically, the act approved loading charges, front-
end load contracts, and management fees.

There was only one thing the funds would have liked, but
didn't get, in 1940. That was freedom to advertise. Since
mutual funds are constantly issuing new stock, they neces-
sarily fall under the prospectus provisions of the 1933 act.
which applies to all new stock issues. This means that a
mutual fund advertisement must either consist of the full
offering prospectus or be limited to a "tombstone" an-
nouncement, consisting of the name of the fund, the offer of
a prospectus, and a descriptive sentence or two about its
objectives. Although these restrictions have been somewhat
relaxed in recent years, mutual funds still regard them as a
thorn in their flesh.

When the S.E.C. went to Congress in 1966 to ask for
legislation that would restrict many mutual fund selling prac-
tices, it wanted an outright ban on front-end contractual

242 HOW TO BUY STOCKS

plans, a 5% ceiling on loading charges, and a drastic reduc-
tion in the standard % of 1% management fee. The fee, as
the S.E.C. pointed out, was considerably more than banks
charged for their investment advisory services.

What the S.E.C. got from Congress four years later was
distinctly less than half a loaf. Front-end load contracts were
not disallowed. They were simply altered to permit buyers to
withdraw from such plans without losing all the money they'd
put down as a commission. The maximum loading charge
was fixed at 9%, not 5%, although the N.A.S.D. was empowered
to see that loading charges were "reasonable." Finally, the
management fee went unchanged, subject only to the provi-
sion that the S.E.C., or any fund shareholder, could bring suit
against a fund charging that the management fee was so
excessive that it represented a breach of "fiduciary duty."

Behind all the demands for reform of the mutual fund
business was a concern that even the Securities and Exchange
Commission was reluctant to express. What might happen if
the market went into a real tailspin  a prolonged downturn?
That would be the time when people who owned shares in
mutual funds would be most tempted to cash them in. For
that is when they, as individuals of generally modest means,
would be most likely to need their savings. And yet that is
precisely the time when it would be most difficult for a mu-
tual fund to redeem its shares.

Funds, of course, always have a substantial cash reserve to
meet redemptions. But i( there should be a persistent demand
for redemptions, a fund would have to sell off sizable blocks
of stock to raise cash and swallow whatever loss it sustained
in these forced sales. Additionally, those very sales might
further depress the market and make it even more difficult for
the trust to meet the next round of redemptions as prices fell
further.

Although fund selling was blamed in some quarters for
deepening and protracting the 1969-1970, 1973-1974, and
1978-1979 market slumps, the funds as a whole suffered
through those difficult periods about as individual sharehold-
ers did. Despite sharp declines in total assets, the funds have
always met the redemption bill up until now.

AU things considered, if you want the protection of di-
versification on a relatively small investment and if you want
somebody else to assume the responsibility of making invest-

SHOULD YOU BUY A MUTUAL FUND? 243

ments for you at a modest fee, buy a mutual fund. But be
sure it's a good one and be sure it's right for you. There are
hundreds and hundreds of different funds, and it can be as
difficult to pick the right one for you as it is to select one
right stock out of all those listed on the New York Stock
Exchange.

As a general rule, the following pointers should be fol-
lowed by any investor seeking the right mutual fund for his
individual objectives.

(l) Recognize your investment goals. Spectacular year-to-year
pias, dividend growth, total returns figures: II the provide
an excellent measure of an individual fund's merits. But they
don't tell die whole story. You want a fund dial most closely
approximates your own individual investment objectives. If
you're looking for high, steadily increasing dividend income
you want a fund that fmphafJTif that particular market aspect
If you want growth you should buy a fund that emphasizes
smau emerging companies. If you're interested principally in
conserving your capital you should avoid all funds that concen-
trate assets in a few fields and employ narrow speculative
methods. There is a fund for every temperament, for investors
of all ages, means, and ambition. Spend some time finding out
if die fund you're thinking of buying has die exact investment
goals you do.

(a) Check die fund's performance record. Just because a fund has
done weD for its investan in the past is no guarantee mat it
wiD do as weu, or even particularly weu at all, in the future.
But, afl things considered, you'd probably radier be investing
in a fund which gpdaed sol over the past three yean dun one
that lort 5oS. Performance records for all mutual funds an
tradced on a regular basis by die Upper, die Wieaenberger,
and die United Business Service mutual fund services. Copies
of their publications are generally available from most large
city libraries and an brokerage house offices. For an idea of
which funds have performed best during recent selected periods
of time, consult page 976.

(3) Look {or consistency. The best funds do weu, or at least slightly
outperform dieir oompetitoR and die geneni market. Just about
way year. There is nothing quite o discouraging for die
neophyte as jumping on die bandwagon of a fund or an
individual stock, which rase spectacularly during some on-

244 HOW TO BUY STOCKS

realistically short period of time, only to have its bubble bunt
during the subsequent market reevahiatioa. Some fuads have
quirky investment philosophies, which work very wett for a
short period of time under unusual market conditions. Just be
sure you don't buy in at the tail end of one of these atypical
performance periods. In fund picking, as In most areas of
endeavor, ifs slow and steady that wins the race  as long as
the slow movement is steadily upward.

(4) Be sure management hasn't changed. There's no point in picking
out a good-performing, solidly managed fund whose investment
goals perfectly match your own if it turns out that both the
goals and the performance record really belong to a portfolio
manager who left your new fund's employ the week before
you made your purchase. A mutual fund, Hke most other
businesses, is only as good as the people who run it, so that
just as when you pick a stock broker you are reaDy picking an
individual to help you chart your financial future, when you
buy a mutual fund you are buying a managerial team composed
of various individuals to buy your stocks for you. Make sure the
team you get is the team you paid for.

(5) Bead the prospectus to learn fund policies. No two funds
operate in exactly the same way in exactly the same areas. Some
reinvest dividends. Some pass them on. Some hold stocks for a
decade. Some turn over their entire portfolio two or three
times a year. If you read every bit of the fund's prospectus
before you buy, you won't be brought up short when you find
out that the fund you've chosen actually practices as a matter
of policy some investment operation with which you have a
basic disagreement.

(6) Develop your own investment viewpoint to help you monitor
your fund's current purchases. It's your money, after all, that
the mutual fund of your choice will be using to pay for the
stocks they select. And although your original reason for
deciding to invest in stocks through a mutual fund will probably
be that you have neither the time nor the expertise to pick
your own stocks, there's no reason why this situation should
remain permanent. In fact, there are two good reasons why
everyone who invests in a mutual fund should carefully monitor
his fund's activities. The first is mat you want to make sure you
are getting the expert management, the philosophical com-

SHOULD YOU BUT A MffTCAL POND? 345

ptability. and the peffomunce that you pod for. If you're not
watching your fund closely there's no way for you to know
either how it's doing, or, perhaps more important, why it's
performing that way. The second reason is that by watching
the fund experts invest, you might fuct gradually, and pain-
lessly, leara enough of the busks to begin a little stock buying
on your own.

Above all things, don't just say yes to the first mutual fund
salesman who calls on you.

Here's a list of the mutual funds that performed the best
since the last edition of this book was published.

Fund

Twentieth Century Growth Investor!

Fidelity Magellan Fund

International Investors

Quasar Auociates

Twentieth Century Select Investors

Evergreen Fund

Research Capital Fund

American General Pace Fund

United Services Fund

44 WaD Street Fund

Strategic Investments Fund

LmdnerFund

Sigma Venture Shares

Value Line Leveraged Growth Investors

Weiogarteo Equity Fund

Explorer Fund

Scudder Development Fund

Oppenbeimer Special Fund

Over-the-Counter Securities

IDS Growth Fund

HartweH Leverage Fund

American General Venture Fond

Constellation Growth Fund

Fund of the Southwest

PUTRENDFund

CflH. 1979-91

405S

3791
352X
3441
341K
339X
334K
3201
3141
3071
3021
2941
2791
27OT
2701
272X
272)(
27OT

2WX

26SX
260X
258X

2S71

asai

243%

246 HOW TO BUY STOCKS

Nineteen funds that have appreciated each of the past 5
years, ranked in order of their 1981 performance.

Fund

Lmdner Fund

Able Associates

Delta Trend

Lindner Fund For Income

Value Line Leveraged Growth

American General Pace Fund

Sequoia Fund

Fidelity Magellan Fund

Windaor Food

American National locoiae Fund

American Genera] Venture Fund

Value Line Income Fund

American GeoenJ Comctodc Fund

IDS Growth Fund

Nicholas Fund

Eatoo & Howard Growth Fund

Tudor Fund

American Ins. & Induitlial Fund

Janus Fund



1981	1980	1979	1978	1977
32.92	32 6X	25. W	218$	28.6S
25.61	56.7X	79.1$	77%	6.4$
23.21	28.91	26.5%	04%	4.71
19.21	14. IX	4.e	7.W	11.81
18.2%	26.91	26.0t	27.31	SISH
ie.2	30.8X	32.e	23.5$	3S.W
16.01	12.8S	12.11	23.7*	19.OT
13.61	64-OT	49.81	29.51	12.71
13.21	22.91	22.91	8.71	0.7
12-21	18.81	17.4)1	2.11	1-81
10.41	28.51	42.11	21.4X	25.81
10.IX	26.9X	27.W	10.81	1.71
8.91	22.71	47.7	13.71	13.51
8,31	76.91	38-Ot	15.7K	7.0K
7.21	35.OT	31.01	25.31	20.31
6.9S	42.9S	34.6X	14.7K	1,91
6.71	43.21	27.4	20.2X	6.41
6.5X	7.W	16.1t	3.7X	2.2t
5.31	51.71	34.8:1	16.31	3.51

CHAPTER  <5L7

Why You Should InvestIf You Can

WHY should a person who has extra money invest it in
stocks?

Here is the answer to that question in one chart and one
table.

Chart I (page 248) shows the movement of stock prices
from 1925 to 1981, as measured by Standard & Poor's Indus-
trial Index.

The table below shows the average annual yield on the
stocks included in Standard & Poor's Industrial Index back to
1926, which is as far back as this series of statistics goes.



1926	4.86	1941	6.62	1956	3.95	1971	2.04
1927	4.73	1942	7.04	1957	4.18	1972	2.61
1928	3.93	1943	4.76	1958	3.87	1973	2.79
1929	3.01	1944	4.69	1Q59	3.11	1974	4.13
1830	4.84	1945	4.13	1960	3.36	1975	3.96
1931	6.40	1946	3.81	1981	2.90	1976	3.79
1932	7.74	1947	4.90	1962	3.32	1977	4.56
1933	4.06	2948	5.47	1903	3.12	1978	4.81
1934	3.37	1949	6.63	1964	2.96	1979	4.87
1935	3.52	1950	6.69	1965	2.94	1960	4.76
1936	3.39	1951	6.17	1966	3.32	1981	4.83
1937	4.83	1952	5.88	1967	3.07		
1938	4.96	1953	5.86	1968	2.91		
193? 1940	3.87 5.51	1954 1955	4.92 3.97	1969 1970	3.07 3.02		

In a period like 1973-1974, it was hard for investors to be
enthusiastic about investing. After all, the Dow Jones indus-
trial average had dropped 45%, and investors had lost more
than $300 billion in that slump. But that's a good reason for
looking at the stock market in the long historical perspective
 and noting, incidentally, that in the past quarter-century

247

248 HOW TO BUY STOCKS




CHART I

WHY YOU SHOULD INVEST  IF YOU CAN 249

there have been a half-dozen slumps which seemed just as
disastrous at the time when they occurred.

The historical record demonstrates the solid fact that the
market has always come back and that in the long run com-
mon stocks have proved to be good things to own.

But, you might ask, what about that almost steady down-
trend in the average return on stocks (see the table, page
247) over the past twenty-five years? Isn't that a cause for
concern?

No, it isn't. Because those returns are percentage Bgures
arrived at by dividing dollar dividends by dollar prices for the
stocks included in the index. Hence, any decline in the aver-
age return could be the result either of an actual decrease in
the dollar dividends paid  or an increase in the price of the
stocks. The latter explanation is clearly the right one as far as
the last two and a half decades are concerned. The average
return may have dropped from 6.69% for the year 1950 to
4.83% in 1981, but during this same period, as Chart I
shows, per-share prices rose from an average index number of
about 20 to over 150. As a result of that great price ap-
preciation, dividends, as a percentage of price, inevitably
dropped. But the decline was relative, not absolute.

To illustrate, suppose you had bought a stock at $20 a share
in 1950 and received the average dividend of 6.7% on it
that year. On this basis, you would have received a dividend
of $1.34. If that stock behaved like the average of all stocks,
it would have been selling at about $150 a share at the end of
1981 and yielding a return of 4.83%. This would mean that
your actual dollar dividend would have increased to $7.23.
Furthermore, it would mean that on your original investment
you would be earning a return of 35.15%, since you would be
getting a dividend of $7.23 on your $20 original investment.

The return that an investor realizes from a stock is not
affected in any way by changes in its price after he buys it.
The return is affected only by a change in the dividend. Thus,
if you pay $100 for a stock paying a $5 dividend, you realize
5% on your money, as long as the $5 dividend is paid, regard-
less of whether the stock drops to $80 or goes up to $ 120, If
the dividend is increased to $6, you make 6%. If it is reduced
to $4, you make 4%  regardless of what happens to the price
of the stock.

Now let's take another look at the chart. It shows that

ago HOW TO BUY STOCKS

stock prices have moved generally upward for the past 50
years in a fairly well defined path. One notable exception is
that precipitous drop from the 1929 peak to the 1932 bottom.

Isn't that an alarming exception?

No, it isn't. The character of the market in recent years
differs markedly from what it was in 1929. It has been more
of an investment market, less o( a speculative one. Thankij to
regulations imposed by the government and the exchange,
there has been little of the type of speculative activity that
produced the big crash. Certainly, from time to time, glam-
our stocks like data processing or drug issues have had a big
play. But there have been no overextension of credit, no
pyramiding, and, most important, little or no manipulation of
the market.

Why have people been investing? Why have stock prices
been going up over the years?

Because American business has grown steadily. And there
is every reason to believe it will continue to grow  continue
to develop new products, new industries, new markets, and
continue to expand all along the line, despite recessions from
time to time.

Figures compiled by the U.S. Department of Commerce on
our gross national product  the total value of all goods and
services produced in this country  tell the story of growth
better than any others. In 1929, the first year for which such
figures were compiled, gross national product was valued at
$103 billion. In the Great Depression, it fell to a low of $56
billion in 1933- Since then, growth has been steady  and
little short of phenomenal. In 1960 the gross national product
was valued at $504 billion; by 1965 it had advanced to $685.
By the last quarter of 1970 it was moving at the rate of about
a trillion dollars a year. And by the end of 1981, it approxi-
mated $3 trillion.

That's one good reason for investing  for owning a share
in American business  but there's a second equally per-
suasive reason.

When the cost of living goes up and the country is in a
period of inflation, prices tend to rise. When the dollar de-
clines in value, it obviously takes more dollars to buy the
same amount of food, clothing, virtually everything, includ-
ing common stocks, because they represent the ownership of
companies that produce these goods.

WHY YOU SHOULD INVEST  IF YOU CAN 251

Thus, in periods of inflation, money that is invested in
common stocks or other property is not as likely to lose its
purchasing power as money that is simply set aside in a
savings bank or invested in bonds that have a fixed dollar
value. No one can argue that common stocks provide a guar-
anteed protection against inflation. That such was not the
case was all too evident in 1973-1974 and 1981, when the
country experienced simultaneous recession and inflation,
with business and stock prices both declining, while prices of
consumer goods soared. But most times, it is hard to find a
better hedge against inflation than common stocks.

For all these reasons  for income, for a chance to see
your capital grow, for the protection of its purchasing power
 you may decide you want to invest in stocks.

But wail a minute. Maybe you shouldn't. Are you sure that
those dollars you plan to put into the stock market are really
extra dollars? Remember, there is an inescapable factor of
risk in owning stocks, even the best of them. Not only does
the market go down from time to time, but even if stocks
generally go up, your stocks may go down. That can be a risk
worth taking if you aren't going to be seriously hurt in case
you lose some of those dollars. But it's not a risk that a
person should take if there is going to be a need for those
dollars to meet some emergency.

What if there were a serious and expensive illness in your
family? Are your savings adequate to meet that situation?
What about the other expenses you may have to meet, such
as the cost of a new car, house repairs, furniture, college ex-
penses for your children? What about insurance? Have you
got enough so that your family would be able to maintain a
decent living standard if you were to die?

If you can answer yes to all these questions, you can, and
you probably should, consider putting your extra dollars into
common stocks.

31

CHAPTER

How Good Are Common Stocks?

PROBABLY the most convincing evidence of the value of
investing in common stocks is the data supplied by several
studies measuring the rate of return on New York Stock
Exchange stocks  dividends plus price appreciation. These
studies were conducted by the Center for Research in Se-
curity Prices at the Graduate School of Business at the Uni-
versity of Chicago through 1970. (The Center for Research
in Security Prices continues the study today.) They constitute
die most definitive measurement of the stock market that has
ever been made.

Basically, the questions to which the center addressed itself
were these: just how good are common stocks as invest-
ments? What average rate of return might an investor expect
to realize if he simply selected a stock at random  without
any professional guidance or research informationfrom
those listed on the New York Stock Exchange? And what
would be his average risk of loss?

Obviously, such questions could be answered only in terms
of the historical record. And this the center set about com-
piling. It took five years and $250,000 to put all the essential
data on computer tape because of the high standards of ac-
curacy that were established.

First, the center insisted on going back to January 1926, so
that it could not be accused of ignoring the 1929 bull market
or the consequent crash. It also insisted on covering all the
stocks that had been listed on the exchange at any time since
1926  not just a cross section or sample but all the stocks
 good, bad, and indifferent  including those that had
been delisted.

Finally, the center wasn't satisfied to work with an annual
or semiannual price, but insisted on recording the price at
each month's end for each listed stock. Since those prices had
to be comparable throughout the whole period, it meant that

252

HOW GOOD ABE COMMON STOCKS? 253

the prices had to be adjusted to account for every stock
dividend, stock split, spinoff, merger, or other change in a
company's financial structure. In addition, information on
about 150,000 dividend payments was put on the tapes.

The center's file of price and dividend data is unquestion-
ably the most authoritative record that exists.

Because the compiling and recording took almost five years
from its 1958 inception, the first study on rates of return was
not published until 1963. It told the story of the market only
through 1960. But once the data were put on tape and the
computer programs written, it became a comparatively simple
matter for the center to keep its study up to date. Now it is
possible to tell the rate of return on listed common stocks for
any period of time from January 1926 right up to the present.

The key table from this study is the one reproduced on
pages 254255. A few words of explanation are in order.
The table shows the percentage gain or loss that an investor
would have realized over any given period of time if he had
invested equal amounts of money in each of the Big Board
stocks and had reinvested all dividends that he received.

While it does take account of the varying commissions that
the investor would have had to pay in acquiring the stocks
over the years, it does not take account of the commission
he would have had to pay in selling out his holdings at the
end of the period. Nor does it take account of the taxes that
the investor would have paid on dividends as received or on
any ultimate capital gain he might have realized. In other
words, this is the story of how a tax-exempt individual would
have made out in the market over the years.

The resultant figures can be compared directly to the com-
pound interest rates paid by banks on savings in the various
periods and to the published yields on most other kinds of
investment, since these figures never take account of taxes
either.

It is not difficult to read the table. If you want to see how
a hypothetical investor would have made out over any given
period, select any starting year you like from the columns
headed "FROM" and read down till you reach the figure for
whatever terminal year you select in the stub at the left
headed "TO." That figure, expressed as a compound interest
return, shows the rate of return that an investor would have
realized had he bought all the stocks on the Big Board at the

254 How TO BUY STOCBS

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HOW GOOD ABE COMMON STOCKS? 255

Rates of Retum on Investment m Coiomoa Stoda
Listed an die New Yoric Stock Exchange
with Beinvextment of Dividends
(Percent per AIWWM Compounded Annually )



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4S&	415	31																		
514	S5	505	607																	
M7	34	XI	104	-15																
;i6	&	111	11)	-42	I															
5	209	141	91	-14	-11		-31													
224	210	153	116	21	S7		1)	117												
6	2f	III	151	71	12 E		167	272		1SI										
	t	119	154	15	135		16 S	234		2S3	141
Z17	Z0	170	147	If	130		IS]	III		111		124	11							
19 i	111	141	127	10	106		121	1S2		137		Ti	If	-11						
271	;1;	114	165	116	IS7		171	215		21 f		171	11 (	;71	S51					
n\	21 &	110	171	136	164		114	216		211		Ilf	113	!25	379	?01				
l\t		111	167	11S	151		174	200		M2		171	172	US	271	111	66			
ilf	171	155	ill	101	12 f		117	IS 6		150		122	114	115	150	19	it US
ios	li>	176	162	IM	155		161	II*		111		16'	167	171	221	141	131	Ifl	571	
202	115	174	161	116	155		161	111		111		161	161	17i	!IS	IS4	141	171	360	144
130	112	161	141	11 S	142		154	170		167		ISO	150	156	III	121	112	127	211	64
11	111	111	151	115	152		163	171		176		162	162	11	III	149	141	151	217	1)7
17 B	Ifl	141	131	116	130		119	151		147		11;	110	132	141	108	95	101	152	f4
177	170	If?	14;	120	115		142	154		151		117	131	117	151	ilf	10 S	114	151	tl
177	171	IS 4	141	124	117		141	156		153		111	111	141	157	1;3	113	122	1(3	105
179	174	IS7	11J	111	144		151	162		160		146	146149	166	115	12 C	13S	177	127
IS7	It;	14	137	111	III		131	1*7		145		112	129	132	146	116	107	111	141	102
Iff	172	15.*	147	121	142		141	159		157	115	144	141	164	117	121	131	172	133
177	173	151	141	II!	115		152	IfZ		1*0		141	149	151	15*	141	117	145	171	144
1(1	lit	i41	131	117	127		111	111		131		12J	127	1)0	141	116	109	115	140	107
1SI	141	113	126	110	110		1?5	112		11.0		120	111	III	130	107	100	IOJ	125	94
151	1*1	115	127	112	122		127	135		132		III	121	121	111	III	10 S	101	121	101
1SI	141	135	121	III	124		IU	116		133		124	122	121	111	111	106	111	131	103
111	133	121	115	101	110		111	111		117		10	104	105	111	13	IS	7	103	77
116	121	18 (	102	11	16		11	114		100		10	(7	17	11	71	16	67	79	54
11 S	110	111	112	1.1	106		1(1	114		112		102	110	101	101	11	11	14	11	7S
140	115	121	117	105	111		116	122		120		111	IBS	101	116	11	11	If	110	19
139	III	111	II*	10 S	112		115	121		111		111	101	101	115	11	14	16	101	19
119	114	123	117	116	113		116	121		120		111	110	110	11S	101	16	11	11 1	92
141	139	121	12.3	112	110		171	121		127		111	111	ill	124	110	101	101	121	11)1
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256 OW TO BUT STOCKS

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HOW GOOD ABE COMMON STOCKS? 257

beginning date and reinvested all his dividends until the
terminal date. Since his investment would have covered oU
the listed stocks, the rate of return can be taken to represent
the average of what he might have realized on any one stock.
On some stocks, the rate of return might have been infinitely
higher, while on others there would have been a 100% loss.

Actually, the center computed results in dollars, not in
percentages, and these results show how the invested dollar
would have increased or decreased (by thousandths of one
cent) during each of the time periods shown in the table. The
dollar difference between any starting date and any terminal
date is simply expressed here in terms of its compounded
interest equivalent, either minus or plus.

Probably the most signiBcant figure in the table is that
9.9% at the bottom of the first column. That figure means
dial an investment of an equal amount of money in each of
all the Big Board stocks on December 31, 1925, would by
December 31, 1980, with the reinvestment of dividends, have
yielded a return equal to 9.9% interest per annum com-
pounded annually.

Other significant findings, as demonstrated by the table,
were as follows.

<i) In H the year-to-year perioA. Jnuaiy 1906 to December 1960,
there n only 91 with negttfve ntes of returnin other
wordi, ke*. In die other time periodi you would hme had a
profiL The kni^nt pn of yem showing looes is the fourteen-
you period from 1908 to 1942. The only other periods when
you would have bad to bold on for as long as six yon in order
to ihow a profit woe the ones (rom 1909 through 1935 and
from 1936 through 1942. Beonue of die market decline* of
1966-1969 and X973-1974. you would have been able to show
a profit in only 15 of Ae 45 year-to-year time periods from
1966 to 1975.

() The longect period of time in which die rate of return was leu
than 5! was i9*8 through 1950' If you ignore the i9^-i93
Clash, die longest period of time in which the return was has
than 5* was 1936 through 1944.

(3) hi (he last 115 yean, there has been oohr one period (1968-
WS) > "on than three consecutive years in which the rate
of return was conristendy less than 5& Fmlhermoie, in (his

258 HOW TO BUY STOCKS

25-year span there has never been a ten-year period in which
you could not at some point have realized a retum of at
least lof.

(4) K you had bought in 1932, there was never a year in which
you would not have realized a profit of at least lot  usually
much more  until 1974.

The Lorie-Fisher study also reports the results that would
have been obtained if dividends had simply been accumulated
and not reinvested, and if dividends were completely ignored.
Obviously, the rates of return were considerably lower in
both cases.

A second study, conducted at the Center for Research in
Security Prices, answers the questions of how often and how
much an investor might have gained or lost on each of the
stocks listed on the exchange from 1926 to 1960. While this
study has not been updated, there is no reason to believe
results would be materially different.

To arrive at its conclusions, the Center computed results
for every possible combination of month-end purchase and
sales dates for every stock throughout the 35-year period
from January 1926 to December 1960. For any one stock,
this would have represented 87,000 monthly combinations.
For all exchange stocks, it meant tabulating results on more
than 56,000,000 such possible transactions.

Here is the key finding of this study: if one had picked a
stock at random from the Big Board list, if one had then
picked at random a purchase date between January 1926 and
December 1960, and if one had picked at random any later
sales date within those same 35 years, one would have made
money 78% of the time. The median return, assuming rein-
vestment of all dividends and payment of brokerage commis-
sions on purchase and sale, would have been 9.8% per
annum compounded annually. At that rate of interest, money
doubles in about seven years, and the study showed that the
investor would have had a better than 50-50 chance of doing
exactly that  doubling his money  with purely random
selection. His risk of losing as much as 20% a year on his
investment was only one in thirteen, whereas his expectation
of making as much as 3.0% per annum compounded annually
was one in five.

HOW GOOD ABE COMMON STOCKS? 259

The study demonstrated two other points of vital signifi-
cance to any investor.

(i) If the investor had pidced three or four stocks at random
instead of |ust one, the risk of loss would have been considerably
reduced, and the probability of a larger profit would have been
considerably improved.

(a) If the investor had not been forced to sell during a period of
economic recocwiif he had been able to hold on for a
year or two  his chance of making a profit and the amount
of profit would have both been significantly increased.

The value of long-term investing, the value of being able to
hold on through a period of weakness in the market, is con-
vincingly demonstrated by the table on pages 260-261, It
may look complicated, but it's well worth five minutes of
study.

The table shows, by examining economic periods from
1926 through 1960, how you would have made out if you
had bought a stock at random from those traded on the New
York Stock Exchange, reinvested your dividends, and sold
that stock in the same period or in any later period. The
boldface decimal figures show you what percentage of the
time you would have made moneythus, .46 means you
would have made money 46% of the time. The lightface
figures on each line immediately below show you the median
rate of return (percent per year compounded annually) you
might have expected to realize. The periods themselves are
all of different lengths, but each one corresponds to a recog-
nized upswing or downswing in business as defined by the
National Bureau o( Economic Research. The U identifies an
upswing, and the D a downswing. The periods listed verti-
cally are for purchases; those listed horizontally are for sales.

Here's how to read the table. Let's assume that you made
your random purchase in the first period between January
1926 and September 1926 and then sold out in that same
period. Your chance of making a profit would have been only
46%, and your average profit or loss would have been minus
4.2%. However, if you had made your purchase in that first
period and did not sell until the last period, between May and
December 1960 (the last figure in the first line of the table),

a6o HOW TO BUY STOCKS BOW GOOD ABK COMMON STOCKS? a6l

Profit Pn)bbaitiei on Cominoa Stocia Loted
a die New Yodc Stock Exchange, 1926-1900

Sate Period



		]	ia.26 OcfcSSB	Nw.27	Aug.29	MM-33	M*y37	June 38		 Pab.43	Oct.45	Nw.48	Ool.	Jty53	AC.U	JrfyOT	Apr. 58	MayOO
Sept.28 Oct. 27	Inly 29	Feb. 33	Apr. 37	May 38	Jan. 45	Sei>t.45	OoL4ft	SwL4B	JIM 53	WrM	JwN>S7	Mw.SB	Afr.flO	DBC.OO
PurchaiQ Period	U D	U	D	U	D	U'	^ D	U	D	U	D	U	D	U	D
Jn. ae-Scpt. aa	U	M JO	.77	Sl	.38	M	.48	r "	.77	.71	JI	J4	W	JB	JI	M
-4.2 18.2X	18.2X	-8.W	-4.W	-l.W	-OJS		4. IX	4.7-1	3JS	&	SM	7M	M*	7J	7.3
Oct.26-0ct.27	D		38	SR	.32	.33	M	.45		.71	.79	J	TO	M	M	M	JI	J
			W.W	21.0)1	-ILW	-ft.7	-3.011	-1JB	3.7	4.4S	3JI	5.U	S.	.7	&	7J	7.1
Nw.2T-July28	U			.75	.15	JI	Sl	JS	m	J7	JX	.73	.77	M	JB	M	M
				10-W	-29.71	-13J	-7.4	-1.0K	;< 1J	&8S	2.11	&M	3C	5.7K	5-	9.S	&21
Aug.29-Feb, 33	D				.13	J8	36	J2	^ M	M	J3	M	M	M	JS	M	JS
					-45.W	31	3.9X	3.91		1 6"	8.8X	7J	&	&	10.01	9.	laa	ia
M.33-Apt-37	U					M	.4a	JS		 M	Jl	J	J3	M	M	JS	J7	J
						21.0X	-o.ai	1.7	f 8,01	9.4S	&4X	9.7C	9.4S	10JK	10J1	1LOS	10.8X
M*y37-M*y3S	D						.13	JSS	^ A.	JS	JO	JS	JI	M	J7	J8	JB
							-S9.6K	2-		t Il.O*	11.4X	&	10.71	105C	UM	10.01	U.9	11.4K
June38-JM>.45	U							J8	M	J7	JC	Sf	Jff	M	JB	J	JB
								9.U	^ UJX	1&	1IM	14-H	13.1X	14JK	13.1X	14.1*	l3.4<
Feb.45-Sept.45	D								S	.74	dM	J3	JS	JS	JI	J9	J4
									A l&W	ll.H	Las	9.4S	9J	12^X	10.71	IL2S	11JS
Oct.4S-Oct.48	U								^	J8	JM	.7	J3	M	JO	JS	J4
										-7^	-&2X	8.1X	9.3S	l&JK	10.71	12.4*	11JB
Nov. 48-Sept 49	D	-,	48	J3	M	-M	J4	J8	JS
												-l.	ai.7x	IS.ll	18JS	It^S	1S.W	14.
Oct. 49-June S3	U	t	.73	M	1	M	JS	J*
									' ,			11.9S	73S	ISM	11.4S	14.0X	WSt
July53-July54	D								,				-7	M	J	JS	JO
													1&8X	UM	12.X	1S.W	13.2S
Aug. 54-Juae 57	U													J4	.48	.79	n
									*					7JM	-0.01	lOB	&a
July57-Mar.58	D														Jff	M	M
															-17.31	SSM	13JK
Apr. 58-Apr. 00	V															M	JB
									1							11JX	O.OT
hteraO-Doc.60	D			.4
; 1',	-U;0

262 HOW TO BUY STOCKS

your chance of making a profit would have been 90%, and
your median profit would have been equal to 7.3% com-
pounded interest for 35 years,

To see how the table proves the value of long-term invest-
ing, look at the boldface figures diagonally down the table
from upper left to lower right. These figures show your
average chance of making money if you had bought and
sold within the same time period. Now contrast the irregular-
ity of these figures with the boldface ones in the last column
to the right, reading straight down from top to bottom. These
show your expectation of profit if you had held your stock
and not sold it until the last period covered by this study.
Down to 1954, all but one are over 90%.

The table on page 225 shows how the figures look when set
down right together.

Certainly these figures demonstrate emphatically the value
of long-term investing.

None of these studies guarantees anything about future
investment success. But if you are willing to assume that the
past is any kind of a guide to the future, their meaning is
dear and unmistakable.

One other study conducted by the center throws significant
light on the question of how large a portfolio has to be in
order to achieve essentially the same rates of return as an
investor would get if he owned all the stocks on the New
York Stock Exchange. The study calculated results tor port-
folios, selected at random, that consisted of two, eight, six-
teen, 32, and 128 stocks that were held for each of the 40
single years from 1926 to 1965 as well as for the eight five-
year periods, four ten-year periods, and two twenty-year
periods. The study shows that with eight stocks, performance
was raised to a range of 94% to 96%. At 128, the figure was
a straight 99% for all time periods. One inference that might
be drawn from this study is that if you think you can pick
stocks that will perform better than an equal number picked
purely at random, you have pretty good assurance of beating
the performance record of the stock market as a whole.

Since these studies cover all the stocks listed on the New
York Stock Exchange, the results they show are the results
you might have expected on the average to achieve with the
random selection of any one stock. For this reason they
exemplify what is called the random walk hypothesis. They

HOW GOOD ARE COMMON STOCKS? 263

have been accepted today in financial and academic circles as
establishing the standard yardsticks against which anyone
who has a technical theory of his own must measure his
performance.

The entry of scholars into the field of stock market re-
search may not guarantee that someday the touchstone to
investment success will be found. But it should go a long way
toward disabusing the public of its misplaced confidence in
those who regularly advertise investment infallibility in the
financial pages of our newspapers.

In this connection, the following observations of Professor
Lorie are highly pertinent:

Many people have been beguiled by the possibility of buying
wealth, believing that it is possible to buy information or formulas
which will permit extraordinary high rates of return on capital. As
evidence (or my statement, one need only look at any issue of the
numerous periodicals dealing with the stock market; they are thickly
strewn with offers to sell for a few dollars the secret of getting rich.
It should be clear that one cannot buy wealth for a few dollars, but
this is not the same as saying that research on the stock market is
without value or that it cannot provide the basis for the more
prudent management of funds.

For many years, It was probably true that formal and quantitative
research was not very useful cither because of its lack of compre-
hensiveness or its lack of rigor. It was very difficult to do compre-
hensive financial research before the availability of high-speed
computers. Rigor was frequently or even typically lacking because
research was usuaBy the product of persons familiar with the finan-
cial markets under investigation but not the canons of scientific
inquiry. ...

As an example of the lack of rigor which formerly characterized
much research, I cite the Dow Theory of stock price movements.
This theory is based on crude measurements, and in its typical for-
mulation is so ambiguous as to require interpreters, and they often
disagree.

It is clear that much of the work done so far [at the center] has
had the effect of discrediting beliefs  and even some relatively
sophisticated ones  about the behavior of security prices. ...

For the businessman and investor, it is true that an awareness of
ignorance is better than an erroneous belief, if only because it tends
to eliminate buying the services of charlatans and attending to the
insignificant.

32

CHAPTER

How You Should Invest  If You Can

THE stock you'd like to buy, of course, is the one that just
doesn't exist. You'd like a stock that is completely safe, one
that pays a liberal dividend, and one that's bound to go up.

There are a lot of good stocks that will probably satisfy
you on any one of these counts. But none will accomplish all
three objectives.

If you want safety in a stock, you'll have to give up the
hope that it will increase sensationally in value.

If you'd like to see your money grow, you have to be
prepared to take a considerably greater measure of risk.

Sometimes it's possible to find either a fairly safe stock, or
one that seems likely to appreciate in price, that will also
yield you a better-than-average dividend. But even here, as a
general rule, you can't have your cake and eat it too. If you
get a liberal dividend, it will probably be at the expense of
one of the other two factors.

Hence, the first step in solving your investment problem is
to decide on the one objective you most want to attain by
investing. Is it safety of capital? Or liberal dividends? Or price
appreciation?

When you start thinking about stocks that might best
match any of these objectives, you should first take a look at
various industries and their future prospects. Remember, the
carriage industry was a thriving business at the turn of the
century.

To see how these various factors might influence your own
investment selections, consider how seven different people in
widely varying circumstances might approach their invest-
ment problem.

Mr. Adams is twenty-four years old, unmarried, and, as far
as he can see, likely to pursue his course of single blessedness
for some time to come. Having received his college degree, he
now has a trainee's job as a chemist with a large food-manu-

264

HOW YOU SHOULD INVEST  IF YOU CAN 265

facturing company. His income is $20,000 a year, and,
thanks to the fact that he cuts living costs by sharing an
apartment with two roommates, he can save at the rate of
$5,000 a year. With a $20,000 ordinary life insurance policy
and a $50,000 group policy issued by his company, he has
made a start toward building an estate for himself.

With the savings that he accumulated he now has about
$10,000, very little of which has to be earmarked for emer-
gencies as long as his responsibilities are as light as they are.
Then, too, if he really got in a serious jam. he knows he
could count on his folks to help him out.

He wants to see his capital grow, so he wants to invest in
stocks that have good growth possibilities, even though such
stocks may yield only a scant return in dividends now.

Such a young man can afford to take a considerable mea-
sure of risk. But before he starts eyeing some of the more
speculative stocks, he probably ought to put out an anchor to
windward. Marriage has a way of creeping up on a man
when he least expects it.

He can probably afford to invest all of his nest egg. Of this,
at least $2,000 ought to go into a money market fund so that
he can have funds of known amount instantly available to
him if he should need them. Another $4,000 might be divided
between two solid common stocks  stocks that might be
described as defensive in character because they have weath-
ered many an economic storm in the past with an unbroken
record of dividend payments.

One of these might be a public utility like Pacific Gas &
Electric or Tampa Electric, utilities that stand to benefit from
the rapid growth of the areas they serve. The other might be a
stock like General Electric. Such a stock may fluctuate a little
more when business expands or retracts. But it is still essen-
tially stable, because it makes so many different products for
so many different markets.

Mr. Adams might then very properly put his remaining
$4,000 into stocks of a more speculative nature  stocks
with good growth possibilities. Maybe one of the drug stocks
that seem likely to benefit the increased number of older
people in our population. Maybe something in computers or
electronics. But probably first of all a chemical stock  a
field in which he should have firsthand knowledge of new and
promising developments.

266 HOW TO BUY STOCKS

Whatever he buys for long-term growth, it may pay him to
comb the list for some "sleepers," rather than simply to fall
for some of the well-known glamour stocks that usually sell
at very high price-earnings multiples. There are many good
solid companies with growth records and further growth po-
tential that can match the glamour stocks but are available at
lower price-earning rations. Finding these overlooked stocks
can be worth a good deal of study and effort. Don't forget
that most of today's glamour stocks were once in the over-
looked category themselves.

As for his future savings  that $4,000 he expects to ac-
cumulate each yearthat money too can go largely into
growth stocks as long as his present situation remains un-       ^
changed. But he probably ought to start a systematic invest-      ^
ment plan with his broker,                                        j

Mr. Adams can accomplish his plan in one of two ways.      ^
He can open a Monthly Investment Plan account, or similar      ^
accumulation plan, such as many large banks and most big      (
brokerage firms have available. That way he can apply his
monthly savings toward the regular purchase of some stock.      ^,
Or he can save his money, and when a sufficient sum has      ^
accumulated, he can buy additional shares on an odd-lot      ^
basis.                                                       ^

Consider now the case of Ms. Barter, a capable young
woman of twenty-four. As a computer programmer trainee in
a large company, she makes $375 a week, about as much as
Mr. Adams. She lives alone in a small studio apartment,      \
responsible only to herself. She has no family to worry about,
and she doesn't expect her mother and father, who live in a
little town out West, to worry about her.

A thrifty person, she has managed to add a little every
month to a small inheritance she received from an aunt. Now
and again she has supplemented these savings with a special      j|
bonus check. Currently, she finds she is able to bank about      j
$200 a month out of her salary. All told, she has about      f
$8,000, a large part of it in savings bonds.

Now Ms. Baxter has decided she wants to invest in stocks.      ^
Why? Because every time she cashes a bond, the $100 she      ^
gets for it buys less than it did the last time  usually not
even as much as she could have bought a few years ago with
the $50 she put into the bond. She wants to put her money

HOW YOU SHOULD INVEST  IF YOU CAN  267

into some investment where its purchasing power will be
better protected and where she'll still get a good return on her
money. And if she's lucky, maybe she'll make a profit on
her stocks  a big enough profit so that shell eventually be
able to take that trip to Europe 'she has always promised
herself.

But maybe stocks, including hers, will go down. That's a
risk she has to take. But fortunately it's one she can afford. If
stocks drop, she can probably wait for them to come back
without any serious ]'eopardy, because her job offers her a
good measure of security. Quite apart from her own medical
hospital insurance, she knows the firm will help her over any
rough spots. And as for protection in her old age  well, the
firm has an excellent pension program. Thus, plus Social
Security, should take care of her quite handily.

What kinds of stocks should Ms. Baxter buy?

Obviously, she wants to be pretty conservative in her selec-
tions. But she probably doesn't have to make safety her sole
objective. She can afford to take what's called a business-
person's risk, and she can look for stocks that pay relatively
liberal dividends.

Ms. Baxter should put her money into three or four differ-
ent stocks, each of them a Hue chip, each a leader in its own
industrystocks like Sears, Roebuck & Company, Eastman
Kodak, Exxon, International Paper, plus one good utility.

Alternately, to benefit from more diversified holdings, she
might put her money into one of the big mutual funds that
have growth as their objectivefunds like Massachusetts
Investors Growth Stock Fund, Putnam Growth Fund or
Fidelity Capital Fund. None of these funds fared very well
during recent dips, but neither did the entire mutual fund
industry  nor the stock market, Ms. Baxter's primary inter-
est is in growth; she should be much more interested in their
longer-range prospects.

To make these investments she will have to sell her savings
bonds.

As for the $200 a month she is able to save, Ms. Baxter
might prudently keep half as an emergency fund until it
exceeds $2,000. With the other $100 a month she too might
open a Monthly Investment Plan, or some other accumula-
tion plan account. As a matter of fact, she might even open

a68 HOW TO BUY STOCKS

two or three such accounts, putting her $100 into one stock
one month and into another stock a second month on a
regular, rotating basis.

Mr. and Mrs. Chandler face quite a different problem,
despite the fact that Mr. Chandler's income as a skilled tool-
maker in an auto parts manufacturing plant is about $35,000
a year. To begin with, they live on a very modest scale in a
small Ohio town. Still in their thirties, they have been able to
raise two children, now eight and ten, buy their own home,
and still save a little bit.

They have only about $4,000 in their bank account But
from now on that's going to grow fast. Mr. Chandler was
made foreman just last month, and that means $125 a week
more in his pay envelope. Furthermore, in just a couple of
months the mortgage will be paid off, and they will have
another $200 a month free and clear.

What it all adds up to is that they've got $4,000 now, and
they figure on having $5,000 to $6,000 a year to invest from
now on.

What about protection for his family? Mr. Chandler has a
$20,000 insurance policy. He considers that plenty in view of
the benefit program which his union sponsors for all members.

He has become sold on stocks. He wants to start buying
stocks now in order to build a little estate and finance college
education for his children.

That's a program that makes sense, provided it is handled
right. He hasn't a lot of money to put into the market, so, to
start with, he wants to be sure that money is well protected,
What if one of his children has to be hospitalized for a long
time?

Where should he start? His local utility  the Ohio Edison
Company  might be as good as any. The dividends will help
pay his electric bill. That's an idea that has real appeal for
Mr. and Mrs. Chandler.

After that, he might buy ten shares of a natural gas com-
pany, a stock that offers assurance of a fairly stable price,
plus some possibilities of growth as natural gas consumption
continues to grow.

His future investments for some time might be of much the
same type  fairly stable stocks but ones that nevertheless
offer some prospect of growth over the long pull. Nothing as

HOW YOU SHOULD INVEST  IF YOU CAN  269

spectacular as computers or electronics, which market
analysts might call "aggressive-growth situations," but per-
haps something like American Can Company, which stands
to grow as our population and food consumption increase, or
Federated Department Stores, or General Foods.

Mr. and Mrs. Davenport are even better off Enancially. But
from an investment point of view they're not as well off as
the Chandlers. As one of the younger officers in a big adver-
tising agency, Mr. Davenport makes $50,000 a year. But his
scale of living is such that after taxes, mortgage payments on
his $100,000 house, and premiums on a $50,000 life in-
surance policy, there's not much left over at the end of the
year  just what he might need to pay an unexpected doc-
tor's bill. His equity in the house  the unmortgaged part
that he owns  and the cash value of his life insurance pol-
icy represent all his savings.

But Mr. Davenport has just received a $20,000 bonus,
because he brought a new account into the agency last year.
And Mr, Davenport knows exactly what he's going to do with
that $20,000. He's going to buy common  stocks in two
companies he has just read about. One of them is a new small
airline serving a growing resort area. The other is a company
that Mr. Davenport believes is going to lick the problem of
desalting seawater economically.

When Mr. Davenport announces what he expects to do
with his bonus, Mrs. Davenport puts her foot down. It
sounds altogether too speculative for her. That money, she
contends, should be set safely aside to provide a college edu-
cation for their two children.

How should Mr, and Mrs. Davenport solve their problem?

Probably $5,000 of their $20,000 ought to go into gov-
ernment bonds in case the family meets a real emergency. As
for the balance, the stock of a good growth mutual fund or a
closed-end investment trust like Lehman Corporation or Tri-
Continental Corporation might represent a happy com-
promise between Mrs. Davenport's conservatism and Mr.
Davenport's "all-or-nothing" impulse.

Ordinarily it would not be prudent for a man to put all his
investment funds in a single security. But a mutual fund or
an investment trust is an obvious exception because of its
diversified holdings. Furthermore, shares in a closed-end trust

270 HOW TO BUY STOCKS

can be bought on the exchange without any loading charge,
and are frequently available at a substantial discount  that
is, at a price below net asset value per share.

Then too, Mr. Davenport is still only in his early forties
and looks like a comer. He's the kind of a man who wfll get a
number of bonuses and salary increases along the way. As
time goes by, he will probably be buying other stocks. And he
might just as well begin buying in good-sized units.

Mr. Edwards is a Nebraska wheat farmer. For fifteen years
life has been good to him. He has had good crops and has
received good prices for them. He is completely dear of debt
on his farm and on his equipment, and all of it is in excellent
condition. Insurance is no worry to him, because his boys,
both of them in college now, could take over the farm and
make a good living out of it if anything should happen to
him.

He has $19,000 in extra capital, over and above necessary
reserves for upkeep of the farm. He's beginning to wonder
if he's doing the best he can with it. His older son started him
thinking about that the last time he was home from college.
Mr. Edwards has $4,000 in savings bonds, $4,000 in a build-
ing and loan association, $8,000 in a savings account, and
about $3,000 in his checking account.

Obviously, he has far more cash than he needs. One thou-
sand dollars in his savings account and another thousand in
his checking account should suffice.

Hence, he could prudently put $13,000 cash and savings
bonds into securities, and he probably ought to sell his $4,000
worth of building and loan shares and invest that money in
stocks too  a total of $17,000. The building and loan shares
provide a good yield. But he can get an attractive return, plus
growth potential, by investing that money in common stocks.
Furthermore, his building and loan shares really represent an
investment in real estate. And since his principal asset, the
farm, is also real estate, it would seem wise for him to di-
versify his investments.

Here is a man who can really afford to take a fair measure
of risk with his money for the sake of getting a better-than-
average growth potential, because he already has a substantial
measure of protection  far more than most people have. In
fact, he can afford to be a bit speculative in his selections.

HOW YOU SHOULD INVEST  IF YOU CAN 271

First, it would be natural for him to invest in a good farm-
machinery stock  something like Deere & Company. But he
ought not to put too large a share of his $13,000 into such a
stock because if farmers suffer a reverse in their fortunes, as
they sometimes do, so do the machinery manufacturers.

He might also properly invest in a company like General
Mills that processes the grain he raises.

But he might also be advised to put some money in the
stocks of companies that have no relationship to his own
business of farming  perhaps natural resource stocks like
the Weyerhaeuser Company, or American Natural Gas, or
chemical stocks like Union Carbide, Dow, or Monsanto.
Other stocks that might suit his situation would be stocks like
Minnesota Mining & Manufacturing, or Procter & Gamble,
or Eastmsn Kodak. All these companies operate in fields that
show great future promise.

Mr. and Mrs. Frank are a retired couple, both over sixty-
five- Social Security and small benefits accruing from a com-
pany pel15!011 plan are sufficient to provide them with an
income of about $600 a month. Their only other assets con-
sist of a home, which they own free and clear in a small town
in Kansas where taxes and living costs are a lot lower than in
urban centers. They have a good-sized garden plot that helps
reduce food costs. They have $85,000 in savings, most of it
realized on annuities and life insurance policies in which Mr.
Frank thriftily invested through the years.

On the other hand, if their assets are limited, so are their
liabilities. Their two children are both married, and their
futures are as secure as those of any people with modest
incomes and frugal habits can be.

The natural impulse of Mr. and Mrs. Frank is to conserve
what they have  to leave their money in the savings bank or
invest it in savings bonds. But even with a return of 6% on
their money, their income from all sources would amount
to only $12,000 a year, or a little more than $230 a week,
And in a time of rising prices and increased taxes, $230 a
week allows little latitude for luxuries  nothing at all for an
occasional trip to visit their children and grandchildren.

Without any appreciable sacrifice of safety, Mr. and Mrs.
Frank ought to consider investing at least part of their money
perhaps $25,000in corporate bonds, especially in a

272 HOW TO BUY STOCKS

period of tight money such as 1981-1982, when high-rated
bonds could be bought at prices that would yield 152 or
16% on their money.

With the balance of their savings they could afford to take
some measure of risk. Two or three good growth mutual
funds might seem like a prudent investment for them. But it
wouldn't be wholly out of order for them to consider some-
thing even more speculative, such as a half-dozen cyclical
stocks. Since these are stocks in industries like steel, au-
tomobiles, chemicals, paper, metals, and petroleum, which
usually follow the business cycle pretty closely, they can
often be bought at attractive prices in periods when business
slows down, as it did in 1981.

During a business decline, dividends might be reduced, and
that could make things a little hard for them. But what if
they did have to sell $1,500 or $2,500 of stock in a bad year
in order to make ends meet? At their age they can afford to
dip into capital if they have to without putting their lives in
peril. And consider the rewards they might reap. Dividends of
10%, i2%, or even 14% were not too remarkable on cycli-
cal stocks in 1981. More important, there seems reason to
believe that significant capital gains can be had over the years
ahead with a careful selection of quality growth stocks.

For rewards like these. Mr. and Mrs. Frank can afford a
sizable measure of risk on the bulk of their capital.

Finally, consider the situation of Mrs. Gordon, the fifty-
seven-year-old widow of a successful doctor. Her principal
assets consist of the family home and $230,000 worth of life
insurance. True, the doctor did leave an assortment of stocks.
But they proved to have a cash value of only about $20,000,
because, like most medical men who have little contact with
business and less time in which to study it. Dr. Gordon had
bought only the most speculative of securities  Canadian
oil shares, stock in a plastic airplane company, and some
preferred stocks that must have looked attractive because of
big accumulations of back dividends  dividends that were
owed but unfortunately never paid.

Mrs. Gordon doesn't want to see her capital dissipated that
way. She wants to live off her investments but leave the
principal intact, so that she can pass it along to her three

HOW YOU SHOULD INVEST  IF YOU CAN 373

children, all of them now launched on substantial careers or
their own.

Mrs. Gordon begins her calculations where every investor
in such a situation must: "How much income do I have to
have?" She figures she needs $25,000 a year to maintain her
standard of living. That in turn means that she must get a
return of 10% on her $250,000.

Time was when an investor like Mrs. Gordon would have
had to put her money into common stocks if she wanted to
realize a return of 10%, Thus, in the early 1950S, she could
have expected to earn only about 3% on government bonds
and 4% or so on corporate bonds and good-grade preferreds.
But thanks to the bull market that got under way then, she
would have experienced little difficulty in Ending top-quality
stocks that would have given her a return of 10% or even
more, counting both the dividends and the capital gains that
she could have realized.

Of course, in the early io8os, the situation had changed.
All Mrs. Gordon would have had to do to realize 10% was
put her money into any top-rated corporate bonds and sit
back and collect the interest.

But that wouldn't wholly satisfy someone of Mrs. Gordon's
temperament. Nor would it protect her against the possible
ravages of continued inflation in all the years that might still
remain to her. Perhaps, down the road, $25,000 a year
wouldn't permit her to continue her present life-style. Perhaps
she should have one eye on guaranteed income, and the other
eye on long-term appreciation in the value of her holdings.

For all those reasons it would make sense for Mrs. Gordon
to divide her $250,000to put half into corporate bonds,
and the other half into good-quality stocks that pay good
dividends and offer prospects of long-term growth.

Most of Mrs. Gordon's stock selections would probably be
industrials of the blue chip variety  stocks that have paid
dividends consistently for a long period of years and thus
offer some compensation for any compromise she may be
forced to make temporarily in the 10% income return that
she feels she needs.

On the New York Stock Exchange 493 common stocks
listed can boast records of consecutive quarterly dividends
running back at least 25 years. Most of these can be classified

2/4 How TO BUY STOCKS

as "die bluest of the blue," because many are also the stocks
of companies that have no bonds outstanding, and little or no
preferred. Hence, all earnings, or virtually all earnings, are
available for dividends on the common stock. This can be
very important in a period of bad business. Stocks like J. C.
Penney, American Can, Borden, Eastman Kodak, General
Electric, American Brands, Scott Paper, and Proctor & Gam-
ble should suit virtually any investor in Mrs. Gordon's posi-
tion.

As a general rule, Mrs. Gordon should not put more than
3.0% of the capital that she has for common-stock invest-
ments into any one industry or more than 10% into any one
company.

Not one of the programs outlined for these seven investors
is likely to perfectly fit your own special situation. But a
consideration of their problems and the ways in which they
might have been solved can serve to illustrate the kind of
sober thinking required of an investor before deciding what
stocks or bonds are right tor the particular situation. Re-
member, there is no all-purpose security  no stock that fits
ideally into every investor's portfolio. Each person must work
out his own investment salvation for himself.

That's why the best advice that was ever given is "inves-
tigate before you invest" And the investigation should prop-
erly begin with your own financial situation.

33

CHAPTER

When Is the Time to Sell?

THUS far we have been talking almost exclusively about buy-
ing stocks  about investing for the long pull.

But just because a convincing case can be made for the
fact that it is a good idea to have extra dollars invested, it
doesn't follow that it is a good idea to keep them invested in
tile same securities forever.

Change is the common denominator of all life. And change
can, and does, vitally affect the value of all investments.

The intelligent investor keeps in mind two broad kinds of
changechange in one's personal financial situation, and
change in available investment opportunities.

As far as the first is concerned, it is perfectly obvious that
the kind of investment program that is well suited to a young
person with no great responsibilities is not the kind of pro-
gram that same young person should pursue when starting a
family. And investments that are geared to that period of life
when the heaviest load is being carried are not the kind to be
made when the kids are through school and die investor is
able  at the peak period of earning power  to branch out
again and try to build something of an estate before having to
start thinking about retirement.

It is, of course, always later than we think. Changes in an
individual's personal situation, in Bnancial circumstances,
often come so gradually that the person is rarely shocked into
an awareness that is is high time he sat down and took a
personal inventory of his situationwhere he stands now
and where he is headed. Most of us are just too used to
drifting with the tide.

This is particularly true as far as investments are con-
cerned because of the strange, irrational attachment that most
men and women seem to feel for the stocks and bonds they
own. It's no overstatement to say that many a person be-
comes married to a stock and is apt to talk about it to

27S

276 HOW TO BUY STOCKS

associates a good deal more pridefully than about almost
anything else.

Once a person buys stock in a company he often seems to
feel some sort of compulsion to talk it up to others  sell it
to them. Thus he seeks from others confirmation of his own
good Judgment. In such circumstances, he regards the sale
of his stock as tantamount to treason.                     ,

There is another psychological reason why most people are
loath to sell securities. Very often, the original investment
decision  the selection of stock A over B, C, or D  was so
charged with emotional conflict that the buyer wants to shut
the door on the whole episode. The investor doesn't relish the
idea of fighting out the issue all over again and weighing the
comparative values of the purchase stock against E, F,
orG.

Nevertheless, there is the inexorable fact that investment
values constantly change and what was a good buy last year
may be an even better sale this year.

Every investor owes it to himself to take an objective look
at his holdings  as objective as possible  at least once a
year. And when he tackles that job, he should ask himself at
least one simple question about every stock in his list: "H I
had the money, would I buy this stock at today's prices?"

If the answer is no, if you own a stock you wouldn't
enthusiastically want to buy at that moment, you should con-
sider selling it, even if you have to take a loss on itor
especially if you have to take a loss.

If you don't want to make the decision yourself, you may
wish to ask your broker for his opinion. In fact, if you
don't want to review your whole investment program once a
year, as you should, you can submit the problem with all
pertinent data to your broker and ask for recommendations
and suggestions. Brokers are used to such requests, and in the
main they do a remarkably conscientious job on them. They
know that suggestions for changes that are made simply for
the sake of building commissions are bound to backfire and
result, eventually, in the loss of customers.

Of course, there are some investors who approach the job
of evaluating their securities with the kind of relish that all of
us should bring to bear on the job. These are usually the
same stockholders who carefully read the annual and quar-

WHEN IS THE TIME TO SELL?  2/7

terly reports that they get from the companies whose stock
they own and painstakingly compare performance with re-
sults in other years and other companies.

While only a trained analyst can get the real meat out of a
corporate report, there are a few simple points that every
investor can check easily to determine if there are any danger
signals that might suggest the desirability of a switch to an-
other stock.

If a stock's dividend is cut, even the least sophisticated
investor is apt to be properly concerned, but the dividend is
actually of less importance in evaluating a stock than the
earnings figure. If a company's earnings drop, the stockholder
has a right to know why. Often there are legitimate reasons.
The company may have decided to put a substantial sum of
money into the development of a new product not yet on the
market, or it may have embarked on some new program of
plant expansion. Such decisions might cut sharply into earn-
ings for any given year, but they may also hold a promise of
expanded profits in years to come.

Again, there are times when business in general or a given
industry in particular may go through a period of stress.
Hence, a company's earnings record must always be consid-
ered on a comparative basis. A bad earnings record for your
stock is in itself no substantial reason for a switch in holdings
if other companies in the same industry are doing no better.

Any cut in dividends or drop in earnings is certain to be
fully elaborated on in the company's annual report. Although
the management will place the most palatable construction
possible on such unpleasant facts, its explanations are apt to
be pretty trustworthy, for these reports must pass the scrutiny
of trained security analysts in brokerage offices and financial
institutions all across the country.

The price-earnings ratio of a stock, which is shown in the
stock tables published in big city newspapers and can always
be computed from the reported figures, is actually a more
reliable measure of investment value than straight earnings
per share. This is because the P.E. ratio reflects something of
how other investors regard your stock. Suppose your stock
sold last year at a price fifteen times earnings, but this year
it sells only at ten times earnings. A drop like that would
reflect a serious loss of investor confidence in your company,

278 HOW TO BUY STOCKS

unless, of course, stocks in general had been under heavy
selling pressure and price-earnings ratios had dropped all
across the board.

A decline in the price-earning ratio of your stock is the
kind of danger signal that suggests that a more intensive      ^
study of other figures in the annual report might be in order.      ^
You might, for instance, look at the income statement and      ^
see how net sales have fared. Have they fallen off to a dis-      ',,
turbing degree? And what about operating costs? Have they      ^
risen unduly? Has there consequently been a serious squeeze

on profit from operations  net sales less operating costs?      ^
How does the margin of profit, obtained by dividing net      J
income by net sales, compare with the figure for earlier years      1-'
and with margins of other companies in the same industry?          H

Next, you might take a look at some of the key figures      ||
shown in the company's balance sheet. You will especially      H
want to look at the current assets and current liabilities. On      ||
the asset side of the ledger you will want to see if there has      t
been any big drop in the company's cash position or in its      ||
holdings of government bonds. You might similarly be con-      ^
cerned about any undue increase in accounts receivable       ^
what people owe your company  or in inventories. Any big      ||,
increase in inventories of finished goods is apt to prove risky,      ||
for a sharp drop in prices could cause heavy losses. Or it      |
might suggest that the company had a lot of unsalable mer-      f
chandise on its hands. On the other hand, a big increase in      |.
the inventory of raw materials might be regarded more hope-      ^
fully. At a time when prices are rising generally, an increase      r
in raw-material inventories might suggest that your company      ];

had very prudently decided to stock up when prices were low.       ^
It could also imply that your company anticipates good sales      ^
ahead for its finished products.                                   ^

As far as current liabilities are concerned, the most impor-      %
tant item is apt to be accounts payable, for this represents the      sf
money your company owes for raw materials, supplies, insur-      %
ance, and the like.                                               ^

More important than the total figure for current assets or      ^
the total figure for current liabilities is the relationship be-
tween the two. Most security analysts figure that current
assets should be twice as large as current liabilities. But that
is only a rough rule of thumb: in industries like railroads,      y.
where inventories are not a major problem and where ac-      ||

WHEN IS THE TIME TO SELL?  279

counts receivable can easily be collected, lower ratios of
assets to liabilities are acceptable. On the other hand, in
industries like chemicals or tobacco, ratios of three-to-one or
four-to-one are more commonly expected.

The difference between current assets and current liabilities
represents a company's net working capital  the money it
has to grow on. This is the lifeblood of a business. Any
serious shrinkage from year to year in a company's working
capital is something that should worry an investor and make
him think seriously about selling his stock.

For an investor, the payoff figure in the balance sheet is the
figure for stockholders' equity or net worth. This is usually
shown on a per-share basis. It is the figure he most wants to
see grow because over a period of time that figure will deter-
mine not only the book value of the stock but the price he is
likely to get for it.

The stockholders' equity is made up of three components;

(i) capital stock, which is the actual declared value of the
company's stock when it was originally issued and which may
or may not be identical with its par value; (2) capital sur-
plus, which is the amount over and above the declared value
that the company might have been able to realize on the
original sale of stock; and (3) accumulated retained earnings
or earned surplus, which is the'amount of money that the
company has earned over the years, less what it has paid out
in dividends.

Of course, even if an investor takes the time and trouble to
look at just a few of these key factors in his company's
annual report  and there is no question that he should 
he is still not likely to have a substantial basis for deciding to
buy or sell. This is because the figures for any given year take
on real meaning only as they are compared with the same
figures for earlier years and for other companies in the same
field.

Finally, the most important question of all  how good
is the management?  is one to which the investor can find
only an implicative answer in any annual report.

In evaluating a company's reports, an investor has the right
to look for help and advice from his broker. Within reason,
he can expect detailed and specific answers to his questions,
reliable data on the basis of which he can make up his own
mind whether to buy, sell, or hold.

280 HOW TO BUY STOCKS

While brokers are frequently accused of stimulating cus-
tomers to switch from one stock to another for the sake of
building commissions, the blunt fact of the matter is that
many don't suggest enough sales to their customers, probably
because they fear being accused of churning. And the cus-
tomer, left to his own devices, goes along with his broker's
inaction, holding on to the same old stocks, blissfully ignQr-
ing his own self-interest, A few years ago a New York Stock
Exchange survey showed that a third of all people who
owned stock had never sold any. They had just bought and
held on.

This static attitude toward investments is reflected in fig-
ures showing the "turnover rate" on the New York Stock
Exchange. The turnover rate shows the percentage of all the
shares listed on the exchange that is traded in any given
year. From 1915 to 1920 it was 117%. Although it dropped
to 70% from 1920 to 1925, it rose to a peak of 132% in
1928. From then on the trend was almost steadily downward
to a low of 9% in 1942. There has been a revival of trading
interest since then, but the average figure for 1950 to 1960
stood at only 15%. It dropped back to 12% in 1962 but
revived again to 16% in 1965 and headed straight on up to
24% in 1968. Falling stock prices and contracting volume
took their toll in 1974, however, and the rate fell back again
to 16%, only to recover to 33% by 1981. Of course, the
number of shares listed on the New York Stock Exchange
has increased steadily over the years, so percentage figures are
somewhat misleading. As the number of listed shares in-
creases, trading activity as a percentage of the total listings is
almost bound to decrease.

As far as actual trading volume is concerned, it was not
until 1963 that the volume of shares traded surpassed the
1,124,800,000 shares that changed hands in 1929. In 1981, it
reached an all-time highup to that pointof 11,850,-
ooo,ooo shares.

The do-nothing attitude of many stockholders holding sub-
stantial profits is unquestionably explained by their reluctance
to pay a capital-gains tax on their profits. This is certainly the
least defensible of all reasons not to sell.

Because the long-term outlook for American business is a
bright and promising one, no one wants to preach a doctrine
of "sell ... sell ... sell." Nevertheless, if you think you can

WHEN IS THE TIME TO SELL?  s8l

improve your investment position, it is ridiculous to go along
comforted simply by the thought that inflation and an ex-
panding economy will rescue you from your own faulty
judgment.

It is a truism of the stock market that there are sell orders
to match all buy orders. There have to be. That's something
worth remembering. And here's something else worth re-
membering. The individual who sells a stock  some stock
you own, perhapsvery often has done his homework a
little more conscientiously than the buyer. He may have a
better reason for selling die stock than anybody has tor buy-
ing it  or than you have for holding it.

34

CHAPTER

The Folklore of the Market

THE cheapest commodity in the world is investment advice
from people not equipped to give it.

Many a man who doesn't own a share of stock fancies
himself an authority on the market. He's always ready and
willing to deliver himself of an opinion about it on the slight-
est provocation. If he actually owns stock himself, chances
are you won't have to ask his opinion. Hell tell you what to
buy, what to sell, and what's going to happen to the market.
And you can't stop him.

The more a man knows about the market, the less he is
willing to commit himself about it. The wisest of them all, old
J. P. Morgan, when asked his opinion of the market, always
used to reply, "It will fluctuate." He wasn't just being canny.
He knew that was the only provable statement that could be
made about the market.

Nevertheless, over the years a number of generalizations
about the market and about investing has come to be ac-
cepted as gospel. Actually, those homespun axioms must be
accepted as just thatlittle more than folklore. Like most
folklore, each of them has a certain element of truth about
it  and a certain element of untruth.

For instance; "Buy 'em and put 'em away."

This would have been a fine piece of advice if you had
bought $1.000 worth of General Motors stock in 1923. By
the end of 1981 that stock would have been worth almost
$30,000, and you would have collected over $70,000 in divi-
dends. Had you been lucky enough to sell your General
Motors before both the gasoline crisis and the 1973-1974
recession had taken their toll, you would have realized more
than $100,000for General Motors has dropped 50 points
since then.

Of course, in the early twenties the car company everybody

282

THE FOLXUSKE OF THE MARKET 283

was talking about was Stutz  not General Motors  and
there was a great deal of speculative interest in Stutz stock.
You might very well have decided to put your $1,000 into
that. How would you have made out on that purchase? The
answer is that you would have lost all your money, and,
furthermore, you would never have collected a penny in divi-
dends.

Of course, there is a measure of sense in the axiom. If you
start worrying about fluctuations of a point or two and try to
buy and sell on every turn, you can needlessly pay out a lot of
money in commissions and you may end up with less profit
than if you'd "bought 'em and put 'em away."

Nevertheless, it's only good sense to remember that securi-
ties are perishable. Values do change with the passage of
time. Industries die and new ones are born. Companies rise
and fall. The wise investor will take a good look at all his
securities at least once a year. And he could do worse than to
ask his broker to review them with him then.
"You never go broke taking a profit."

That's obviously true. But you can certainly be badly hurt.
Suppose you had put $50 into Sears, Roebuck in 1906. By
1940, the stock that you had bought would have been worth
$1,276 at its high. That would haveJaeen a nice profit  and
you might have decided to take it.

But look what you would have lost it you had sold. By
^954 your same holdings in that stock would have been
worth over $4,300, and by the end of 1981 your $50 invest-
ment would have been worth almost $12,000.

Or consider another classic case. In 1914, you could have
bought 100 shares of stock in International Business Ma-
chines for $2,750, and in just eleven short years you could
have sold out for $6,364. Certainly you can never go broke
taking a profit of nearly 250%.

But as far as IBM stock is concerned, you certainly would
have taken a licking if you had sold in 1925. For by the end
of 1981, your original 100 shares would have grown to
291,192 and they would have had a market value of over
$17,000,000. A few years earlier, when IBM was selling at
$365 a share, you could have sold your IBM for $26,571,270.
The government's antitrust action (which was not dismissed
until January 1982), coupled with the recession, whittled
away over half of that value in the next two years.

2&4 HOW TO BUY STOCKS

Of course, a profit is always a nice thing to have  in the
pocket, not just on paper.

"Buy when others are selling, SeU when they buy."

This is a neat trick, if you can do it.

Obviously, you can't make money if you consistently buck
the trend of the market. Where, for instance, would you have
been if you had been selling stock all through various ,bull
markets since 1950?

So the trick lies in anticipating the action of all the others
 in buying just before the crowd decides to buy and selling
just ahead of them. This is exactly the trick that the ex-
ponents of various formula plans try to turn by hitching their
buying and selling operations to various technical declines or
advances in the market.

Others, less scientific, simply try to sell at the top and
buy at the bottom. But how do you know when the market
hits bottom? How far down is down?

Make no mistake about it. Anyone who tries to practice
this fine art is "playing the market" in the purest sense of the
phrase. He's speculating; he's not investing.

"Don't sell on strike news"

There's some truth to this old adage. Nowadays, labor
troubles in any big company or in any industry are apt to be
pretty well publicized. Consequently, the market is likely to
have discounted the possibility of a strike during the time
when it was brewing. The stock wfll already have gone down
in price in anticipation of the strike, and it may even advance
when the strike news breaks.

Again, many people think that a strike doesn't really dam-
age a company's long-term profit picture. They contend that
while a strike is on, demand for the company's products is
only deferred. As soon as the strike is over, the company
begins enjoying better business than ever.

But such a theory is often little more than wishful think-
ing. After all, most strikes end with the company facing
higher labor costs. And many times the demand for its
products, which the company couldn't fill while its employees
were on strike, has been happily filled by a competitor.

"Don't overstay the marlcet."

A fine piece of advice. But how do you know when to sell
and take' your profit  if that's what you're primarily inter-
ested in?

THE FOLKLORE OF THE MARKET    285

Sometimes you can tell by watching those basic business
indicators that show what's happening to production, dis-
tribution, and consumption of goods. But sometimes you
can't, because the market doesn't always pay close attention
to them. Sometimes business looks good and the stock market
skids. Sometimes the reverse is true.

Nevertheless, if business appears to be on the skids and the
stock market is still boiling merrily upward, sooner or later
there's going to be a reckoning.

"Always cut your losses quickly"

Nobody wants to ride all the way downhill with a stock if
the company is headed for bankruptcy, as Chrysler  a
formerly well regarded stock  seemed to be in 1981. How-
ever, at the same time you don't want to be stampeded into a
sale by a price decline that may have no relationship to the
fundamental value of the stock.

Remember, the price of a stock at any time reflects the
supply and demand for that stock, the opinions and attitudes
of all the buyers and all the sellers. If a stock is closely held,
if its floating supply  die amount usually available in the
market  is limited, the price of that stock can be unduly
depressed if one large holder sells a sizable block of it just
because he needs the cash. That doesn't mean the stock is
intrinsically any less worthwhile.

The trading market on any given day is made by just a tiny
handful of all those who own stocks. On the exchange,
60,000,000 shares may be traded in one day, but that still
represents only Vi of 1% of all shares listed on the exchange.
The 99-5% of shares which aren't being sold that day are
being held on to by investors who have some reason for
holding on  or think they have.

Of course, there is much truth in the observation that
unsophisticated investors do tend to sell a stock too readily
when they have a profit in it and to hang on to a stock in
which they have a loss, hoping that it will come back.
"An investor is fust a disappointed speculator."
This cynical observation has a measure of truth in it. Every
stock buyer hopes for a big fat fast profit, even if he won't
admit it to himself. So, when the market drops, he does the
best he can to assuage his disappointment by assuring himself
and everybody else that he never really expected to make a

fl86 HOW TO BUY STOCKS

lolling  he was just investing on the basis of his stocks*
fundamental values.

This is especially true of odd-lot buyers, who, all too often,
finally decide to buy only when the market is already too
high.

So often does this happen that some speculators gauge
their own actions by the relation of odd-lot buying to odd-Jot
selling. When that ratio increases  when the proportion of
odd-lot purchases rises  the speculators begin to anticipate
a reversal of the upward trend.

But in the long run, the small investor often has the last
laugh. After all, the stock market has gone up pretty steadily
for 50 years. Since the odd-lot man is principally a heavy
buyer of the market leaders  the 100 stocks that usually
account for two-thirds of the exchange volumehe has
made out pretty well over the long pull.

On the other hand, many a big speculator, like Daniel
Drew, has died broke.

"A bull can make money. A bear can make money. But
a hog never can."

That's one to remember.

The desire to make money leads most people into the mar-
ket. Call it ambition, or call it greed, but it still remains the
prime motivating force behind our whole business system,
including the stock market.

But greed is always dangerous. It's an engine without a
governor. So you made a killing once in the market. Good.
You were lucky. Don't think you can make one every day.

If you own a good stock, one that's paying you a good
return on your money and seems likely to go on doing so,
hang on to it. Don't keep looking for greener pastures, bigger
profits. And forget about the other fellow and the killing he
made  or says he made. Maybe he can afford to speculate
more than you can.

In short, if you're an investor, act like one.

35

CHAPTER

Who Owns Stock?

IF Wall Street didn't exist, it would be necessary to invent it.
In fact, that's just exactly what our forefathers did.

Why must there be a Wall Street?

Because in our economy, capital, like labor, must be free
to work where it wants to. If you've got extra dollars, you've
got the right in our society to say where you want to put
them to work in order to make more dollars.

And that's a right that would be a pretty empty one if there
weren't some means for you to switch your funds from one
enterprise to another when you wanted to, just as you might
switch from one job to another.

Wall Street provides that means. It's a marketplace for
money.

And in the past thirty years, it has played an increasingly
important role in our economy. It has made it possible for
millions of people to put their savings to work in American
business. That has been good for diem, good for business,
and good for the whole country.

Time was when only wealthy people owned stocks and
bonds, but that's no longer the case. For one thing, there
aren't as many truly wealthy people as there used to be.
Death and taxes have taken their toll.

If business is to have the money it needs to go on growing,
somebody has to take the rich man's place. That somebody
can only be the investor of moderate means  thousands of
such small investors, because it takes 1,000 of them with
$1,000 each to equal the $1 million in capital that one
wealthy man may have supplied yesteryear. And tomorrow it
will take many, many more thousands of them, because busi-
ness is constantly in need of more and more investment capi-
tal to build new plants and replace old equipment. From the
turn of the century to the end of World War II, business put
$218 billion into plant and equipment. But in the next ten

287

aS8 HOW TO BUY STOCKS

years expansion accelerated so rapidly that $232 billion of
capital was neededmore than in all the preceding 46
years. And industry continues to invest in new plants and
equipment at an accelerated rate. By the early io8os such
expenditures were running over $100 billion a year.

Wall Street bears the primary responsibility for recruiting
the new investors who must supply this capital. Wall Street
and all its counterparts throughout America.

Wall Street takes its responsibilities seriously. Every year it
puts millions of dollars into booklets, pamphlets, and letters
to explain securities. It uses educational advertising: news-
papers, magazines, television, radio, even billboards. It has
taken the story of stocks and bonds to country fairs, depart-
ment stores, labor unions, and women's clubs. It has even put
the story into movies that any group can show free of charge.

How well has Wall Street done with all this educational
effort in stimulating new investor interest?

Better than you might think  but not nearly as well as it
must.

Not until June 1952 did Wall Street know just how it stood
on the job. Strange as it may seem, nobody could say how
many stockholders there were in the country until the New
York Stock Exchange got the Brooldngs Institution to Bnd
out. American Telephone & Telegraph knew it had 1,200,000
stockholders back then. And 30 other big companies knew
they had 50,000 or more apiece. But nobody knew just what
duplication there was in those stockholder lists. And nobody
knew the grand total for all companies.

The Brookings Institution reported in 1952 that the total
was 6,490,000, representing a little more than 4% of all the
individuals, and just about 10% of all the families, in the
country. Disappointing as that total figure was when it was
announced, Wall Street found encouragement in the fact that
about one-fifth of the total had become stockholders in the
preceding three years.

Four years after the Brookings study, the New York Stock
Exchange retained Alfred Politz Research, Incorporated, to
make another census of shareholders. Politz reported a total
of 8,630,000 stockholders in publicly owned corporations, an
increase of 33% in four years.

Since then, the New York Stock Exchange has conducted
similar censuses every four or five years, and until the second

WHO OWNS STOCK? 289

last report, published in December 1975, each census showed
a steady increase in share ownership. In 1970, the exchange
reported that the total of individual stockholders had passed
the 30,000,000 mark. In 1972, estimates placed the number
at a record 33,500,000. But the 1975 census showed an
18.3% drop to 25,200,000. This recovered to 32,260,000
million in i98i's census.

Here are some highlights of that study.

The typical American stockholder is a 46-year-old man.
Male shareholders had outnumbered women in die 1965
1970 census, but the standings were reversed in 1970-1975,
only to revert in 1981. In fact 52.9% of all stocks were
owned by men, as against 47.3% for women. The median age
declined by over seven years, reflecting the increasing number
of young people entering the market.

The 1981 report also showed that the value of the average
investor's portfolio was $5,450, down from over $10,000 in
1975. New York replaced Chicago as the city with the largest
number of shareholders.

The average investor was a technical or professional
worker with at least four years' college education and an
average household income of $29,000 a year, 60% more than
the national average of $17,700. In 1975, the average share-
holder's income was $19,000, compared with a national
average of $11,800almost the same percentage variation.

But despite the gains shown in 1981's census. Wall Street
still finds itself confronted by the fundamental question that
has been nagging it for a quarter of a century.

Why is it that so many people who can afford to invest
don't own any stocks?

Why should shareowners represent only about a quarter of
all U.S. families while 64% have savings accounts, 62% own
their own homes, and more than three-quarters have life in-
surance?

In short, why don't more people invest?

There's one clear-cut answer to that. Millions of people
still don't understand stocks and bonds. And what people
don't understand they are apt to be afraid of.

We may be the richest nation in the world, the very bul-
wark of a modern and enlightened capitalism, but the blunt
fact of the matter is that we are still not a financially enlight-
ened nation.

290 HOW TO BUY STOCKS

Yes, ignorance is unquestionably the biggest deterrent to
investing. But there's another factor in the picture too. Suc-
cessful investing isn't simple. It means dunking your own
investment problems through to a logical conclusion. It
means being willing to study all the facts available about
various securities. It means checking up on a stock both
before you buy it and after you buy it.                    -

That's not easy, admittedly. But it's not beyond the capabil-
ities of any of us. Not if Nicholas J. Harvalis could do it-
You're not likely to remember the story in the newspapers
about him when he died in 1950, But he was an uneducated
immigrant who worked all his life in restaurants for a wage
that never exceeded $125 a month, but who still managed to
leave an estate of $160,000.

Here is how he did it, as related by his counselor. Max D.
Fromkin of Omaha:

Fromlcin & Fromkin
Keeling Building
Omaha 2, Nebraska

February 13th, 1951

I give you now the story of Nicholas J. Harvalis, late of Omaha,
Nebraska, who departed this life on the last day of the month and
year of 1950, to wit, December 31, 1950, shortly after the close of
the market for the year.

Nicholas was a friend of mine for over 2.5 years, and during that
time I was his attorney and counselor.

Nicholas came to this country from Greece at the age of 15 years.
He was without education and money, and he immediately went to
work as a waiter in various cafes and restaurants operated by his
countrymen in Omaha at wages which provided a bare living for
him.

He was unmarried and lived the many years in Omaha alone in a
modest room.

He was thrifty to a point of many times denying himself the
comforts of life in order to save from his earnings sufficient to make
investments for his security and old age. He employed his leisure
hours reading and studying financial papers and books. He also
spent many hours in the public library poring over history and
philosophy.

On May 18, 1927, he became a citizen of the United States by
naturalization. He was a firm and optimistic believer in the op-
portunities offered the common man in the United States, and he

WHO OWNS STOCK? 291

believed that the greatest return in investments was in common
stocks of well-managed companies.

Thus, beginning about 1937, he started a systematic purchase
of common stocks. His early investments were in National Distil-
lers, Laclede Gas, General Motors, S. S. Kresge, Atlantic Refining,
International Nickel, J. C. Penney, General Electric. He bought
a few shares in each of these companies and added to them from
time to time.

He kept meticulous records of all of his transactions, including
dividends received. His dividends, which at first were modest, he
would save and reinvest in these same stocks.

He subscribed to the Wati Street Journal and avidly read the
paper from cover to cover. As a matter of fact, at the time of his
death the only thing in his room apart from bare furnishings was
a neat stack of issues of the WaU Street Journal for the last two
years,

In 1943, he began selling stocks for long-term profits when he
felt the market was high, and later he began a repurchasing
program.

In 1943, his earnings from wages as a waiter and soda Jerk in
a local drugstore known as the Paxton Pharmacy at igth & Hamey
Streets in Omaha were $1,602.00, while his income from dividends
of common stocks was $1,825.00.

In 1944, his earnings from wages were $1,525.00, and his
dividends from common stocks rose to $2,285.00. In the same year
he made from gains in the sale of stocksthe sum of $2,600.00.

In 1945, his wages were the same, but dividends from stocks
came to $2,785.60. Long-term profits in that year were $7,713.84.

In 1946, his dividends from stocks fell to $1,506.24, but his
gains on the sale of stocks were very substantial.

In 1947, his dividends rose to $2,191.24.

In 1948, his dividends were $10,562.98.

In 1949, his dividends were $7,081.24.

In 1950, his dividends were $10,095.50.

During all these years he earned from wages as a soda jerk a
sum not to exceed $1,600 per year.

When he died on December 31, 1950, he was the owner of the
following common stocks:

1,370 shares Cities Service common
200 shares Boeing common
300 shares Rock Island common
100 shares General Electric common
200 shares American Bank Note common
40 shares Hearst Consolidated Publications 7% preferred
200 shares Great Northern Iron Ore.

The above shares had an approximate value at the time of his
death of $160,000.

292 HOW TO BUY STOCKS

Nicholas J. Harvalis kept perfect records and had in his room
every statement from his broker of every transaction he had ever
made. In addition he made accurate reports for income tax purposes
and was proud to pay his government every cent of tax for the
privilege of his citizenship and the opportunity that his government
gave him. In my association with him as his attorney I found him
always to be a very polite, mild-mannered, and courteous in-
dividual. He was often asked for advice on the market and was
always very cautious to mention only highly rated dividend-
paying stocks.

Nicholas amassed this huge sum considering his limitatipns and
in his death he leaves to his brother and sisters (11 of them) in
Greece a substantial inheritance, which they will no doubt spend
more freely and with less good judgment than the man who earned
it.

Very truly yours
MAX FHOMKIN

Or consider the story of Sam Hamilton, a dishwasher in a
mission and a janitor at the Pacific Stock Exchange. The
methods by which this shy octogenarian amassed a $300,000
estate will never be known exactly, but according to a spokes-
man for the Life Line Mission, mentioned in his will, Mr.
Hamilton must have gathered some pretty good information
in his many years of sweeping and cleaning around the stock
exchange.

Few of us would be willing to pay the price Mr. Harvalis
or Mr. Hamilton did for their achievement. But then most
of us would be willing to settle for just a small measure of
their success  the success that can be achieved not by luck,
not by "inside tips," not by speculation, but only by prudent
and intelligent investing.

36

CHAPTEK

Stock Screens

BY utilizing high-speed computers. Wall Street research firms
have been able to examine the total body of all stocks avail-
able for investment and ferret out those that meet only vari-
ous sets of rigorous statistical criteria. Now it is even possible
to program the computer to sift through thousands of poten-
tial investment-grade stocks and pick out only that handful
that meets several sets of these criteria simultaneously
stocks that have similar earnings, dividend payout, cash flow,
or capitalization characteristics that make them likely invest-
ment candidates for certain specific types of stock buyers.

These computer stock "screens" or "nets" are available
from a wide range of brokerage house research departments.
They also appear on a regular basis in a number of general
financial advisories and magazines, including Standard and
Poor's Outlook, Value Line's Investment Survey, and in
Forbes "Statistical Spotlight" columns. The average investor
should find these computerized stock screens a tremendous
help in narrowing his range of potential investment vehicles,
as well as an invaluable aid in determining just what criteria
are important in picking a particular stock for him to buy.

The following is a selection of basic stock screens that were
applicable in January io8a. They are presented here to give
you some small idea of how they work and of the tremendous
potential range of their statistical fine tuning.

COMPUTER SCREEN #1: NYSE. Companies That Have
Paid Higher Dividends in Each of the Past Ten Years and
Whose Current Yield Is over 10%

The computer ran through all the stocks listed on the New
York Stock Exchange. First it pinpointed alt the companies
that had raised their dividends in each of the past ten years.
There were 162. From these it then selected the 24 stocks
whose current yield exceeded 10%. The rationale for this

293

294 How TO BUT STOCKS

screen is obvious. It is for income-conscious investors who
seek the stability of a NYSE-listed company, a higher than
average current yield, and a solid indication based on past
evidence that that yield will continue to rise every year }ust as
the real value of the yield diminishes because of the dollar's
gradual devaluation.

This screen can be more finely tuned to pick out companies
whose yield has risen by a certain percent in the past ten
years, stocks whose recent price action does not reflect their
rising dividends, stocks with low price/earnings ratios, et
cetera. The beauty of screening stocks with computers is that
additional criteria can be added to the program indefinitely,
until the only stocks the computer has left are those that
match the individual investor's needs and wishes perfectly.

Computer Screen #i's results are shown below.

Stock

Allegheny Power System
Atlantic City Electric
Cleveland Electric Illuminating
Connecticut Natural Gas
Florida Power and Light
Hawaii Electric
Household International
Houston Industries
Idaho Power

Kansas Gas and Electric
Long Island Lighting
Louisville Gas and Electric
Middle South Utilities
Minnesota Gas
Montana Dakota Utilities
Nevada Power
Niagara Mohawk Power
Public Service Indiana
Rochester Gas and Electric
South Carolina Electric and Gas
Southwestern Public Service
Utah Power and Light
Washington Water Power
Wisconsin Public Service



CwWHtYield W l&S	Pgroaitfaggfi lalOYM54
11.8	50
13.5	42
12.2	77
10.5	176
11.4	93
11.0	96
12.0	140
12.0	52
14.1	42
13.9	39
12.3	27
12.8	56
10.8	47
1L1	106
11.6	258
13.7	46
12.4	78
12.6	100
12.1	33
11.5	87
12.2	124
12-9	66
10.9	66

STOCK SCREENS 295

Faced with these 24 dividend-increase leaders, the indi-
vidual investor can then decide whether he wants a company
with a larger current yield (Kansas Gas and Electric, Long
Island Lighting, Niagara Mohawk Power) or one that has
raised its dividend extraordinarily fast (Nevada Power,
Florida Power and Light, Houston Industries). He is also
now free to investigate thoroughly the individual companies
the computer has selected, to see if they fulfill his other
investment criteria, to see if they stand up under obJective
financial scrutiny, and to determine if there is any negative
reason why these particular stocks are the great bargains they
seem to be. In this particular screen, for example, most of the
stocks pinpointed by the computer are utilities. And in early
1982, utilities, which need to borrow huge amounts of money
to finance their continuing operations, were under great pres-
sure because of the dramatic increases in interest rates on
those borrowed funds. This is a dramatic indication of how
and why computer screening of stocks should never be the
end of the road for investors, but merely a tool for beginning
the stock selection process, a process which should always
continue with an extensive investigation of the companies the
computer has selected out.

COMPUTER SCREEN #2. Companies Whose Dividends
Will Re 100% Free of Federal Income Tax during the
Coming Year

Here the computer has pinpointed stocks whose current
yearly dividend exceeded the earnings that it reported to the
IRS for tax purposes. The IRS has determined that when that
happens, the difference is a return of capital, and therefore
not subject to federal income tax. It is important to remember
that investors must use the portion of a dividend that is a
return of capital to reduce their cost basis for the stock.
When they sell the stock either their capital gain will increase
or their loss will decrease. It is also important to remember
that since the dividends these companies are paying out are
greater than the amount of money they are taking in, neither
this dividend, nor in some cases the very financial under-
pinning of the companies themselves, can be considered very
secure.

Computer Screen #a companies are American Family,

296 HOW TO BUY STOCKS

Apache Petroleum, Boston Edison, Fail-child Industries, For-
est Oil Corp., General Dynamics. Green Mountain Power,
Grumman Corp., Mesa Petroleum, National Student Market-
ing, Ohio Edison, Pennsylvania Power and Light, Public
Service Company of New Hampshire, Rockower Brothers,
Rouse Company, San Juan Racing Association, U.V. Indus-
tries Liquidating Trust, Universal Marion.                '

This screen can further be Bne-tuned to reveal which com-
panies have been paying tax-free dividends for an extended
period of time, which are anticipating future earnings to on-
set their accumulated payouts, and which offer a particularly
generous yield. (Many of the stocks included in this screen
have yields of 10% or more.)

COMPUTER SCREEN #3. Stocks Selling for at Least
an 80% Discount to Their Net Liquidating Value

American International (selling at 51% of its net liquidat-
ing value), Superscope Inc. (53%), Bobbie Brooks Inc.
(54%), Craig Corp. (64%), Sterchi Brothers Stores (69%),
Barber-Greene (70%), Facet Enterprises (71%), Dynamics
Corporation of America (74%), Aileen Inc. (75%), Vista
Resources (78%), Cordon Jewelry (78%); this is a list of
stocks whose current per-share price on the exchange is not
equal to at least four-Bfths of its real per-share worth in terms
of net working capital (that is, current assets less all current
liabilities, including long-term debt and preferred issues).
Theoretically it offers investors a chance to buy a dollar's
worth of assets for 51^ to 78^.

COMPUTER SCREEN #4. Stocks Whose Current Price
Earnings Ratios Are under Three

Pan American Worid Airways (1.2 price/earnings ratio),
Atlas Corp. (2.1 p.e.), Mesta Machine (2.3 p.e.). Allied
Supermarkets (2.4 p.e.), U.S. Steel (2.4 p.e.), Fflmways Inc.
(2.5 p.e.), L.T.V. Corp (a.6 p.e.), L-F.E- Corp. (2.9 p.e.),
Republic Steel (2.9 p.e.): this is a list of stocks whose cur-
rent per-share price has a ratio to its current annual earnings
per share of less than 3: i. All other things being equal, it is a
screen of stocks selling at bargain-basement prices relative
to the amount of money they made the previous year.

STOCK SCREENS 2Q7

COMPUTER SCREEN #5. Stocks Whose Total Annual
Return Is at Least 63% of Its Current Per Share Price

Armada Corp. (total annual return is 93% of its current
per-share price), A.V.X. Corp. (71%), Millipore Corp.
(69%), International Harvester (67%), Robintech Inc. (66%),
Benguet Corp. (66%), Adas Consolidated "B" (65%), Tubos
De Acero (64%), American Quasar Petroleum (63%), Spectra
Physics (63%), Sunshine Mining (63%), K.D.T. Industries
(63%), Ranger Oil (63%); for the purposes of this screen a
company's annual return is defined as its current yield plus
its growth plus its appreciation due to a changing p.e. trend,
This screen therefore identifies thirteen companies with stock
selling at per-share prices very near to the amount of return
they're generating on their capital every year.

COMPUTER SCREEN #6. Stocks Whose Outstanding
Shares Have the Greatest Market Value

Such stocks are American Telephone and Telegraph
($44,53 billion total market value), IBM ($33-5 billion).
Exxon Corp. ($26.03 billion), Schlumberger ($14.18 bil-
lion), Standard Oil of Indiana ($13.40 billion), Standard Oil
of California ($12.79 billion). General Electric ($12.70 bil-
lion), Shell Oil ($11.28 billion), Eastman Kodak ($11.26
billion). General Motors ($11.25 billion).

One hundred and two publicly traded U.S. corporations
had market values in outstanding shares exceeding $2 billion
in early 1982- A list of these stocks ranked by total market
value would be extremely useful for an individual who placed
a great value on either the size of his stocks' stake in the
world economy, or in their ability to withstand external
economic shocks or internal financial problems by virtue of
their very size.

COMPUTER SCREEN #7. Stocks of Companies with
Average Growth Rates over 30% for the Past Ten Years
and Projected i8%+ Growth Rate for the Next Five Years

Some of these are Wal-Mart Stores (39% average growth
rate over the past ten years). Fremont General "A" (37^)*
Tymshare Inc. (36%), Texas Oil and Gas (34%), Ranger

2Q8 HOW TO BUY STOCKS

O'1 (34%). Church's Fried Chicken (33%), Dome Pe-
troleum (33^), First Mississippi (33%), Natomas Com-
pany (33^). Valley Industries (33%), Humanna Inc. (32%),
Lennar Corp. (32%), Petro-Lewis (32%), Waste Man-
agement Inc. (32%), Mary Kay Cosmetics (31%), National
Data Corp. (31%), Sigmor Corp. (31%), Western Company
of North America (30%).

Of course, just because a company has grown dynamically
in the past is no guarantee that it will continue the same
pattern of growth into the future. But it is a good starting
point. And the fact that a company has attained impressive
growth over a full decade with no notable negative impact on
its financial structure automatically gives it a positive image
in investors' minds over companies which have not achieved
similar growth. And if you add to this screening process the
factor of a low price earnings ratio you can further identify
stocks whose dramatic growth has not yet been discovered by
the marketplace.

COMPUTER SCREEN #8. Stocks with over 20% Return
on Capital over the Past Five Years, Ranked by Earnings
Retained to Common Equity

Tandy Corporation (40% of earnings retained to common
equity), Texas Pacific Land Trust (39%), Intermedics Inc.
(37%), Commodore International (32%), Criton Corp. (30%),
Teledyne Inc. (28%), Fremont General "A" (28%), Rolm
Corp. (27%), Savin Corp. (27%), Brooks Fashion (26%);

here is a screen which measures the productivity of a company
with its capital relative to how much of that productivity the
company uses to invest in its future.

COMPUTER SCREEN #9. Stocks of Companies That
Have Earned in the Past Five Years More than Three Times
as Much Cash Flow as Was Required to Build
Plant and Pay Dividends

Lin Broadcasting (6.34 times the amount of "cash Sow" to
cash out), Shapell Industries (5.64), Commerce Clearing
House (5.01), Presley Construction (4-13), Teledyne Inc.
(4.04), U.S. Home Corp. (4.02), Columbia Pictures (3.99),
Pulte Home (3.67), Standard Pacific (3.58), Capital Cities

STOCK SCREENS 299

Communication (3.56), Kaufman and Broad (3.46), Loews
Corp. (3.26), General Housewares (3.06), Premier Industrial

Corp. (3-04)-

There can't be a much better test of a public corporation's
overall efficiency than the extended record of how much more
money it has earned than it has paid out.

COMPUTER SCREEN #10. Stocks of Companies with No
Long-Term Debt, 15% Recent Returns on Equity, and
Price/Earnings Ratios under Six

American Filtrona Corp., Falconbridge Copper, O'Sullivan,
Page Airways, Sturm, Ruger and Co., Tri-Chem, United Keno
Hill Mines, Wham-0 Manufacturing: here's a screen of com-
panies that don't owe anybody any money, make a lot of
money themselves, and haven't had the price of their stock bid
up by eagle-eyed bargain hunters  yet.

Obviously the number of different computerized stock
screens it is possible to come up with is limited only by the
number of different statistical variables it is possible to feed
into the computer. And there are so many variables that
impact in so many different ways on the varying preferences
and needs of individual investors that the number of different
combinations is practically limitless. With the aid of screens
you can get from your broker, or glean from the financial
press, and with the information you get by comparing the
historical performances of similar stocks in all kinds of past
markets, it should be possible for you to narrow your invest-
ment choices down to a handful of stocks that satisfy your
own personal financial demands.

37

CHAPTER

The New Investment Arecis

FOR the first six editions o{ this book we limited the invest-
ment areas under discussion to the basics; stocks, bonds,
mutual funds, and options. We did this not only because
these vehicles comprised the principal investment tools in
Wall Street's basic inventory, but also because they were the
most accessible areas for the average investor and they of-
fered the most tested means of participating in America's
present and future growth.

We still believe that common stocks are the best long-term
investment tool for the average American. They are truly
"shares" in the tremendous accumulated wealth and glowing
future prospects of this country's business community. And
now, perhaps more than ever before, this is both a present
reality and a future hope that is being unrealistically dis-
counted in the marketplace. On June 30, 1976, the day on
which the sixth edition of this book went to press, the Dow
Jones industrial average stood at 1002.76. As this seventh
edition is being prepared, in February 1982, (he Dow has
fallen to 833.80. In a s^year period, during which the price
of almost everything else has at least doubled, the price of the
average stock, as measured by an assortment of popular aver-
ages, has declined 15 to 20%. Publicly owned American
companies are making historically high profits, paying out
historically high dividends, and their prospects, in both do-
mestic and international markets, have never looked better.
Still, stock prices are down. This is not a condition that can
continue for very long. We believe common stocks are the
last bargain around, and that prudent investors who show
their faith in American commerce by buying them now stand
to profit more than participants in any other investment area
 that is, as soon as the relationship of these stocks* value to
their cost rights itself. As it always has.

3<*o

THE NEW INVESTMENT AREAS 301

Still, because the prices of American stocks and bonds
have remained so relatively depressed throughout the seven-
ties and early eighties, because inflation has remained so high,
and because investment professionals, including most of the
major brokerage houses, have been so diligent in creating new
instruments for these increasingly complicated financial
times, the investor finds himself now faced with a growing,
and increasingly complicated, field of alternatives vying for
his investment dollar. Most of the products available in these
emerging investment areas can be participated in through
your stockbroker. Those that cannot can surely be explained
to you by him. What follows is a brief description of all of
these alternate investment vehicles, an explanation of how the
average investor can participate in each of them. and some
suggestions for further reading about them.

Futures: Commodity and Otherwise

Buying futures is very much like buying stock options. When
you buy a future you are buying the right to purchase a
certain amount of a specific thing at a specific price for a
specific period of time. For example, you can buy the right to
purchase 5,000 bushels of wheat for $4.30 a bushel for any
time up to six months. In times of generally rising prices,
which, in fact, is most of the time, the "farther out" the
option is  that is, the longer it remains possible for you to
buy the commodity at that specific pricethe more the
option costs you. The principal difference between futures
contracts and stock options is that in futures contracts the
buyer never actually takes physical delivery of the commodity
he has bought. There is no equity in buying futures.

It is now possible to buy futures contracts in over 30
different commodities, including soybeans, cocoa, orange
juice, cattle, and other edibles; silver, gold, platinum, copper,
and other metals; lumber, cotton, heating oil, and other in-
dustrial materials; the yen, franc, pound, and other foreign
currencies; Treasury bills and bonds and other money market
instruments. It is even possible now to buy a contract on the
future course of interest rates and the popular stock averages.
Futures trading, however, is generally only for speculators.

302 HOW TO BUY STOCKS

Ninety percent of all individual-futures traders lose money.
And aggregate losses are six times aggregate gains. Even the
best commodity traders lose money more often than they
make it. They stay ahead of the game by taking small losses
right away while letting their gains pile up.

It is the staggering potential profit on a small initial cash
investment that is the principal appeal in buying futures. 'The
initial cash requirement is generally 5 to 10% of the market
price of the commodity. There is no interest charge on the
outstanding balance. And commission charges are relatively
low. Thus, if the price of a commodity goes up 10% before
the future contract on it expires, the investor who bought that
contract can double his money or more.

The best solution for the average investor who wishes to
participate in the futures market is to do so through a com-
modity market pool, which acts like a mutual fund for fu-
tures buyers. According to the Commodity Futures Trading
Commission, there were 827 such pools in 1982, up from 532
in 1979. In a pool, as in a mutual fund for stocks, the
investor simply buys shares, usually in minimum amounts of
five units of $1,000 each. He pays a one-time commission of
$70 per unit. Some pools include cash disbursements, but,
more often, gains and losses are simply distributed among the
units, to be taken when the investor sells one. Investors in
such pools enjoy the high leverage of the futures market
without worrying about margin calls or making trading deci-
sions in markets that change from minute to minute. Even
during such generally bad years for commodities as 1980-
1981, the pools did well. Of the 36 pools monitored by Nor-
wood Securities, a Chicago brokerage house that doesn't
handle commodities business itself, half showed net gains in
unit value, for an average gain of 26.3%. The other half
showed declines averaging 12.8%. Further, of the nineteen
funds in existence at the start of 1981, eleven had gains
averaging 32.9%; the others had an average loss of 15.3%.

Further reading on futures: Stanley W. Angrist, Sensible
Speculating in Commodities (Simon & Schuster).

Commodities Magazine, 219 Parkade, Cedar Falls, Iowa,
50613, published monthly.

Tewdels, Harlon, and Stone, The Commodity Futures
Trading Guide (McGraw-HiIl).

THE NEW INVESTMENT AREAS

Gold

Until the Great Depression of the 1930s, Americans were
allowed to own as much gold as they wanted to. Gold coins
were legal tender. But in 1934 the Gold Reserve Act made
ownership of gold bullion, except for industrial purposes,
illegal. It also fixed the price of gold at $35 an ounce From
that point until 1968, as the price of everything else rose
dramatically, the price of gold remained static. In 1968 the
Gold Pool, formed by the United States and seven other large
western governments to trade gold at a stable $35 price, went
out of business because of increased demand for the metal
from foreign investors. The price of gold was set free. From
that point until early 1980, spurred on by President Ford's
lifting of the gold sales ban to individual Americans in i974>
the price of gold rose in steady spurts to $875 an ounce. It
has since settled back to less than 40% of that price, al-
though gold bugs everywhere predict an eventual rebound to
even higher highs.

Gold is the purest hedge investment m the marketplace. It
is an internationally recognized medium of exchange. It is
portable. And, unlike paper currency, it has legitimate under-
lying value. In times of political economic turmoil people
return again and again to gold as the medium of exchange.
This is why gold prices rise in times of growing inflation (and
falling interest rates) and also why gold always moves up-
ward whenever world peace is threatened. Gold is a crisis
commodity. It does well when everything else is doing poorly,
or looks as if it is about to do poorly.

There are five basic ways to invest in gold.

(i) Gold futures, which allow you to buy a fixed amount of gold
at a fixed price for a certain specified amount of time, like II
futures contracts, are basically closed-ended speculations meant
only for sophisticated traders.

(a) Gold stocks  shares in U.S., Canadian, and South African
minesare, many of them, traded OQ die larger exchanges
and some, particularly the South Africans, because of the
uncertain political climate in that country, pay substantial
dividends.

304 HOW TO BUY STOCKS

(3) Gold mutual funds buy a wide range of such gold mining
stocks.

(4) Gold bullion cm be bought through, aod both stored and
insured by, large brokerage houses nice MerriD Lynch.

(5) Gold coins, both antique and fleshly minted: these latter are
bullion coins sold for little more than the price of die gold they
contain. Most weigh one ounce. 61 February lofia, the AmeHcan
Gold Coin Exchange, a subsidiary of the American Stock
Exchange, made gold coins the most accessible gold investment
for most Americans when it began trading South African
Krugeiranis, Mexican pesos. Canadian Maple Leafs, and
Austrian crowns at or near the spot-metal price plus approxi-
mately *% commission. Purchasers could avoid local sales taxes
by having their coins stored in a Delaware vault operated by
the exchange. Again, major brokerage houses are equipped to
handle such transactions.

Sflver

When Alexander Hamilton was establishing this country's
monetary system, he pegged silver at one-sixteenth the price
of gold. Since then silver has generally commanded a price
reflective or that relationship. In early 1980, however, while
gold was climbing to its all-time high of $875 per ounce,
silver was staging its own panic buying rally. Fueled by in-
creasing margin buying by the Hunt brothers of Texas, silver
shot up in a few short months from $10 to over $50 an
ounce. Then the Commodities Trading Commission stepped
in and demanded that more cash be put into such speculative
margin buys. The price of silver dropped even faster than it
had risen, until in mid-igSa it fell below $5 an ounce, at a
time when gold was selling for $350 an ounce. The old 16: i
gold/silver ratio, which had been reestablished during silver's
1980 climb, had fallen to an all time low of 60: i.

Silver, like gold, is basically a crisis metal, a natural store
of value to which investors automatically turn when the value
of paper currency seems to be eroding. But because silver is
so much cheaper than gold, it is also much less portable.
With silver currently selling for one-fiftieth the price per
ounce as gold, $10,000 worth of physical sflver takes up 50

THE NEW INVESTMENT AREAS 30g

times as much space and is 50 times heavier to carry than the
same sum in gold. This lack of portability seriously dimin-
ishes silver's worth as a crisis investment. Still, silver has a
wide variety of industrial uses  in photography, dentistry,
and industry  and this fact, plus the chronic shortfall be-
tween annual demand and yearly production, leaves most
metals analysts feeling that silver is a very good long-term
investment indeed at current prices, despite the government's
repeated attempts to sell off its massive stockpiles and despite
the heavy supplies of hoarded ornamental and coin silver that
always seem to appear during any price increase.

Like gold, silver can be bought either on the futures mar-
ket, in the form of stocks in mines (although as of this
writing there exists no mutual fund that buys only silver
stocks), as bullion, or as coins. Most large brokerage houses
can buy bullion for you in one-ounce, twenty-ounce,
go-ounce, loo-ounce, or i.ooo-ounce bars or ingots. All such
bars should have international hallmarks. Experts agree that
the best way to buy silver coins is to buy U.S. silver coins
minted prior to 1976. One hundred dollars in dimes, quarters,
and halves weighs about five and a half pounds and contains
71.5 troy ounces of silver. Collector coins, such as Morgan
half-dollars, may sell at premiums higher than the meltdown
value of their silver. As this is written, several large silver
mining companies are planning to manufacture their own one-
ounce coins to rival the Kruggerands and other gold coins.
There is not yet, however, any official market for the trading
of such silver coins.

il

Other Metals

The only other precious metal that is widely traded on world
markets is platinum. It is essential for a large number of
industrial processes, and is extremely rare. Over twenty times
as much gold as platinum is mined every year worldwide.
Platinum is traded on the futures exchanges, as is its sister
metal palladium. They are the only other precious metals so
traded. Both platinum and palladium are also available, al-
though not readily, in physical form,

Of the nonprecious industrial metals, copper is the most
actively and widely traded. Copper futures contracts are

306 HOW TO BUY STOCKS

traded on most commodity exchanges. Other industrial
metals that maintain active markets but that are generally
impractical for individual investors to speculate in are alumi-
num, antimony, lead, pig iron, mercury, tin, steel, and zinc.
Daily quotations for all are published in the Wall Street
Journal and New York Times.

During the early igSos one other family of metals has
emerged as a particularly interesting investment areathe
so-called strategic metals: titanium, cobalt, chromium, man-
ganese, tantalum, indium, rhodium, vanadium, and several
others. All of them have very specific industrial applications
and several are critical in the production of defense weaponry.
In 1981 President Reagan announced his intentions to in-
crease as soon as possible the supplies in the drastically de-
pleted U.S. strategic metals stockpile. Strategics are mined
primarily in South Africa and Russia. Political disruptions
and dwindling supplies of these metals could therefore send
prices sharply higher at any moment. Individuals can invest
in strategics by buying quantities of the metals themselves
through brokers, by acquiring stocks in companies that utilize
them, or, perhaps in the near future, by pining an investment
pool or partnership that will buy the metals for their investors.

The difficulties in buying strategic metals are many; there
is no organized exchange or futures market for them; trades
are executed through dealers in direct negotiations; prices
aren't published in newspapers or any other readily available
publication; the metals come in many different grades, com-
plicating matters enormously; markets are thin, and like any
other "hot" investment area the strategic field has its share of
shady salesmen and marginally viable brokerages. That is
why the handful of large brokerage houses that traffic in
strategics are so careful about them, requiring of potential
customers an annual income of $25,000 or more, $75,000 in
net assets exclusive of a house, $20,000 in liquid assets, and
the signing of a suitability letter that spells out all the poten-
tial dangers. Typically, 25% of the amount of a strategics
purchase price must be put down beforehand, with the bal-
ance due in two days. Commissions run to about 5% of the
purchase price plus insurance and storage fees.

Further reading on gold, silver, and other metals: Donald
Hoppe, How to Invest in Cold Coins (Aroo [paperback]);

Donald Hoppe, How to Invest in Gold Stocks (Arlington

THE NEW INVESTMENT AREAS 307

House), Silver Profits for the Eighties by Jerome Smith
(ERG Publishing); Get Really Rich in the Coming Super
Metals Boom by Gordon McLendon (Pocket Books [paper-
back]); "Behind the Hype for Strategic Metals," Changing
Times Magazine (November 1981); Cold Newsletter, 8422
Oak Street, New Orleans, Louisiana, 70118.

Coins, Gems, and Other Collectibles

In addition to the gold and silver coins that are in common
circulation or are currently being manufactured to be bought
by investors, there is another class of coin  the collectible
coin, sometimes of ancient vintage  which by virtue of its
rarity sells for a premium above that which most other coins
command.-These coins can be bought from local dealers, but
-iHs'always best to compare prices, condition, and guarantees-
Prices for the same graded coin can vary substantially among
dealers- Two large, reliable firms that guarantee their coins
are Numisco in Chicago and Deak Perera in New York City.

Gems are another hard-asset investment area that has at-
tracted considerable public interest in recent years. Gems can
be bought as either rough stones, cut stones, or as com-
ponents in new or antique jewelry pieces. Diamonds alone
constitute one very active gem market. The other two markets
are composed of colored precious gemstones (rubies, emer-
alds, and sapphires) and semiprecious stones (opals, topazes,
aquamarines, tourmalines, amethysts, garnets, tsavorites, et
cetera). The retail markup for gems is very high, so investors
must be prepared to hold on to them for a long time to make
a profit. Quality and cut are also of great importance, so that
some experience in judging stones is necessary before plung-
ing into the gem market. Until recently individual investors
who wished to buy gems had to do so either from a retail
merchant or a private party or at auction. Recently, however,
there has been talk of several brokerage houses setting up
"diamond trusts," permitting small investors to own units of
investment-grade diamond collections for minimum invest-
ments of $1,000.

The number of collectible investment areas is almost limit-
less; art, antiques, stamps, autographs, rare books, antique
cars, vintage wine, baseball cards. Almost any well-made arti-

308 HOW TO BUY STOCKS

fact that appeals to the aesthetic sense or nostalgic sensibili-
ties of a cross section of human beings and is in somewhat
short supply is a potential investment collectible. The keys to
getting into the collectible market are (i) knowledge  find
out as much as is possible about your specific area of invest-
ment (2) passionif you don't really care about what
you're collecting, your time would probably be much more
fruitfully spent investing in some less subjective area (3)
quality  all experts agree that it is the better examples of
any collectible that appreciate the fastest and the most  (4)
knowing where to buy  in collectibles prices and quality
vary more widely than in any other investment area.

Most collectibles, like coins and gems, are bought either
from retail dealers or galleries, or at auction, particularly
from the larger international auction houses like Sotheby's
and Phillips, which started out dealing mostly in art but have
rapidly expanded into every imaginable collectible area. Dur-
ing the early io8os several small regional brokerage houses
experimented with the notion of coin, stamp, and art pools 
getting $10,000 from individual investors, securing the ad-
vice of expert consultants in these various collectible fields,
and buying a portfolio, in whose future appreciation the in-
dividual investors would share to the extent of his financial
contribution to the pool. The progress of such pools lost its
momentum during the collectible price decline of 1981. But
because the notion of a "mutual fund" for collectibles seemed
like an idea whose time had come, such pools promised to
make a comeback as soon as collectible and other hard-asset
investment prices start rising again.

Further reading: everything the beginning or advanced in-
vestor in collectibles is likely to need to know can be found in
current or back issues of Collector Investment Magazine, a
marvelously readable, comprehensive, and concise guide to
current trends in all the collectibles markets (740 Rush St,
Chicago, IL, 60611); Bowerd and Ruddy Galleries, Los
Angeles, High Profits from Rare Coin Investments; Michael
Freedman, The Diamond Book (Dow, Jones, Irwin).

THE NEW .INVESTMENT AREAS  309

Real Estate

Real estate was the big inflation-hedge investment winner all
throughout the seventies, with prices in some areas of the
country rising by 500 to 600% during the decade. With 9*6
mortgages paying for 15*1 inflation, homebuyers were actu-
ally being paid to buy an investment that they could then
both live in and use as a tax deduction. It seemed like the best
of all possible worlds. In the early eighties, however, as mort-
gage rates rose and inflation rates fell, it became extremely
problematical whether or not real estate prices, despite the
pent-up demand caused by the maturing baby boom and the
long-standing inactivity in building, could sustain their previ-
ous gains.

Nevertheless, as real estate boomed, the proliferation of
imaginative variations on investing in land and commercial
and residential property kept pace. At this writing it is still
possible, of course, to buy traditional real estate parcels 
single-family houses, apartment buildings, commercial par-
cels, and raw land  through traditional real estate brokers.
But it is also possible to buy cooperative and condominium
apartments, time-sharing opportunities in resort properties,
high yielding second mortgages with capital gain potential in
three to five years, real estate investment trusts traded on the
various stock exchanges, pooled partnerships formed and
marketed by various syndicators and brokerage houses, "rich
uncle" partnerships formed by developers to help cash-poor
house buyers come up with a down payment. It's even pos-
sible to invest in timberland pools, like the one formed in
1981 by First Atlanta Corporation. Yes, there are almost as
many ways to invest in real estate today as there are individ-
uals willing to invest. But the wrinkles are endlessly compli-
cated, and the potential for loss heightened by those
complications. Real estate investors need to be particularly
nimble and well informed.

Further reading: Robert G. Alien, Nothing Down (Simon
& Schuster); Harcourt, Brace and Jovanovich Newsletter
Bureau, Real Estate Investment Letter, 747 Third Avenue,
New York, NY, 10017 (monthly); Albert Lowry, How You
Can Become Financially Independent by Investing in Real
Estate (Simon & Schuster); George Maier, Guide to Success-

310 HOW TO BUY STOCKS

ftd Real Estate Investing (Prentice-Hall); Maury Seiden and
Richard Swesnidc, Real Estate Investment Strategy (John

Wiley).

Foreign Currencies

As the world shrinks faster and faster every year, each indi-
vidual country's economic condition and inflation rate im-
pacts more directly on its neighbors and trading partners.
Thus what kind of money an individual investor holds has
come to be almost as important as what sort of investment he
puts that money into. Money, after all, is every bit as much a
commodity as sugar or wheat, every bit as much a medium of
exchange as gold or silver, and, during the late seventies and
early eighties, it has come to be as popular a tool of inter-
national investment as stocks and bonds. When the Swiss
franc appreciates 30% a year compared with the American
dollar, while the American stock market is declining ao%
during that same period, the investor who bought francs with
his dollars rather than shares of General Motors or U.S. Steel
has not merely switched the nationality of his monetary hold-
ings; he has made an extremely good investment by selling
out of a weak commodity and buying into a strong one.

The average investor is perhaps more intimidated by the
prospect of currency transactions than by any other invest-
ment possibility. Trading in foreign currencies seems like an
exotic undertaking, forbidding because it is supposed to be
for only the very wealthy, dangerous because all one gets in
return for one's "real money" is a lot of strange-looking
paper, which represents an unfamiliar medium of exchange in
a very distant place. Yet buying foreign currencies is one of
the simplest and most pleasurable of investment activities.

Basically there are four ways to invest in foreign currency.
You can buy a futures contract on that currency on one of
the futures exchanges. This is a good way to proceed if you
think that currency is going to have a pronounced move in a
short period of time. Futures trading is generally conducted
in Canadian dollars, Swiss francs, Japanese yen, the West
German mark, the British pound, the Mexican peso, the
Netherlands guilder, and the French franc. You can also buy
foreign currency directly from a bank or foreign-currency

THE NEW INVESTMENT AREAS 311

broker. You can do this either in the form of the notes
themselves or in travelers' checks denoted in that currency.

The third way to invest in foreign currency is to open a
Swiss bank account. Swiss banks offer an extraordinary array
of services: checking and savings accounts in all major cur-
rencies; trading and storing of precious metals; buying and
selling stocks and bonds on all the world's major exchanges;

managed accounts in stocks, bonds, commodities, metals, et
cetera; safe deposit boxes; and, of course the Swiss banking
community's renowned and inviolable code of secrecy. Open-
ing a Swiss bank account is simple. Just pick the name of a
bank out of the many books written on the subject and write
them a letter. All correspondence is conducted in English.
You can open an account with a personal check, a bank
cashier's check, or a money order.

The fourth way to invest in foreign currencies is through
the Eurocurrency market. Eurocurrency certiBcates pay
higher dividend rates than Swiss bank savings accounts, are
available in a wide variety of foreign currencies, and are
available for three-, six-, and nine-month periods.

Foreign Stocks

Most Americans think that the stock market begins and ends
on Wall Street. But there are stock markets in London, Paris,
Zurich, Milan, Hong Kong  in fact in all the world's major
cities. And during the late seventies and early eighties as the
American stock market stagnated, many of these bourses
flourished, as Japanese and German companies flexed their
industrial and technological muscles, as Australian and other
PaciBc Basin countries began mining and marketing their
staggering natural resources, and as the Third World let it be
known that the shift of wealth away from the large indus-
trialized democracies was not to be a passing phenomenon.

Today it is almost as easy to buy shares in most foreign
stocks as it is to pick up ten shares of IBM. You can open an
account with a foreign broker in much the same manner as
you do here. Or you can invest in any of hundreds of indi-
vidual foreign stocks from all over the world that are traded
on American stock exchanges as American Depository Re-
ceipts (ADRs). Or, finally, and perhaps most conveniently

312 HOW TO BUY STOCKS

and prudently for the average American investor, you can
choose one or more from the growing list of American mu-
tual funds that invest exclusively in foreign stocks. There are
now over two dozen such funds, with more being added all
the time as foreign investment opportunities and the Ameri-
can economic community's perception of those opportunities
increase. Some funds invest in only one geographic area, Uke
Merrill Lynch's Pacific Fund and Japan Fund. Others spread
their stock-picking net all over the world, like Templeton
Growth Fund or Scudder International Fund. All offer Amer-
ican investors who believe all the growth isn't going to take
place at home a chance to broaden their horizons in a geo-
graphical and industrial diverse portfolio of international
holdings. Contact your stockbroker for more details on spe-
cific funds.

Further reading on foreign currencies and stocks: Harry
Browne and Terry Coxon, Inflation Proofing Your Invest-
ments (Warner Books [paperback]); Adrian Day, Investing
without Borders (Alexandria House Books); Paul Einzig, A
Textbook on Foreign Exchange (St. Martin's); Mark
Skousen, High Finance on a Low Budget (Bantam Books
[paperback]); Young's World Money Forecast, 366 Thames
Street, Newport, RI, 02840 (monthly).

Money Market Funds

"The rich get richer and the poor get children." And when it
comes to interest on money market vehicles, the rich have
always been able to get high yields with their big deposits
while the average investor has always had to settle for his
5U% from a simple savings account That is, until some
Bnancial entrepreneur figured out (hat if you got enough
people with small amounts of money together, they would
then have as much cash as one rich investor, and they, or
their representative, could go to any bank or corporation or
Treasury office and get the highest yield available on that
money. That's what money market funds do. They pool lots
of little guys' money, invest it in short-term money market
instruments, take a small percentage of the total portfolio
yield as a service charge, then return the rest to the individual

THE NEW INVESTMENT AREAS 313

investor in proportion to the amount of money he has in-
, vested. In early 1982, there were over 100 such money mar-
ket funds, with their number increasing weekly. Two dozen
 or so invested solely in government securities for safety's
sake. The others had their portfolios apportioned thus:

. 38.6% commercial paper (short-term, unsecured corporate
;y promissory notes); 15.2%, short-term repurchase agreements
f (usually governmental); 12.2%, bank certificates of deposit;

^ 11.2%, European and Yankee dollar investments (foreign
^ bank certificates of deposit); 9-2%, bankers' acceptances
% (used to finance foreign trade); 7.7%, federal agency securi-
$ ties; and 7.1%, U.S. Treasury bills.

4   With demands persisting for credit from corporations and
I1. the government alike, money market fund yields ranged be-
^ tween 15% and 17% throughout 1981 and into 1982. Of

H, course, the big investor with more than $100,000 to plunk
^ down in a bank certificate of deposit or a piece of short-term
^ commercial paper could still negotiate with a bank or broker

* a rate of interest a point or so higher than any a money
^ market fund could provide. But at least the spread between
f the yields millionaires could command and those available to
I, the average investor had narrowed to a palatable range
(r1 through this most popular investment innovation of the sev-
): enties.

All ma]'or brokerage houses now include a money market
' fund among the products they offer to their customers.
y   Further reading; William E. Donoghue, Complete Money
.^ Market Guide (Bantam Books [paperback]); Dorwghue's
^ Moneyletter, P.O. Box 401, Holliston. MA, 01746 (24 is-
s' sues); Money Fund Safety Ratings, 3471 N. Federal High-
| way. Fort Lauderdale, FL (monthly); Paul Samoff, The
^ Smart Investor's Guide to the Money Market (Signet Books
J [paperback]).

Tax Shelters

Of course, the best investment plan in the world won't do you
any good if you don't get to keep any of the money you make
by following it. And the biggest guarantor to your keeping as
little of your investment income as seems possible has always

JL.

314 BOW TO BUY STOCKS

been the taxing arm of the federal government. Still, just as
the tax man taketh away, he also giveth, because the govern-
ment has discovered that if it taxes too heavily the proBts
every investor has to take some risk to make, pretty soon
there won't be any investors willing to take such risks. And
no risk capital means no business expansion. And no business
expansion means no jobs, no taxes, no government, and, ul-
timately, no country.                                '

So the government has made statutory additions to the
federal tax code that allow investors to shelter a certain
amount of income and gains from specific investments
either in the form of deductions, exclusions, or deferred
payments. And various tax experts and economic entrepre-
neurs have set up a wide assortment of programs designed to
help investors in all income brackets to take advantage of
these shelter opportunities- In earlier chapters we have dis-
cussed two of the most common investment tax shelters: the
long-term capital gains tax, which shelters from federal taxes
80% of all profits on stocks held for one year or longer, and
the exclusion from all federal taxes of interest on municipal
bonds.

But in recent years many large brokerage houses have
formed tax shelter departments of their own  to help their
customers pick the appropriate shelter opportunity for their
fiscal and family situation from among the many confusing
and constantly changing opportunities available. Investors
can now shelter income by investing in certain areas of real
estate, oil and gas exploration, equipment leasing, livestock
raising, movies, and an exotic assortment of other specifically
structured shelters. These tax shelter programs are not for the
beginning investor, nor even for the average wage earner
paying less than 30% of his income in taxes. But as income
increases tax shelters begin to make more sense. As long as
they show promise of making money eventually as well as
sheltering it from taxes now, as long as you are in a high
enough tax bracket so that the expenditures and fliiquidity
inherent in any tax shelter makes sense, and as long as you
pick a trustworthy and competent specialist to pick the right
shelter for you from the maze of endlessly changing options
available. Your broker can either recommend someone to you
or choose for you someone from the tax shelter section of his
own firm.

THE NEW INVESTMENT AREAS Qlg

Retirement Plans

Most specialized tax shelters may just be for investors in the
upper income brackets. But there is one long-term tax shelter
Opportunity that is for everyone. It is the tax-deferred retire-
ment program in the form of Individual Retirement Ac-
counts, Keogh Plans, and annuities. Every American should
take advantage of the many saving features these plans offer.

Beginning in 1982 everyone with earned income, whether
covered by an existing pension plan or not, can contribute up
to $z,ooo of that earned income ($4,000 for joint return,
$2,250 for couples with one nonworking spouse) to an In-
dividual Retirement Account (IRA). This money is automati-
cally sheltered from federal taxes until the individual starts
taking it out of the plan at age 59^, at which time he wfll
^ probably be in a lower tax bracket. In addition, all the money
^/this money earns while it is in the IRA is exempt from taxes.
''^ However, stiff financial penalties apply to those who remove
^ funds from their IRAs.

1'    The individual IRA holder has a wide variety of choices of
H how to invest his IRA money, but except in the case of
^ government retirement bonds, the money has to be invested
^ through a custodian or trustee who's been approved by the
IRS. Such trustees include banks, credit unions, mutual
funds, insurance companies, and brokerage firms. You can
^ have as many IRA accounts as you wish as long as the total
^ annual contributions don't exceed $2,000. Annual adminis-
trative fees charged by trustees may make it impractical to
have too many IRAs, however. And you can move your
^ money between your accounts only once a year, although if
^ you invest in a so called fund family  a mutual fund like
^  Dreyfus or Fidelity, which has many different types of funds
If  (money market, stock, bond, and others) you can move
p  your money around among as many different component
|t funds of the fund family as you wish as often as you want.
"1  You should ask your broker which IRA investment plan he
y recommends for you.

t     Should you try to lock in high-current-interest yields with a
',. fixed-rate certificate of deposit? Should you invest in a fund
'^  family? Or should you establish a self-directed IRA account
^ at your brokerage house, which allows you to pick your own

316 HOW TO BUY STOCKS

stoclcs for your IRA portfolio? Whichever way you go, the
advantages to establishing and maintaining an IRA to its full
limits are staggering: if you put in $2,000 annually beginning
at age 29%, and it grows at only loX a year, youll have
over $360,000 at age 59^.

Keogh Mans are IRAs for die self-employed. They work in
very much the same way as IRAs except that individuals with
Keogh Plans can contribute up to 15% of their annual in-
come, or $15,000 a year, whichever is less. Keogh Plan hold-
ers can also have an IRA.

A wide variety of annuities, some of them tax sheltered,
are also available from various fund families, brokerage
houses, and insurance companies. These are self-imposed
long-term savings programs with no maximum limits on their
contributions.

Whichever form of retirement account you choose, you
should deBnitely choose one, with the help of your banker or
broker. Not only are they a painless way to save for your
retirement, but they offer an unprecedented opportunity to
shelter part of your present income, and all of that money's
future yields, from federal taxes.

Further reading on tax shelters and retirement plans: Wil-
liam Drollinger, Tax Shelters and Tax Free Income for
Everyone (Epic); Robert and Carol Tannenburg, Tax Shel-
ters: A Complete Guide (Harmony Books), The Retirement
Letter, 7315 Wisconsin Avenue, 1200 N. Bethesda, MD
20014 (monthly); Tax Shelter Digest, Suite 604, 9550 Forest
Lane, Dallas, TX, 75243 (monthly).

Cash Management Accounts

In the early io8os many large brokerage houses and other
Bnancial institutions began to develop programs for "um-
brella-ing" all their services in one account. Merrill Lynch's
Cash Management Account was the pioneer in this field. It
allows customers who start with a $20,000 balance in their
account to write checks against it, use a special Visa
card against it, buy stocks, bonds, gold, or any of Merrill
Lynch's numerous other investment products with it, either in
cash or on margin, all transactions to be recorded in one
monthly statement and all of the spare cash in the account

%';

THE NEW INVESTMENT AREAS 317

to be yielding competitive current money market fund rates.
The CMA and its numerous competitors are an extremely
useful new tool the American brokerage community is de-
veloping to help dear away the confusion surrounding, and
consolidate the activity in, the staggering number of varied
investment possibilities that have been developed for the aver-
age investor in the past few years. Surely even more new
investment possibilities, and ways of making them more
understandable and accessible to the public, are on the way.

38

CHAPTER

Further Reading

NOW that you have familiarized yourself with the basics of
investing in common stocks you can begin to deepen your
knowledge of specialized areas and techniques. What follows
is a list of books to help you do just that. They are the books
most often recommended by investment authorities. Some are
old. Some are new. Some are dispassionately restrained. Some
are passionately strident. But all are eminently approachable
by the average reader. And all should be read with careful
attention to the individual pre]udices and idiosyncrasies of the
authors and a clear eye to how the information and tech-
niques outlined in them can best be applied to your own
individual investment program.

Basics

Kiril Sokoloff, The Thinking Investors Guide to the Stock
Market. The editor of the Personal Finance Letter explains
why stock prices move the way they do in simple, under-
standable language.

Paul H. Cootner, ed.. The Random Character of Stock
Market Prices. A scholarly examination of market forces in
22 essays written by 22 different specialists.

Gerald Loeb, The Battle for Investment Survival and The
Battle for Stock Market Profits. The "Dean of Wall Street"
outlines his practical stock investment theories, based on 35
years' experience as a broker.

David Darst, The Complete Bond Book and The Hand-
book of the Bond and Money Markets. Everything you need
to know about bonds and how and when to buy them.

C. Colbrun Hardy, ed., Don and Bradstreet's Guide to
Your Investments. A simplified guide to aU investment mar-

318

FUHTHER BEADING  319

kets and how to participate in them. Revised annually.

Andrew Tobias, The Only Investment Guide You'll Ever
Need. A brief, witty and extremely lucid disentangling of the
sometimes overpowering money puzzle.

Burton Crane, The Sophisticated Investor. A former New
York Times financial reporter distills his lengthy experience
to outline the basic happenings on Wall Street.

United Business Service, Successful Investing: A Complete
Guide to Your Financial Future. A complete guide to sensi-
ble, long term investing.

Technical Analysis

Robert D. Edwards and John Magee, The Technical Analysis
of Stock Trends. The Bible of the Chartists. The essential
work on technical effects on stock prices.

William D. Gann, Forty-five Years in Wall Street. One of
Wall Street's most successful veteran technicians explains his
24 rules for profitable trading.

Joseph Granville, CranviQe's New Strategy of Daily Stock
Market Timing for Maximum Profit. Wall Street's most flam-
boyant technician reveals his trading secrets.

William Jiler, How Charts Can Help You in the Stock
Market. The most basic primer on technical strategy. Clear.
Concise. Comprehensive.

Jesse Livermore, How to Trade in Stocks. The legendary
speculator summarizes his trading philosophy.

Thomas Noddings, Advanced Investment Strategies. The
most accessible explanation of "hedging" techniques ever
written.

Alexander Paris, A Complete Guide to Trading Profits. A
short course in technical analysis, mixed with a brief distilla-
tion of fundamental strategies.

Richard Russell, The Dow Theory Today. The most
famous and reliable technical theory thoroughly examined,
simply explained, and totally updated.

William X. Scheinman, Why Most Investors Are Wrong
Most of the Time. A relatively new concept  a blending of
technical and fundamental analysis with psychological factors
called divergent analysis.

320 HOW TO BUY STOCKS

Hairy Schultz, Bear Markets: How to Survive and Make
Money in Them. Explains how to prosper during the 33%%
of the time the general market is tumbling.

Kenneth Smilen and Kenneth Safian, Investment Profits
Through Market Timing. A Professional Approach. When to
buy and sell is as important as what to buy and sell. Two
professional money managers explain their timing tips.

Ernest Staby, Stock Market Trading: Point and Figure
Investing Made Easy. Explains the technician's most popular
technique clearly and thoroughly.

Conrad Thomas, How to SeU Short and Perform Other
Wondrous Feats. A breezy distillation of all the technicians'
many tools.

Jerome Tuccille, Everything the Beginner Needs to Know
to Incest Shrewdly. A successful broker outlines Ac basic
theories and techniques.

Fundamental Analysis

Benjamin Graham and David Dodd, Security Analysis: Prin~
ciples and Techniques. The fundamentalist Bible. Explains
how to recognize underlying value in a stock and the com-
pany it represents.

Benjamin Graham, The Intelligent Investor. The "Father
of fundamental analysis" outlines the sound principles he's
devised in his half-century of stock market experience.

Douglas Bellemore, The Strategic Investor. A guideline to
a prudent lifelong stock-accumulation program.

Richard Blackman, FoQow the Leaders. A practical self-
help book for everyone who seeks to build a profitable long-
term investment program.

Roger BridweU, The Battle for Financial Security: How to
Invest in the Runaway 8o's. A guide for middle-income in-
vestors to inflation-resistant stocks.

Peter L. Bernstein, Economist on WaU Street. A. literate
contrarian and former money manager delivers a dispassion-
ate overview on both economic theory and sound practical
investing.

Ira Cobleigh, The Dowbeaters. Outlines techniques used by
Wall Street's most successful minds to identify potential capi-
ta] gains candidates.

FURTHER BEADING  321

David Dreman, Contrarian Investment Strategy, The basic
explanation of contrarian thinking. Explains why experts are
mostly wrong and how to profit from this fact.

Philip Fischer, Common Stocks and Uncommon Profits. A
successful investment counselor explains how he picks win-
ners for his wealthy clients.

Norman Fosback, Stock Market Logic. The results of a
five-year study applies mathematics to the study of financial
data to produce stock market profits.

Jacob 0. Kamm, Making Profits in the Stock Market. A
sound long-term stock buying plan based on an intelligent
and unified overall game plan.

Winthrop Knowlton, Growth Opportunities m Common
Stocks. An experienced analyst tells how to recognize the
most dynamic growth stocks.

Lin Tso, The Investor's Guide to Stock Market Profits in
Seasoned and Emerging Industries. A respected veteran
analyst tells how to pick the right industries to invest in at the
right time.

Burton Maljdel, The Inflation Beater's Investment Guide.
A Princeton professor explains why, and which, stocks are
die best inflation hedges for the eighties.

Justin Mamis and Robert Mamis, When to SeU. First-rate
advice on the critical issue of marlet timing.

Sam Shulsky, Sam Shulsky on Investing. The veteran fi-
nancial journalist sums up his own practical investment
philosophy.

Kiril Sokoloff, The Paine Webber Handbook of Stock and
Bond Analysis. An industry-by-industry analysis of portfolio
design and proper diversification.

John Touhey, Stock Market Forecasting for Alert In-
vestors. A perceptive analysis of the 11 economic indicators
the author feels most influence the market

John Train, The Money Masters. An in-depth analysis of
the techniques used by the great portfolio managers. Indis-
pensable.

James Nisbet, The Dow is Dead. How to find, and when to
buy and sell, stocks in undiscovered growth companies.

322 HOW TO BUY STOCKS

Anthologies

Bill Adier, ed.. The WaU Street Reader. Selections from all
the prominent theorists: Loeb, Cobleigh, Crane, et cetera.

Harry D. Schultz, ed,, A Treasury of WaU Street Wisdom.
More of the same.

Special Interests

Leonard Silk, Economics in Plain English.
Colleen Moore, How Women Can Make Money in the

Stock Market.

John Tracy, How to Read a Financial Report,
Peter Wyckoff, The Language of Wall Street.
George Selden, The Psychology of the Stock Market.
David Markstein, How to Make Money with Mutual

Funds.

Paul Samoff, Puts and Calls: The Complete Guide.

Sidney Fried, Investing and Speculating with Convertibles.

Edwin 0. Thorp, Beat the Market: A Scientific Stock

Market System.

Adam Smith, The Money Came.
Victor Harper, Handbook of Investment Products and

Services.

Charles Mackey, Extraordinary Popular Delusions and the

Madness of Crowds.

Behind The Scenes

"Brutus" (John Spooner), Confessions of a Stockholder.

T. A. Wise and the Editors of Fortune, The Insiders, A
Stockholder's Guide to^aO. Street.

Martin Mayer, WaU Street, Men and Money.

Murray Teigh Bloom, Rogues to Riches.

John Sprizer, If They're So Smart, How Come You're Not
Rich.

Leonard Sloane, The Anatomy of the Floor.

Robert SobeL Inside Wall Street.

FURTHER READING 323

History

John Brooks, Once in Colconda. The Seven Fat Years.
Charles Collman, Our Mysterious Panics.
Stewart Holbrook, The Age of the Moguls.
John Kenneth Galbraith, The Great Crash.
Matthew Josephson, The Robber Barons.
Donald Rogers, The Day the Market Crashed.
Robert Sobel, NYSE. AMEX. The Last Bull Market. The
Big Board. Panic on Wall Street. The Great BuU Market.
Dan Thomas, The Plungers and the Peacocks.

Biography

Bernard Baruch, My Story.

Ralph G. Martin. The Wizard of Wall Street: The Story of
Gerald M. Loeb.

Sidney Rheinstein, Trade Whims.
Paul Samoff, Jesse Livermore, Speculator King.

Bibliographies

Sheldon Zerden, Best Books on the Stock Market.
James B. Woy, Investment Methods: A Bibliographic
Guide.

Sylvia Mechanic, Investment Bibliography (Brooklyn Pub-
lic Library).

Index

Abelson, Alan, 195
account, opening an, 135-37
accounts receivable/payable, 378
accrued dividenda, 19
adjustment bond, 29
advertising, 125, 241
agency basis (OTC trade), 117
American  Depository  Receipt,

114,311
American Institute Counselors,

205
American Institute for Economic

Research, 204-205
American Motors, 89
American Stock Exchange (Amex),

62, io6-io8, no, i72, 184,

i88

annual meeting, 8
annual report, 8, 277-370
annuities, 316
annunciator boards, 71
antitrust laws, 64
asked price, 11
assets, 10

AT&T,33-34,54-55,185, a88
audits, 140

Automated   Quotation   System
(NASDAQ), 118, to-i2i,
184,i88
averages (of stock prices), 185
averaging down, 225

Babson Reports, Inc., 205
balance sheet, 278
balanced funds, 240
bankruptcy, 140-142, 285
banks, 2-3, 103, 114, 198-199
Barrens Weekly, 194-195
Banich, Bernard M., 177
bear market, 152, 155, i6i, 175,
190-191

bearer bonds, 3, 47, 136
bid, 11, 71-72. 8i-8a; simul-
taneous, 84
bid-and-asked quotation, 81, 84,

97,98,ii9,120,121-122
blue chips, 185
blue-sky laws, 38
board, 132-133
board lots, 111

board of directors, 7-8, 55-S6
board tape, 185
boiler-shop operations, 112
bonds,24-35,42-48, ii4
book value, 10, 11
break-even point, 142
broken lots, 111
brokers, 58-59, 60-61, 8o, 124-

127,201

broker's letter, 218

Brdokings Institution, 288

bucket-shop operator, 131

bull market, 152, 155, i6i, 167-

i68,190
Bunker Ramo Corporation, 117-

n8
"Business Report, The" (PBS),

197
Business Week, 195

Cabot Market Letter, The, 210
call, 21, 33, 169, 171, 174
Canadian stock exchanges, 110-

112

capital, 6, 144-145
Capital Gains Research Bureau,

200
capital-gains tax, 150-151, 163-

164, 174-175,280,314
capital requirement rules, 140
capital stock, 279
capital surplus, 279
capitalization, 9

325

326 INDEX

Carlisle, DeCoppet & Company,

95-96,101

cash account, 136-137
cash management accounts, 316-

3i7
Center for Research in Security

Prices, 252, 258
Central Certificate Service, 73
central securities market, 65
chairman, 8, 56
Changing Times, 196-197
chart and statistical services,

204-2il

Chartcraft, Inc., 206
Chase Manhattan Bank, 103
Chicago Board Options Exchange,

172

Churning, 127, 213, a8o
classified (A and B) stock, 15
closed-end trust, 232-233
coins, 367-368

collateral-trust bond, 29-30
collectibles, 367-368
commissions, 58-67, 7i, 77, loi

102, 104. n6-ii7, 235-236
Commodity Futures Trading Com-
mission, 302,304
commodity market, 301-302
common stock, 6-13, ig, 252-

263

common stock fund, 239
competitive bidding, 26
compliance officers, 213-214
Compustat, 218

Computer Directions Advisors, 5
computers, 108, 119, 122, 132,

177,218-221,293-299

confirmation (of transaction), 138
consolidated stock tables, 181
Consolidated Tape Association,

133
consolidated ticker tape system,

122,133,i66,176-177
constant dollar plan, 228
constant ratio plan, 230
control position, 95
convertible bonds, 29
convertible preferred stock, 20-

21
corporate bonds, 24, 2735, ll4,

144,184, 228-231
correspondents, 57

coupon rate, 32
covering (short sales), 161
cross, 72,89, 91-92
cumulative preferred stock, 19
current assets/liabilities, 278279
Current Market Perspectives, 204
custodian account, 139
customer's man, 129, 130, 131
Cutler-Hammer, 89        ' '
cyclical stocks, 147-148

Daily Action Stock Charts, 204
Daily Stock Price Record Ser-
vices, 203
day traders, 159
debenture, 28-29
DeCoppet & Doremus, 95-96
delisting, 55

Depository Trust Company, 73
desk-model quote machines, 133,

i85

Dexter Securities Corporation, 65
discretionary accounts, 127, 221
Dividend  Reinvestment Plans,

103

dividends, 9, 17, loi, 147, 182
dollar bonds, 47
dollar cost averaging, 102, 223-

227

Donaldson, Lufkin & Jenrette,

144-145
Douglas Aircraft Company, 179-

i8o
Dow Jones Industrial Average,

185-186, 187-188, 231, 247,

3oo

Dow Theory, 190, 191
Dow Theory Forecasts, Inc., zo6
down tick, 70
Drew, Daniel, 165, 286
Dreyfus Corp., 65-66, i8o, 315
dual listing (on exchanges), 109
Dun's Monthly, 196

earned surplus, 279

earnings, 9

Economic Education Bulletins,

205
Economic Recovery Tax Act, 103,

i5

Employee  Retirement Income
Security Act, 218

INDEX 327

employee stock purchase plans,

102

equipment trust obligations, 33
equity, 9

equity capital, 25
even tick, 166
ex-dividend, 183
ex-rights, 183
exchange acquisition/distribution,

91-93

execution at the close, 77
extra dividends, 14

fails to deliver, 141
Federal Reserve Board, 53, 135,

154-155,158, l62,193
Finoociti! World (London), 195-

196

financing, 34

first-mortgage bond, 30
flared commissions, 58, 6a, 63-

64,96

fixed-price orders, 76-78
float (a bond issue), 28
floating supply (of stock), 285
floor broker, 57, 70, 87, 130, l67
floor brokerage, 71, 77
floor reporters, 74
Forbes, 195, 293
Forbes Special Situation Survey,

205
Ford Motor Company, 91, 191-

192

foreign currencies, 310-311
foreign stocks, 114, 311-312
formula investing, 228-231
Fortune, 196
free-riding, 138
front-end load funds, 236-238,

242
full disclosure, 36, 38-39. 217,

241
futures trading, 301-302

gems,307

General Motors, 55, 282

general obligation bonds, 46

get the market and the size, 84

go-go funds, 239

go long/short, 161

gold, 303-304

good faith deposit, 134
Cordon vs. N.f. Stock Exchange,

64
government bonds, 42-44, io8,

114,184

Cranville Market Letter, 208
gratuity fund, 56

gross national product, 250-251
gross spread, 90
growth stocks, 148

Haack, Robert W., 62
Harry Browne's Special Reports,

209

Haupt, Ira, & Company, 141
hedge, 175, 239,303
hit, 72
Holt Investment Advisory, The,

210

Horsey (M.C.) & Co., 204
hot issues, 122

Housing Authority bonds, 47
Hulbert Financial Digest, The,

208
hypothecation agreement, 156,

i6i

IBM, 83, 283

in-and-out trading, 54, 238

income bond, 29

income statement, 278

incorporation, 144-145

industrial average, 185-186

industrial revenue bonds, 47

industrial stocks, 111, 185

inflation, i, 44-45, 251

inside information, 178-181, 217

inside price, 115116

Insiders, The, 210

institutional investors, 24, 6167.

93-94,235
Institutional Network (Instinct),

94

insurance companies, 114* i22
interest rate (bonds), 27, 42-43.

44
Intel-mountain Stock Exchange,

109

International Moneyline, 209
investment: long-term, 252-263;

vs. speculation, 12, l49* 181,

250

328 INDEX

investment advisers, 198-211
Investment Advisers Act, 200-

202

investment advisory account, 198-

199
Investment and Barometer Letter,

205

investment bankers, 25, i8o
Investment Bulletin, 205
investment clubs, 221-222
investment companies, 232-246
Investment Company Act, 241
Investment Company Amendments

Acts, 237

investment counselors, 198-211
investment returns, 4-5, 9, 252
Investment Survey, 293
investment trusts, 232246
investment-type securities, 147.

i8i
IRA, 103-104, 315-316

I'oint accounts, 136
joint managers, 91

Kaplan case, 64
Keogh Retirement Plans, 103-104,
3i5-3i6

level load fund, 237

leverage, 34

liabilities, 16

life insurance, 3

limit order, 76-77, io7

liquidation, 11

loading charge, 235, 241-242

locked-in stockholders, 151

Lockheed, 82

long-term capital gain, 150

Lone-Fisher study, 258

management fee, 240, 242
margin rules, 52-53, 156-157,

162-164
margin trading, 52-53, 137, 140,

154-160,i73,213-214
Market Consensus Letter, 207
market comer, 165
Market Logic, 209-210
market-makers, 65, 88, us. "7.

119,120-121

market order, 71. 76

market stabilization, 57, 8i-8a,

85,9i

markup/markdown, 115-116, ii7

matched and lost, 84

maturity, 32, 33

mergers, 22, 142

Merrill Lynch & Co., 63-64, 66,
9i, i4S, 312; Cash Manage-
ment Account, 316-17; ,aod
odd-lot orders, 97-98, 98-99.
io7; and S.E.C., 179; Share-
holders plan, 100, loi

metals, 306-307

Midwest Stock Exchange, 108-
109

minors (as stockholders), 136-
i37

Money, 196

money market funds, 2-3, 312

313
Monthly Investment Plans, 100-

10g,223,227-228

Monthly Stock Digest, 215

Moody's Investors Service: bond
ratings, 30-31; Dividend Rec-
ord, 203; Manuals, 203

Morgan, J. P., 282

mosaic theory, 217

municipal bonds, 45-47. "4,

314

mutual funds, 232, 233, 234-
246,312

National Association of Invest-
ment Clubs, 222
National Association of Securities

Dealers, 116-121, 125-126,

214,242
National Clearing Corporation,

120
National Directory of Investment

Newsletters, 210-211
National Quotation Bureau, 118
negotiated deal, 26
net asset value per share, 233
net capital ratio, 140
net change, 182
net price, 62

net price basis, 115-116,117
net working capital, 279
net worth, 279
Networks A and B, 133

INDEX 329

ew issues, 15-16, 36-41
-. Vms Issues, 210

New York Stock Exchange, 58-
67, 109-no; and Amex, 106,
107-108; census of stockhold-
^     ers,   288-289;   companies
listed on, 54-56; compliance
officers, 213-214; composite
^.    index, 187-188; margin main-
y     tenance, 156, 158; member

firms, 56; M.I.P., ioo; on-line
^      price surveillance, 8586; oper-
ation of, 6878; regulation or,
51-57; and regional exchanges,
108-111; and short selling,
161-163; turnover rate, 280

New fork Times, 194

Newsletter Digest, 207

newsletters, 207211

newspapers, 121, i8o-i8i, 184-
iSs.189

no-load fund, 240

no-par stock, 10

noncumulative preferred stock, 20

notunembers, 62, 65, no

nooparticipating preferred stock,
19-20

Norwood Securities, 302

not4ield order. 88-89

obligations (bonds), 26-27
odd lots, 95-99, io/, 286
offer, 71-72,8i-8a
offering circular, 38
oil/mining stocks, 111, 112, 149
one-eighth rule, 166
Ontario Securities Acts, 112
open-end trust, 233
open order, 135
optical scanner, 74
option trading, 169-177, 301
OTC Chart Manual, 204
Outlook, 293

outstanding (shares), 7
over-the-oounter market, 113123,
184

Pacific Stock Exchange, 109, 133,

172

paper profits, 159-160
par value, 7, 10; parity, 170, 171

participating preferred stock, 19-

20

partnerships, 144

pass the dividend, 17

penny stocks, 26, 40, 148149

pension funds, 219, 235

Pension Reform Act, 103-104

periodicals, 194-197

Personal FinanceThe Inflation

Survival Letter, 209
Philadelphia Stock Exchange, 109,

172

pink sheets, 118

Pohtz, Alfred, Research, a88

pools, 165, 302

portfolio management, 218-220

position, 62

preceding day (dosing price), 182

preferred stock, i8-i

premium, 43, 169-170

price appreciation, 11

price-earnings ratio, 182, a 77-

278

price indicators, 70
pnce manipulation, 51
principal (dealer), 117
private placement, 27, 38-39
Professional Investor, The, 210
Professional Tape Reader. The,

209

prospectus, 36-37
proxies, 8; proxy fight, 8
public offering. 36
put option, 171, 172-173, *74
pyramiding, 159-160

quality ratings (bonds), 30-31,

47
quarterly reports, 55

railroads, 33

random walk, 262-263

BCA Corporation, 226-227

real estate, 3-4, 309-310

reciprocity (mutual funds), 238

red herrings, 37

redemption bill, 242

refinancing operations, 34

refunding bonds, 34,47

regional exchanges, 109-110, 184

330  INDEX

registered bonds, 32, 136
registered floor traders, g7> 70-71,

86-87,130,i67
registered representatives, 129-

133, 214-215, 219

registered trader (Canada), 111-

112

registrar, 55

registration statement, 36
Regulation A Bling, 38
Regulation T, 135
repeat prices, 76
representative bid/spread, 119-

120

research departments, 215-219
Research Reports (AIER), 205
retail price, 115-116
retained earnings, 9
retirement plans, 103105, 315

317

revenue bonds, 46

rights, sale and value of, 15-16

risk, 27, 40-41, 239, 251; evi-
dent/unseen, 1-2, 3-4; and
government bonds, 4344; and
option trading, 169-171, 175-
176; and specialists, 86-87;

and speculation, 146, 148

risk capital, 149-150

riskless transaction, 116

round lots, 95

round-trip (trade), 236

Ruff rimes, 2io

Rukeyser, Louis, 197

Rule, 63. 65, no

Salomon Brothers, 63

savings account, 2

savings and loan association, 34

savings bonds, 42-44

scalping practices, 200

Sears, Roebuck, 283

seat (onN.Y.S.E.), 56-57

second-preferred stock, ai

secondary distribution, 90-92

securities, i

Securities Acts Amendment, 51,

213
securities analysts, 216-218, 220

221

Securities and Exchange Com-
mission, 58, 6o, 62-64, 65,

no, 201-202; and floor trad-
ers, 57; and inside trading,
178-181; and investment ad-
visers,   200-202,   investo/s
guide, 127-128; and mutual
funds, 237, 241, 242; and new
issues, 36-37; and OTC stocks,
118, i2i, 122, 123; reforms,
51-52,  i07-io8, 2IA-214;

and regional exchanges, 108-
109, no; and short selling,
165-167; and S.I.P.C,, 142-

143

securities dealers, 80-81, 95-97
Securities Exchange Act, 36, 120,

179-180, 213
Securities Industry Automation

Corporation, 108
Securities Investor Protection Cor-
poration, 142-143
Securities Reform Act, 51, 143,

213

sell-limit order, 90
selling concession, 90
selling group, 25
selling short against box, 164-

165

serial maturity bonds, 32-33, 47
service charges, 59-60, 95-96,

127-128
settlement date, 138
share (of stock), 6; fractional, 100
shareholders, 6, 7, 288-289
shares volume, 182, 28o
Shearson Hammill & Co., 180
shingle theory, 214
short-form prospectus, 37
short interest, 167-168, 190
short selling, 161-168, 178-180,

190-191

short-term capital gains, 150151
silver, 304-305
sinking fund, 32

Southeastern Stock Exchange, 109
special offering, 91
special-purpose funds, 239
special tax bonds, 46
specialist block purchase/sale, 89
specialists, 77-87, 167
specialist's book, 81
speculation, 63, 146-153, 30i-

302; and hedge funds, 239;

INDEX 331

and investment compared, 29,
148-1491 181, 250; and option
trading, 172-174. 177

speculative capital, 150

speculative stock, 148

plit (stock), 22

spread, 111, 116,120

Standard & Poor's: bond rating,
30-31, 215, 293; Corporation
Records, 202-203; 5oo-stock
price index, 186-187, 230;

Industrial Index, 247; Industry
Surveys, 203

stock, 6-13. 15, 144-145, 252-
263; large blocks of, 61-64,
88-94; new issues of, 15-16,
36-41

stock accumulation plans, 100-
105,223,227

stock ahead, 77

stock certificate, 7, 15, 73-74

Stock Clearing Corporation, 73

Stock Guide, 203-204

stock indexes, 185-188

stock market crash of 1929, gi,
52-53,  159-160.  i9a-i93,
241,250-251

Stock Picture, The, 204

stock screens, 293-299

Stock Summary, 215

stock swapping, 28

stock tables, 181-182

stock-watching service, 52

stockholders, 6, 7, 288-289

stockholders' equity, 279

stop order (to buy/sell), 77, 174

stopping a stock, 83

straddle, 176

street name, 139

supervised lists, 199

taking a position, 115

tax (on bond earnings), a8

tax shelters, 45-46, 103-104,

313-314

technical factors, 189-190, 199
technically strong/weak, 190
telephone/teletype booths, 68-70
television, 197
tender offer, 23

Texas Gulf Sulphur Company, 179
third market. 62-63, 65, 93-94

tick, 85

ticker tape, 74-76, 132
tune deposits (banks), 2
tombstone announcement, 37-38
Toronto Stock Exchange, 110-111
trading departments, 117
trading floor (N.Y.S.E.), 68
trading hours (N.Y.S.E.), 72, 182
trading posts (N.Y.S.E.), 70
trading units (lots), 115
trading volume, 182, 28o
Trans-Lux screens, 132
transfer agent, 55
transportation index, 185, 191
Treasury bills, 4243
Treasury bonds, 42, io8, 184
trust fund, 137
Truth in Securities Act, 36
turnover rate, 280
turnpike bonds, 47
TWA,9i
two-dollar broker, 71

unbundling, 6o

underwriting, 25-26, 90-91
up tick, 70, i66
usury laws, 155
utilities, 103, 185

Value Line, 206-207, 293
Vanderbilt, Commodore, 165
variable ratio plan, 230231
venture capital, 6

Wall Street Digest, 208
Wall Street Journal, 185, 194
Wall Street Transcript, The, 207
"Wall Street Week" (PBS), 197
warrant, 16
wash sales, 165166
watered stock, 10
Weeden & Co., 62, 6g
Weekly Report, 206
Wellington Letter, The, 209
wholesale price, 115-116
Williston (J.R.) & Beane, 141
wire houses, 57
World Business Weekly, 195

yield to maturity, 33-34
Zweig Forecast, The, 208-209

ABOUT THE AUTHORS



^          BBENDAN BOYD, who writes the syndicated column
i'          "Investors' Notebook," is a free-lance writer and
'-<.         investor. He lives in Boston, Massachusetts-
Louis ENGEL, the original author of How to Buy
^           Stocks, had a lifelong career in the investment

trade.

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