A stock represents partial ownership of a corporation.  When you buy shares of a stock, the company gives you a stock certificate which shows that you own a small fraction of that company.  As with most anything in life, owning stocks has its advantages and disadvantages.

The benefit of owning stock is that when the company makes money, so do you.  For example, through your research, you learn that Disney is building new theme parks in Hong Kong, Japan, and Anaheim.  They also launched go.com on the Internet and their show Who Wants to be a Millionaire? is the most popular show on network television.  With this information, you decide to buy 100 shares of Disney stock in hopes that the company will announce good earnings and that the stock price will go up in the future. As a shareholder, you will be rewarded with a higher share price of the stock, meaning that you made money.  Not only millionaires can buy shares of a stock but kids, schoolteachers, policemen, housewives, and just about every one can also buy shares of a corporation. 

On the other hand, owning stock has its disadvantages.  When you buy shares of a stock, you get a full share of the risk of an operating business.  Owning stock does not guarantee that you make money.  For example, you hear Theglobe.com was a very hot Internet stock.  However, you didn’t do too much research but bought 100 shares at over $100 per share.  A few months later, the share price is less than $10.  Your hard-earned savings are now gone.  Some stocks may even go bankrupt and you could lose even more money.

Whether you make or lose money with stocks, you still have voting power in the company.  As a shareholder, you are allowed one vote per share of stock that you own.  In order to vote, you must either attend a corporation meeting or fill out a proxy ballot, which is just like an absentee ballot in an election.  With the proxy ballot, another person casts your vote for you.  The voting usually decides who will be on the board of directors, just like voting for Senators and House Representatives to the Congress.  The board of directors oversees matters such as the company budget, purchasing other companies, issuing additional stock, and paying a dividend.Overall, the board oversees major decisions made by the executives of company.

Owning shares of a stock has its risk and reward.  However, from the above examples you can see that if you research a company before buying it, stocks can be profitable.  Stock prices may go up or down on a daily basis. In the long run if the company is making money, the share price will go up because as a shareholder you share the profit of the company.

Companies sometimes decide to make the transition from the private market to the public market.Public companies may also decide to issue more stock.  People just starting companies will issue stock for many reasons, though not without some disadvantages.

Click here to learn more about IPOs.

Stocks consist of two markets: primary and secondary.  The primary market, also known as the new-issues market or initial public offering (IPO), allows new or growing businesses to sell stocks to raise money.  Investors of IPOs can later sell the new stocks in the secondary market, allowing buyers and sellers to trade stocks quickly and effectively.  The New York Stock Exchange (NYSE) and Nasdaq are the secondary market, where investors trade stocks that they already own, and the company which initially issued new stock doesn't receive additional money.  When issuing stocks, the company will go from a private to a public company.

With the money received from investors, entrepreneurs can expand the business by building new factories and hiring additional employees.  As a result, the business becomes more profitable.  The entrepreneur becomes richer and the investor, now a part owner of the company, will get a higher value on the stock they bought from the company.

Private companies that want their business to grow need money for many reasons:

To develop new products

To buy more advanced equipment

To pay for new buildings and inventories

To hire more employees

To provide for a merger or acquisition

To lower the debt

To give company owners greater flexibility

To place a value on the company.

To acquire this extra money or capital, such companies go public by issuing  
stock.

An investment banker usually manages the offering of a company’s shares and serves as the link between companies and possible investors.

However, issuing stock has its disadvantages:

Fees, expenses go up

 
Senior management has new responsibilities

 
Information has to go public

Sense of entrepreneurship may be lost

When a company goes public, the buying and selling of shares is just like a large auction, people selling to others who are willing to buy.

After a company goes public, it has to pay underwriters, attorneys, and accountants.  At least one senior officer must spend countless hours a month meeting government requirements and keeping investors informed.  The issuing of stocks will lead companies to close self-evaluation and much private information is revealed.

Companies in the primary and secondary markets issue stock for many different reasons.  The transition from the primary to the secondary market transforms small, private businesses to large, public corporations.  Either way, stockholders invest in hopes of making money.

Dividends are just like a small reward a company pays you for owning shares of its stock.  The company takes a portion of its earnings, which it divides and distributes to shareholders.  In general, a company that has a slow growth rate pays high dividends.  On the other hand, a company with a high growth rate usually pays no dividends.

Historically, large corporations and utility stocks have paid regular dividends.  Utility stocks such as Real Estate Investment Trust (REIT) and Southern California Edison pay high dividends.  These companies usually have growth rates of less than 10% and slow stock price appreciation but have high cash flow.  They can pay dividends to investors attracted to income.  Contrastly, large corporations such as Microsoft and Cisco have growth rates around 30% and high stock appreciation but do not pay dividends.  Instead, they reinvest the earnings into the company in order to make the business grow. 

The board of directors votes on the various aspects of dividends such as their approval and dates of distribution.  Dividends are usually paid quarterly and sometimes annually or semiannually.  However, many companies don’t pay dividends at all.  Older stocks are more likely to pay dividends than the latest IPO.

If the board of directors does decide to issue dividends, it will be announced at a set amount and will be paid to the shareholders as of a record date.  Dividends will be paid on the distribution date, sometimes called the payable date.  In order to receive the dividend, you must own shares of the stock on the record date.  Since almost all stock trades are settled in 3 business days, you must buy the shares at least 3 days before the record date.

Historically, large corporations and utility stocks have paid regular dividends.  In recent years, events have changed greatly.  Large corporations like IBM have cut its dividend payments considerably.  Other large companies such as Microsoft do not pay any dividends at all.

An increasing number of public companies offer a dividend reinvestment program (DRIP).  It automatically uses your cash dividends to purchase additional shares of the stock without a broker.  Shareholders not participating in a DRIP will receive a check from the company when the dividends are distributed.

When investing in the stock market, the main objective is to look for stocks that have high stock price appreciation.  Dividends are a small bonus for owning certain stocks

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Stock splits occur when a public company issues more shares of stock to existing shareholders.  In a 2-for-1 stock split, a company issues another share for every one already sold.  After the split, 1 pre-split share will be replaced with 2 shares, and the share price is halved.  For example, you own 100 shares of IBM trading at $120.  They announce a 2-for-1 split and you now have 200 shares, and the share price is $60.  A stock split doesn’t change the value of the shares you own.  A stock split is just like trading in a dollar for 4 quarters.

Splits can either be ordinary or reversed.  In ordinary splits, the share price lowers while the number of outstanding shares increases.  A 2-for-1 split, for instance, is an ordinary split.  Companies usually perform ordinary splits to reward the shareholders.  In reverse splits, the share price increases while the number of outstanding shares decreases. A low-priced stock may have a reverse split so it looks like a more valuable company.  A company may also perform a reverse split to eliminate small shareholders.  For example, a penny stock worth $1 may have a 1-for-10 split and be worth $10.  Now, 10 old shares would be needed to equal 1 new share.  Ordinary splits usually occur among high-growth technology stocks, while reverse splits happen among low-priced stocks.

For accounting purposes, a stock split is a non-event because the market value of the company stays the same, and each shareholder’s total fraction of the company owned remains the same.  In general, the share price of a company goes up after a split.  The split happens in the first place because of a high stock price.  After the stock split, investors anticipate more upsides in the share price.  For example, JDS Uniphase split three times in the past 7½ months.  On the other hand, Berkshire Hathaway was less than $10 and was as high as $38,000.  It has never split because the management wants to encourage investors to hold on to their stock for a long time.  The share price is less attractive for short-term investors.

A stock split will change the number of outstanding shares and share price, but investors will still have paid the same amount for the shares of stock.  Ordinary splits increase the number of outstanding shares and decreases the share price of a company.  It makes the price more affordable and attractive for the general public to buy.  Ordinary splits are often the result of a high run of the share price.  Reverse splits are usually for penny stocks to make the share price higher in order to make the share price more attractive.

A shareholder rights plan states the rights of shareholders for a company.  The management of the company usually proposes the plans, and the shareholders approve them.  Shareholders get the rights when they purchase shares and transfer the rights when the shares are sold. A change of a shareholder rights plan is usually printed in the annual proxy statement and announced publicly.  For example, IBM's board adopted a shareholder rights plan under which the company will issue a dividend of one right for each common share held by holders.

If you buy a share or shares of stock in a public company, you become a part owner of that company. As a shareholder of one share of Microsoft, you enjoy the same basic privileges and rights as Bill Gates, who owns millions of shares. Most companies use a one-vote-one-share system. Even though your one share of Microsoft does not count much against Mr. Gates’ millions of votes, the company takes each vote seriously.

As a shareholder, you have the privilege to receive quarterly reports and an annual report informing you of the financial health of the company. The quarterly reports tell how much money the company has made or lost and business activities during the reporting period. The annual report is a combination of all quarterly reports and is often printed with fancy charts and photographs. It gives detailed business and financial information about the company. 

As a shareholder, every year you’ll be invited to attend the annual shareholders’ meeting, where you can ask Mr. Gates questions about Microsoft.  If you cannot go to the annual shareholders' meeting, the company will send you an absentee ballot, allowing you to vote by proxy. You will have the right to vote for Microsoft’s board of directors, the shareholders’ representatives who keep track of the important issues of the company. They will, in turn, hire officers such as Steve Ballmer to run the company.

The responsibility of the company's board and management is to realize the inherent value in the company's business and maximize shareholders' value. The shareholder rights plan will protect the interest of investors.

Stocks may seem complicated, but they can be broken down into two basic groups: common and preferred stock .  In addition to these two groups, a company may issue classes of stock, sometimes Class A and B.

Common stock is the most common form of stock you will encounter.  It represents fractional ownership of a company.Common stocks are easy to transfer.  When the market opens, a common stock may be sold or bought at whatever price another investor is willing to pay.  Common stockholders usually have voting rights and have higher potential for return compared to preferred stockholders.

The second type of stock is preferred stock.  It not only represents partial ownership of a company like a common stock but also pays dividends at specified rates.  In addition, dividends are paid to preferred stockholders before common stockholders.  Also, if a company is performing poorly, common stock dividends are usually removed first.  Moreover, if a company sells its assets because of bankruptcy, preferred stockholders have a claim on the assets before common stockholders.

However, preferred stockholders do not usually have voting rights, and the dividends are not increased if the company performs well.  

Companies sometimes offer convertible preferred stocks which allow shareholders to convert their shares to common stocks at a set price.  For example, Microsoft issues a class of convertible preferred stocks at $140/share, meaning shares of preferred stock can be converted to common stock if Microsoft's share price is over $140. 

Besides common and preferred stock, a company may have classes of stock, usually Class A or Class B.  Classes of stock are used to separate ownership and control.  For example, Berkshire Hathaway has a BRK A and a BRK B.  The A stock is worth $50,000/share while the B stock is worth only $2,000/share.  BRK A shareholders have voting rights, but BRK B shareholders do not.  The two classes may also be issued with a specific goal in mind, such as a merger.  For instance, a company may issue Class E shares to finance the acquisition of another company.  For example, General Motors (GM) issued class H stock for the acquisition of Hughes Electronics. 

Stocks can be broken down into common and preferred or even Class A and Class B.   Owning any type means you are a part owner of a business, but some classes have limited privileges.

 

By reading the title, you probably have a good idea of the nature of these two types of stocks.  Blue chips, like in poker and other card games, are the most expensive chips.  Likewise, blue chip stocks are worth the most, primarily the larger companies.  Pennies are worth very little, just like penny stocks, which are those trading under $5.  Blue chips are usually the type of stock you want to invest in, and penny stocks should be avoided.

Blue chip stocks are the most valuable, with the Dow Jones Industrial Average and S&P 500 Index as measures.  They are usually the household names such as AT&T, McDonald’s, and Starbucks and tend to be large or mid-cap stocks.  Blue chips have a long operating history, steady earnings, and a good reputation.  They also have high liquidity, or the ability to trade large amounts of a stock without any problems.  Blue chips are considered safe, especially if the market is falling.  However, some blue chips do not always perform well.  For example, Eastman Kodak, a Dow stock, has performed quite poorly over the past few years, dropping around 35%.

In large contrast to blue chips are penny stocks, ones selling under $5.  Penny stocks are the newer companies with little operating history and are considered mini-cap, even smaller than small-cap.  They are usually indicated with an .OB or OTC (over-the-counter) after the stock symbol.  They have numerous problems, including no margin (borrowing money to buy more shares) and low liquidity and volume.  Penny stocks are very risky and speculative and may drop lower than their already low price.  Often, penny stocks will perform a reverse split to make the share price more attractive for investors.  Because of the high risk of penny stocks, they should be avoided.

In some cases, however, a large-cap stock may not be considered a blue chip.  Shares of the high-flying Internet stock, VA Linux, went up 300% on the date of the initial public offering (IPO) and had a high enough market cap to be considered large cap, but it didn’t have a long enough operating history to be considered blue chip.  In addition, numerous IPOs start out strong but drop drastically in the following months.  For example, Beyond.com had an IPO price of around $14 in June of 1998, rose to a high of $33.50 in January of 1999, and has since dropped as low as $1.60.  Within the past year, the share price has dropped 92%.

Blue chips and penny stocks are basically opposites.  Blue chips are usually the household names and are quite safe to buy.  They may not always perform well, as seen in the case of Eastman Kodak.  A price decrease may occur from a change in technology or management.  Investors still have to be selective when purchasing blue chips.  On the other hand, penny stocks are the newer companies and are usually a riskier investment.  Unfortunately, investors have the misconception that penny stocks are cheap and therefore have upside potential.  However, a lower share price doesn’t mean the stock is cheap.  Investors should consider earnings as well.  If the company is not making money, the share price will go even lower.  Penny stocks are speculative and risky.  They are not for most investors because the risks outweigh the rewards.  Investors should choose blue chips carefully and avoid penny stocks.

Some types of stocks are better off left for Wall Street professionals.  The experience and knowledge of Wall Street experts is necessary for investing in cyclical stocks, companies that rise and fall with the business cycle.  Predicting a business cycle is not an easy task.  On top of that, the cyclical stocks tend to lead the business cycle by six to ten months.  In other words, some cyclical stocks will start doing well six months before the economy comes out of a recession.  This is why only professionals can time, invest, and profit from cyclicals in a timely manner.

Cyclical stocks come in many forms.  They are usually those in which the demand can be flexible.  For example, General Motors is a cyclical stock because people do not constantly need to buy cars.  If the interest rate increases, buyers will not have enough money to afford the cars, causing General Motors to lose profits.  On the other hand, non-cyclical stocks are quite constant in demand.  For example, Coca Cola is a non-cyclical stock because even if interest rates rise, people will still need food.  The difference between a cyclical and non-cyclical stock is tied closely to consumer need and demand.

The business cycle, along with cyclical stocks, involves interest, inflation, and unemployment rates.  If these factors increase, businesses will do poorly and have lower profits.  Contrastly, a decrease in these factors will cause businesses to boom and have very strong earnings.  This rise and fall can be unpredictable and last for a constantly changing number of years.  A change in the economy usually happens during election years when the new president can change policies.  As a result, the changing policies may cause the boom or bust of the economy.

Buying cyclical stocks can have certain risk factors.  Investors may not be able to judge whether the economy will perform well or poorly.  They can’t guess when the next change in the business cycle will happen.  Investing in cyclicals can be risky because the economy is quite unpredictable.

However, buying cyclical stocks can be very profitable if investors can predict what will happen to the economy.  If they can anticipate a surge, they can buy cyclicals before the rise.  Later, if they anticipate a drop, investors can sell the cyclical stocks before the fall.  Being able to predict what will happen to the economy minimizes risk and maximizes profit when investing in cyclical stocks.

Wall Street experts will be better at predicting changes in the economy and business cycle, so novice investors should try to avoid cyclicals.  However, if any investor can anticipate a change in the economy, cyclical stocks can be very profitable.

As an investor, you want to buy low and sell high.  But you can also buy high and sell even higher to make a profitable investment.  You’re probably wondering, how is this possible?  The usual buy low, sell high lies within value stocks, but a type of stock called growth stocks enables you to buy stocks at an expensive price and sell at an even higher price.  Now the real question is how you can determine if a stock is cheap or expensive.  Its value is not how much it’s selling at  - $5 or $150 – but rather its price-to-earnings ratio (P/E) in relationship to the benchmarks for the U.S. stock market, the Standard and Poor’s 500 Index (S&P 500).  For example, if the P/E for the S&P 500 is 25 a 150 P/E for Oracle is considered expensive.

P/E is the price-to-earnings ratio.  The P/E is found by taking the share price of a company and dividing it by the company’s earnings per share (EPS).  The share price of a company can also be the P/E times the earnings per share.  For example, the share price of Boeing is $50 and the EPS is $2.5.  This means the stock is selling for 20 times its earnings. If the P/E is used correctly, it is a good indicator of whether you are paying a lower or higher price for a stock.

 

Value stocks usually grow slower than the S&P and are considered “cheap.”  A stock can be considered cheap if its P/E is lower than previous years or that of the S&P.  For example, General Electric has a P/E typically between 30 and 40.  If you buy it with a P/E of 30 and sell at 40, you will have made a larger profit than if you bought the stock when its P/E was 37 and you sold it at 40.  On the other hand, the low P/E means the company may have problems or a slow down in the growth of earning.  You could also buy the stock at a P/E of 30 and it could stay at 30 for a long time.  However, if you buy a stock in good financial shape and one that has an explanation for the cheap share price, the stock will probably resume growth eventually.  Overall, value investors are bargain hunters and use the strategy of buy low, sell high.

Growth stocks tend to grow faster than the S&P and have a higher P/E than that of the S&P.  Unlike value investors, growth investors look for stocks with high growth potential.  They often buy stocks with high P/E or even negative earnings.  For example, Yahoo! has a P/E of over 1,000 and Amazon has been in the red and will be losing money for years to come.  Unfortunately, by paying a high price for those so-called “.com” Internet high flyers with a far worse earnings outlook than that of Amazon, many investors put their money at risk. This is an unwise strategy.  The most profitable situation would be if a generally fast-growing company has a dip for a temporary setback.  You can buy the stock at the low price and make a profit when the company resumes its usual, fast growth.  For example, Lucent Technologies has reported a 30% earnings growth in 16 consecutive quarters.  The company just reported lower quarterly earnings as a result of production problems.  The share price dropped from $85 to $50.  This presented a buying opportunity for those who believed Lucent would solve the problem and resume the earnings growth.  

Growth and value stocks are two types of stocks in which you can make a respectable profit.  Value stocks will be selling at a lower P/E than usual and can sometimes stay at lower prices for a long time.  Investors may have to wait patiently for the stock market to realize the intrinsic value of the company. Growth stocks can sell at very high P/Es but still have plenty of room for growth.  The ideal situation would be if a fast-growing company with good fundamentals drops below its usual P/E due to a temporally set back.  Whether you buy a growth or value stock, you will most likely make a good profit in the long run.

How would you like to get income as well as capital appreciation on your investment?  You can consider income stocks that not only pay a relatively large dividend but also provide capital appreciation.  In comparison with investing money in the bank or in Treasury bonds, you won’t get any capital appreciation but your income is guaranteed.  For example, if you put $1,000 in the bank at 4% interest, you will get $40 interest annually, but the original $1,000 is unchanged.  Income stocks are those that pay dividends and provide capital gain but income or gains are not guaranteed.

An important term when investing in income stocks is yield, the percentage of the share price a company pays in dividends annually.  To calculate the yield, take the dividend amount you will receive for the year divided by the share price of the company.  For example, if Disney pays a $0.25 dividend quarterly, you will receive $1 in dividend annually.  If Disney is trading at $40, the yield would be 1/40, or 2.5%.  If the share price drops to $20, the yield would be 1/20, or 5%.  In other words, if the annual dividend remains constant and the share price decreases, the yield will increase.

High income stocks, or those paying high dividends, are usually the utility stocks or Real Estate Investment Trust (REIT).  Traditionally, REITs have high cash flow from real estate rental, which they distribute to shareholders quarterly as dividends.  Utilities and REITs usually have yields between 5% and 10%.  When buying income stocks, shareholders could make money from the quarterly dividends as well from as an increase in share price.  Going back to Disney, in addition to the $1 dividend, investors would also see a share price increase as a result of the success of the most-watched show on network television, Who Wants to be a Millionaire?  However, if the company loses money, it could stop paying dividends.

One strategy for buying income stocks is investing in large-cap, high-yielding stocks.  An easy way to pick these stocks is using a method called Dogs of the Dow.  It involves buying the ten Dow stocks with high yields and good dividends because the share price is having a temporary setback.  When the company resumes upward growth, investors will have made a profitable investment.  By looking at the historical data and investing in Dogs of the Dow, investors can get a better return and higher yield on their investment.  Blue chip stocks may have a temporary setback but would resume their growth and pay dividends regularly.

Investors mainly looking for income but also willing to take a little risk can invest in income stocks, which don’t provide guaranteed income like putting money in the bank or Treasury bills.  However, if investors pick stocks correctly such as Dogs of the Dow, income stocks can be a rewarding experience, providing both income and capital appreciation.

Suppose you invested $1,000 in Microsoft 10 years ago.  Your investment would now be worth $100,000.  The same $1,000 in Dell Computers a decade ago would have resulted in a whopping $900,000.  Does this sound too good to be true?  Well, suppose your $1,000 went into Drkoop.com a year ago.  You would now be left with a measly $200, an 80% drop.  On the other hand, the $1,000 could have also been invested in the bank at a 4% interest rate.  In 10 years, the money would be worth $1,500.  Many investors are constantly looking for the next big company like Dell or Microsoft to have explosive growth, but they may have the unfortunate experience of investing in very volatile stocks like Drkoop.com.  The world of technology stocks can be very profitable compared to putting money in the bank, but don’t forget about companies like Drkoop.com

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Share prices of technology stocks can skyrocket because of the rapidly growing Internet/information technology age.  The new technology age has led to many new markets, including e-commerce, content providers, business to business, fiber optics, telecommunications, Web site providers, and the ubiquitous “.coms.”  All of these markets are constantly producing innovative products, and the stocks are having tremendous profits.  For example, Cisco Systems has soared in the networking industry, JDS Uniphase in fiber optics, Yahoo! in Web content providers, and Arriba in business to business.  Picking the winners in technology stock will produce very rewarding returns.

While technology stocks can be very profitable, the fast-growing industry has led to many new, unstable companies.  Countless technology stocks have dropped over 60% from a year ago.  For example, NetZero has dropped 68%, eToys 77%, Ask Jeeves 80%, and HotJobs.com 81%.  The new technology stocks have no real earnings, or the possibility of future earnings can vary greatly.  Investors put money into new technology stocks to rush in on the popularity of the .com initial public offerings (IPOs) and others.  These new companies may have a 200%-300% increase on the opening day of the IPO but drop quickly afterwards.  The growing companies have no fundamentals or earnings, causing investors to lose patience, sell the stock, and cause the share price to drop.  The new Internet age economy can result in high percentage losses if you choose the wrong stocks.

Technology stocks can be an area that can make investing a worthwhile experience compared to putting money in a bank account.  Picking winners such as Dell and Microsoft will result in remarkable rewards on your investment over time.  Picking losers can ultimately cause you to lose your entire investment.  However, if you research the company and learn about the fundamentals and earnings outlook, investing in technology stocks will result in large profits.

Certain types of stocks can be very beneficial to U.S. and even foreign investors.  With the new information technology age, trading stocks globally is now possible with one mouse click.  Through the Internet and many brokerages, investors can invest in stocks in markets ranging from Tokyo to Germany.  Similarly, foreign investors can buy shares of U.S. companies.  Investing in foreign stocks can help investors broaden and diversify their portfolio.  The information technology age makes investing globally almost as easy as investing domestically.

The ease of investing in foreign stocks is providing investors the opportunity for diversified portfolio.  The diversification can help offset losses.  For example, the European markets prospered because of an improving economy while the U.S. markets tumbled due to a rise in interest rates.  One market dropped but the other rose, causing investors to minimize losses.  Also, U.S. investors can invest internationally without looking overseas.  Over 1,800 foreign companies list stocks on U.S. markets, usually in the form of American Depository Receipts (ADRs).  The ADRs trade like normal stocks and the share price will move accordingly even though a company could be millions of miles away.

Investing worldwide can be done easily but has a few catches.  First of all, investing globally is more complicated than buying stocks on the U.S. market.  Foreign companies may have different rules and may be under less investigation than U.S. companies.  Moreover, the foreign exchange rate can fluctuate from country to country.  Investors have to take a risk on the currency exchange rate.  Also, drops in foreign markets can cause other markets to perform poorly.  For example, Japan’s Nikkei index fell almost 40% within a year and a half.

Foreign stocks can compensate losses and are now available through many brokerages such as Merrill Lynch.  Since advanced technology has made overseas trading easier than ever, an increasing number of stocks are being listed on foreign exchanges.  If investors are willing to take a risk with the foreign exchange rate and changes, foreign stocks can help investors diversify their portfolio and make profits in the long run.

As an investor, you have to make decisions on buying stocks in large or small companies.  In the stock quote table on the Internet, a column called market capitalization indicates the market value of a company.  The market capitalization, also known as market value or market cap, is found by multiplying the share price by the number of shares outstanding.  For example, a company at $10 with 20 million shares outstanding has a market cap of $200 million.  Stock market experts do not have set numbers for small, mid, and large cap stocks, but the following table gives you an idea of the market caps for small, medium, and large companies:  

Market Capitalization
Small-cap	Under $500 million
Mid-cap	$500 million - $1 billion
Large-cap	Above $1 billion

Small-cap stocks are usually those with a market cap less than $500 million.  Investing in small-cap stocks can be risky because they are usually the newer stocks and their companies have not proven to be stable or profitable.  However, small-cap stocks can have very high growth potential compared to large-cap stocks.  A small-cap stock is much more likely to double or triple than a large-cap stock.  Overall, small-cap stocks have high risk but high return.

Large-cap stocks are those with a market cap usually above $1 billion.  Investing in large-cap stocks can be quite safe because those companies have proven to consistently produce good earnings and be very stable in growth.  However, being a large-cap stock means it will grow slower than a small-cap stock.  A small company is more likely to grow than one that is already large.  In the long run, large-cap stocks have low risk but slow growth.

Medium, or mid-cap stocks are those with a market cap usually between $500 million and $1 billion.  These stocks are just in between small and large cap stocks.  Mid-cap stocks are not as risky as small-cap stocks but are not as stable as large-cap stocks.  They will provide fair profit in the long run. 

The market value of a company can divide stocks into 3 categories: small, medium, and large.  The boundaries of the 3 categories vary from expert to expert.  Small-cap stocks have high risk but high return.  Large-cap stocks have low risk but low return.  When buying stocks, investors will have to choose between the tradeoff of risk and return.

Many investors are looking for a quick and easy way to determine what stocks to buy. Many Wall Street professionals use the P/E ratio, or price-to-earnings ratio. In order to figure out the P/E ratio of a stock, take the share price divided by the average earnings per share of the past four quarters.  You can compare this ratio with the overall market P/E. Growth stocks tend to have a higher P/E than the S&P 500, the benchmark of the U.S. market. Utility companies tend to have high dividends but low growth and therefore, low P/Es. On the other hand, high-tech stocks have high growth rates and earnings, meaning high P/Es.

In the new economy era, investors have plenty of reasons to look beyond the traditional price-to-earnings (P/E) ratio when evaluating stocks.  For example, most of the high-tech stocks trade at ridiculously high prices but experience high growth rates.  A method to account for a stock’s P/E ratio is its relation to the company’s growth rate as follows:

PEG = P/E / growth rate

i.e. the ratio of the P/E and growth rate

The PEG becomes an effective tool for investors to determine how much of a premium they should pay for high-tech companies with strong earnings.  A simple investment rule of thumb on Wall Street is that the PEG should be 1, meaning the stock is fully valued.  In other words, the stock’s price-to-earnings ratio equals the percentage of the growth rate of the company’s earnings per share.  For example, consider the comparison of the old and new economy stocks as shown in the following table:

Comparison of Old and New Economy Stocks
Ratios	Dell Computer (new)	3M (old)
Share price ($)	40	80
Earnings per share ($)	0.90	4.40
P/E ratio	45	18
Expected growth rate (%)	30	11
PEG	1.5	1.6

By looking at only the P/E, Dell’s is 45, almost triple that of 3M’s.  However, 3M’s PEG ratio of 1.6 is higher than Dell’s 1.5 PEG, suggesting that Dell is a better buy because of its high growth rate.