fraction of that price. But what if a buyer comes in when no other broker
wants to sell close to the last price? Or vice versa for a seller? How is
price continuity preserved? At this point enters the Specialist. The
specialist is charged with a special function, that of maintaining
continuity in the price of specific stocks. The specialist does this by
standing ready to buy shares at a price reasonably close to the last
recorded sale price when someone wants to sell and there is a lack of
buyers, and to sell when there is a lack of sellers and someone wants to
buy. For each listed stock, there are one or more specialist firms assigned
to perform this stabilizing function. The specialist also acts as a broker,
executing public orders for the stock, and keeping a record of limit orders
to be executed if the price of the stock reaches a specified level. Some of
the specialist firms are large and assigned to many different stocks. The
Exchange and the SEC are particularly interested in the specialist
function, and trading by the specialists is closely monitored to make sure
that they are giving precedence to public orders and helping to stabilize
the markets, not merely trying to make profits for themselves. Since a
specialist may at any time be called on to buy and hold substantial amounts
of stock, the specialist firms must be well capitalized.
In today's markets, where multi-million-dollar trades by institutions
(i. e. banks, pension funds, mutual funds, etc.) have become common, the
specialist can no longer absorb all of the large blocks of stock offered
for sale, nor supply the large blocks being sought by institutional buyers.
Over the last several years, there has been a rapid growth in block trading
by large brokerage firms and other firms in the securities industry. If an
institution wants to sell a large block of stock, these firms will conduct
an expert and rapid search for possible buyers; if not enough buying
interest is found, the block trading firm will fill the gap by buying
shares itself, taking the risk of owning the shares and being able to
dispose of them subsequently at a profit. If the institution wants to buy
rather than sell, the process is reversed. In a sense, these firms are
fulfilling the same function as the specialist, but on a much larger scale.
They are stepping in to buy and own stock temporarily when offerings exceed
demand, and vice versa.
So the specialists and the block traders perform similar stabilizing
functions, though the block traders have no official role and have no
motive other than to make a profit.
3. SECURITIES. CATEGORIES OF COMMON STOCK
There is a lot to be said about securities. Security is an instrument
that signifies (1) an ownership position in a corporation (a stock), (2) a
creditor relationship with a corporation or governmental body (a bond), or
(3) rights to ownership such as those represented by an option, subsription
right, and subsription warrant.
People who own stocks and bonds are referred to as investors or,
respectively, stockholders (shareholders) and bondholders. In other words a
share of stock is a share of a business. When you hold a stock in a
corporation you are part owner of the corporation. As a proof of ownership
you may ask for a certificate with your name and the number of shares you
hold. By law, no one under 21 can buy or sell stock. But minors can own
stock if kept in trust for them by an adult. A bond represents a promise by
the company or government to pay back a loan plus a certain amount of
interest over a definite period of time.
We have said that common stocks are shares of ownership in
corporations. A corporation is a separate legal entity that is responsible
for its own debts and obligations. The individual owners of the corporation
are not liable for the corporation's obligations. This concept, known as
limited liability, has made possible the growth of giant corporations. It
has allowed millions of stockholders to feel secure in their position as
corporate owners. All that they have risked is what they paid for their
shares.
A stockholder (owner) of a corporation has certain basic rights in
proportion to the number of shares he or she owns. A stockholder has the
right to vote for the election of directors, who control the company and
appoint management. If the company makes profits and the directors decide
to pay part of these profits to shareholders as dividends, a stockholder
has a right to receive his proportionate share. And if the corporation is
sold or liquidates, he has a right to his proportionate share of the
proceeds.
What type of stocks can be found on stock exchanges? The question can
be answered in different ways. One way is by industry groupings. There are
companies in every industry, from aerospace to wholesale distributers. The
oil and gas companies, telephone companies, computer companies,
autocompanies and electric utilities are among the biggest groupings in
terms of total earnings and market value. Perhaps a more useful way to
distinguish stocks is according to the qualities and values investors want.
3.1 Growth Stocks.
The phrase "growth stock" is widely used as a term to describe what
many investors are looking for. People who are willing to take greater-than-
average risks often invest in what is often called "high-growth"
stocks—stocks of companies that are clearly growing much faster than
average and where the stock commands a premium price in the market. The
rationale is that the company's earnings will continue to grow rapidly for
at least a few more years to a level that justifies the premium price. An
investor should keep in mind that only a small minority of companies really
succeed in making earnings grow rapidly and consistently over any long
period. The potential rewards are high, but the stocks can drop in price at
incredible rates when earnings don't grow as expected. For example, the
companies in the video game industry boomed in the early 1980s, when it
appeared that the whole world was about to turn into one vast video arcade.
But when public interest shifted to personal computers, the companies found
themselves stuck with hundreds of millions of dollars in video game
inventories, and the stock collapsed.
There is less glamour, but also less risk, in what we will call—for
lack of a better phrase—"moderate-growth" stocks. Typically, these might be
stocks that do not sell at premium, but where it appears that the company's
earnings will grow at a faster-than-average rate for its industry. The
trick, of course, is in forecasting which companies really will show better-
than-average growth; but even if the forecast is wrong, the risk should not
be great, assuming that the price was fair to begin with.
There's a broad category of stocks that has no particular name but that
is attractive to many investors, especially those who prefer to stay on the
conservative side. These are stocks of companies that are not glamorous,
but that grow in line with the economy. Some examples are food companies,
beverage companies, paper and packaging manufacturers, retail stores, and
many companies in assorted consumer fields.
As long as the economy is healthy and growing, these companies are
perfectly reasonable investments; and at certain times when everyone is
interested in "glamour" stocks, these "non-glamour" issues may be neglected
and available at bargain prices. Their growth may not be rapid, but it
usually is reasonably consistent. Also, since these companies generally do
not need to plow all their earnings back into the business, they tend to
pay sizable dividends to their stockholders. In addition to the real growth
that these companies achieve, their values should adjust upward over time
in line with inflation—a general advantage of common stocks that is worth
repeating.
3.2 Cyclical Stocks.
These are stocks of companies that do not show any clear growth trend,
but where the stocks fluctuate in line with the business cycle (prosperity
and recession) or some other recognizable pattern. Obviously, one can make
money if he buys these near the bottom of a price cycle and sells near the
top. But the bottoms and tops can be hard to recognize when they occur; and
sometimes, when you think that a stock is near the bottom of a cycle, it
may instead be in a process of long-term decline.
3.3 Special Situations.
There’s a type of investment that professionals usually refer to as
“special situations”. These are cases where some particular corporate
development–perhaps a merger, change of control, sale of property, etc.–
seems likely to raise the value of a stock. Special situation investments
may be less affected by general stock market movements than the average
stock investment; but if the expected development doesn’t occur, an
investor may suffer a loss, sometimes sizable. Here the investor has to
judge the odds of the expected development’s actually coming to pass.
4. PREFERRED STOCKS
A preferred stock is a stock which bears some resemblances to a bond
(see below). A preferred stockholder is entitled to dividends at a
specified rate, and these dividends must be paid before any dividends can
be paid on the company's common stock. In most cases the preferred dividend
is cumulative, which means that if it isn't paid in a given year, it is
owed by the company to the preferred stockholder. If the corporation is
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