The Diary of a Small Investor

Introduction:

January 20, 1998

I have received many e-mail correspondences asking questions about the basics of investing in the stock market. When I first thought about adding something to my web page, Inside the Stock Market about the "basics", I was going to do just that. However, after thinking about it, I told myself that there is already plenty of material available in book stores and on the internet talking about the basics and instead of just writing about the basics, I would write about my true-life experiences in the stock market, hence The Diary of a Small Investor.

I still plan to include basic stock investment principles and to try and give novice investors some ideas on how to invest their hard earned money. I will also include my general strategy on how to setup a portfolio of stocks.

I couldn't possibly complete this story in a short amount of time, there is simply to much to write about. I do plan to try to add new chapters each month (it may take me longer then a month, depending on how long a chapter is) so keep checking back. I sincerely believe that if you continue to read this story as I update it, and someday become a stock investor, you will start to experience for yourself many of the things that I talk about in this diary.

I have seen numerous individuals get involved with the stock market only to quickly back out because what they experienced was not what they expected or what they were promised by Wall Street and others. This is unfortunate because many of us need the higher returns, only possible in the stock market, to achieve many of our financial goals. I hope I can give you a better idea of what to expect so you will be better prepared and won't be scared off.

I hope you will enjoy reading The Diary of a Small Investor. Please e-mail me all suggestions and comments, it's easy to do, just click on my e-mail address at the end of the diary. I appreciate your feedback!

Getting Started:

The first question a beginning investor needs to ask themselves is, "Who's going to advise me?" Am I going to be my own adviser or am I going to pay someone else to advise me? They say don't be your own lawyer, however, when it comes to investment advice, I say you are better off being your own adviser. There are only a few good investment advisers out there and those few are very expensive, too expensive for most of us. If you have less than $100,000 to invest your only option is to do it yourself.

When I got started in 1984 I called numerous brokers, the only question they asked me was how much do I want to invest, when I told them $2000, they lost interest and I never heard from them again. After that I went to investment advisers, again, they were not interested. My only alternative for so-called professional advice was mutual funds. I found out very quickly that the financial planners only recommended mutual funds that had a front-end load. At the time most mutual funds had front-end loads of 3-8% which meant if I gave them the $2000 they would take $60 to $160 right off the top for their commission, I would be starting out 3-8% in the hole. This is still true today, that is, if you want to talk with an adviser or financial planner you will pay for it either through a front-end commission or an hourly rate. Obviously, financial advisers and planners aren't going to work for free and I'm not suggesting they should. What I am saying is that most of us don't have the extra money to pay for advice especially bad advice.

My First Mutual Fund:

May 3, 1999

The last time I wrote here was January of last year, how time flys.

Today the Dow closed above 11,000. It only took 24 trading days for the Dow to go from 10,000 to 11,000. When I started investing in 1984 the Dow hadn't even broke through 2,000 yet.

As I stated in "Getting Started," I found out very quickly that no professionals were interested in my business, I just didn't have enough money at the time.

After I found out I was not going to get professional help, a friend of mine at work told me about mutual funds and suggested I give them a try. My friend told me that all I had to do was call the company and they would send me the information on how to get started. After receiving the information, I filled out the forms, and mailed them a check. I was now a shareholder in a mutual fund.

My friend was into stock mutual funds and it was for that reason that my first mutual fund was a stock mutual fund. As an owner of a stock mutual fund I got interested in the stock market in general. One thing that I learned simply by observation was that whenever the bond market went up the stock market went up more.

You see, the most important thing an investor must determine is the Asset Allocation of their investments. That is, what percentage of my money was I going to allocate to stocks, bonds, and cash? Like I said, the only reason I initially bought a stock mutual fund was because that's what my friend bought, however, after seeing that stocks went up faster than bonds, stock mutual funds would continue to be my choice.

I can't emphasis how important asset allocation is. You must constantly evaluate the asset allocation of your investments. Making changes when your investment goals or economic conditions change. You could pay someone to do this, but like I said in "Getting Started" unless you have a lot of money you won't get very good advice. Even if you do have a lot of money, I still don't think you will get what you pay for. In the late-Eighties the so-called gurus of Wall Street were mostly saying the Nineties, in no way, were going to beat the stock market returns of the Eighties, they were all wrong. Not only are the so-called professionals wrong more than they are right, but they are more worried about their interests than yours. Yes, as long as their interests go along with yours there's not a problem, but just wait until there's a conflict between yours and their interests and see who wins out. Finally, the asset allocation the pros will give at a cost, will be something very close to the following. For a "young" person (or someone who wants to be an aggresive investor) an allocation of 60% stocks, 30% bonds, and 10% cash. For an older person (or someone who wants to be a conservative investor) 30% stocks, 50% bonds, and 20% cash. If you want to get more specific, keep the percent in bonds at your age, if you are 40 keep 40% in bonds. Now back to my asset allocation in the mid-Eighties.

I was not interested in cash because I didn't have that much money to begin with and if I was going to make any money I couldn't have my money in cash. Right from the beginning I was invested in 100% stocks, not because I was a savy investor, but because that's what my friend was into and because I would soon learn that the only way to really make money which is what I needed to do was to be in stocks.

Mutual Funds, The Basics:

From Barron's Dictionary of Finance and Investment Terms:

"Mutual fund, fund operated by an investment company that raises money from shareholders and invests it in stocks, bonds, options, commodities, or money market securities. These funds offer investors the advantages of diversification and professional management. For these services they charge a management fee, typically 1% or less of assets per year.

Mutual funds may invest aggressively or conservatively. Investors should assess their own tolerance for risk before they decide which fund would be appropriate for them. In addition, the timing of buying or selling depends on the outlook for the economy, the state of the stock and bond markets, interest rates, and other factors."

From Barron's definition, "fund operated by an investment company." From what I have seen, the term investment company is a bad choice of words here and can be very misleading. For the most part, the operator of a mutual fund is a manager much more than an investor. The shareholders of the mutual fund are the real investors and most definitely are the only ones who take on the risk. Here are some examples of what I am talking about.

(1) XYZ company operates a stock mutual fund called XYZ Gold fund. How XYZ operates the fund is much simpler than you would think especially if you listen to their ads about the fund. The ads will state that XYZ constantly monitors the fund's assets, buying and selling when company fundamentals change as to maximize shareholders return. The ad will state our analysts are always on the go, all over the world, checking up on the companies we own shares in, again to maximize the shareholders return. What XYZ really does is it simply buys the largest cap stocks in the sector (the gold sector) until it has about 60% of the fund's assets invested. Then it will buy some of the best mid cap stocks until it has about 80% of the fund's assets invested. Then it will buy some of the best small-cap stocks in the sector until it has about 90% of the fund's assets invested. And finally, it will retain the last 10% of the fund's assets in cash. The cash position is maintained incase shareholders want to redeem their shares.

How they determine which stocks are the "best" is most likely simple fundamental analysis which is based on the company's balance sheet and income statement (current and previous ones). There may be some subjective opinion also considered such as the quality of management and economic conditions for the sector and economy. XYZ will turnover (number of shares traded as a percentage of total shares in the fund) or another way of putting it, they will buy and sell stocks to give shareholders the impression they are earning your money, but the fund is still a fund that at best will just track the gold index (XAU) over time.

About market cap or market capitalization. Market Capitalization is the number of shares outstanding times the current market price of the company's common stock. A company that has 100 million shares outstanding and has a current share price of $10, has a market cap of $1 billion. Every day the stock trades, the market cap will change depending on how much the price of the stock changes. General rules for market cap size: 1) large-cap = greater than $5 billion, 2) mid-cap = $1-5 billion, and 3) small-cap = less than $1 billion.

There is another term used for market cap size and it's called microcap. Generally, microcap refers to market cap sizes that are less than $200 million. For my purposes, just because a stock is considered a microcap does not make it a penny stock. Some say a penny stock is simply a stock that sells for less than $5 a share, others say it's a stock that sells for less than $1 a share. However, a stock price of less than $5 or even $1 does not alone make a penny stock. More analysis is necessary to really determine if a stock is a penny stock or not. The bottom line is the term Penny Stock usually implies a stock that has a share price of less than $1, is very volatile, and the stock is traded in the over-the-counter (OTC) market. The financial condition of a penny stock is very uncertain and penny stocks are considered very risky investments. Now back to the XYZ Gold fund.

This type of fund, the XYZ Gold fund is called a sector fund, a fund that invests primarily in a specific sector of the stock market. However, the way I explained it above, works for just about any fund. That is, the XYZ Latin American fund which would be called an international fund would use the same method. To start the fund the operator would go out and buy the largest cap stocks in some of the largest countries in Latin America, for example, Mexico and Brazil.

When you think about it you can see why XYZ Company does it this way. There is no risk. Both the XYZ Gold fund and Latin American fund will basically track the gold index (XAU) and Latin American Index. If the indexes do well, so to will the XYZ Gold and Latin American funds. If the indexes don't do well neither will the XYZ gold and Latin American funds, but they, the operator of the funds have the perfect excuse, "Yes, our gold fund is not performing well, but what do you expect, neither is the gold index." And many shareholder in the funds will simply accept this.

To prove to myself that most funds were run like this, I setup a portfolio this way. That is, I went to a basic stock screener on the internet and ask for stocks in the oil service industry. I also asked for earnings and revenue growth rates and book values. I first selected the largest cap stocks like Schlumberger and Halliburton, then I bought some mid-cap stocks selecting those with the best revenue and earnings growth rates and book values, then I did the same thing with some smaller cap stocks in the sector.

I started the portfolio December 3, 1998 and five months later the portfolio's return was 62.92% as compared to Fidelity Select Oil Services' return of 63.17%. The Oil Services Index (OSX) for the same period returned 66.64% (no dividends were considered for any of the portfolios). It took me two hours to setup the portfolio. Fidelity charges customers a front-end load of 3%, there is a back-end load if you redeem your shares within thirty days, and it charges one of the highest annual management fees for maintaining the portfolio. No wonder the top exec at Fidelity is a billionaire.

It's also interesting to point out here that by running my own portfolio in energy services gave me much more flexibility than I would of had by simply owning Fidelity Select Energy Services mutual fund. I could sell individual stocks in the portfolio as individual company fundamentals changed. However, with the mutual fund all I could do was reduce my overall position in the fund, I am at the mercy of the fund manager.

My second example is regarding risk.

(2) If in 1999 you started to dollar cost average (investing a certain dollar amount in shares at the same period) in the XYZ Gold and Latin American funds and ten years later you had less money in the funds than you put in because the funds had performed poorly and you questioned professional financial consultants about the issue, you would be told that you picked the wrong funds. For the period the gold and Latin American indexes did not perform well so these funds didn't perform well. You would not be told that the fund managers didn't perform well. The performance of your portfolio was not based on the fund company or the fund manager as much as it was based on the specific funds you selected. The most important decision which was which specific funds to invest in was made by you. The least important decision was which specific stocks to buy for each fund was made by the fund manager. Is this not interesting: the most important decision was made by you the shareholder, the novice, and the least important decision was made by the fund manager, the so-called expert. However, when you think about it, it all makes sense if you look at it from the point of view of the fund company. The fund company is getting paid money to make the least important decisions.

What's my point with these two examples is a mutual fund company is a manager of assets, not an investor of assets. The most important decisions such as what portion of your portfolio should be in stocks, bonds, and cash, and which specific funds should you invest in, in each category, are made by you. Also, you are the one who is assuming the risk, the mutual fund company assumes no risk and is not required by any rules or laws to produce any given returns. Give credit where credit is due. The fact is the mutual fund industry knows more about marketing than investing. Here's a recent quote from Wall Street Week (PBS) on April 30, 1999:

Rukeyser asks John C. Bogle, Sr. Chairman, The Vanguard Group, "What do you think when you see a TV commercial in which Peter Lynch talks with Don Rickles." Bogle replies, "Well, my first thought is who's paying for this and it's of course the shareholders of those funds which does raise interesting questions about whether this industry is, has moved from a traditional focus on management to a whole new business, a business of marketing and if it's any big concern I have about the mutual fund industry today, it's turned its back on trusteeship, fiduciary duty and management [you notice how he did not use the term investing], and turned its face toward or its emphasis on, marketing, bringing in large assets to earn large fees and I don't think that's the right thing to do for the investor."

This diary and Inside the Stock Market are not about trying to get you on my side, but they are about trying to get you to think about the issues that affect your finances and the economy. I feel that giving you an alternative viewpoint, that is, one that is the opposite from what you will hear from corporate America, the financial news media, and politicians will allow you the opportunity to take your experiences with the mutual fund business and take Mr. Bogle's comments and draw your own conclusions.

In my two examples I talked about a gold fund and an international fund, these are two types of many stock mutual funds. As I stated earlier, there are three categories of mutual funds: 1) stock, 2) bond, and 3) cash, but in each of these categories there are many different types. Since my experiences are mostly with stock mutual funds I am going to talk about the different types of stock mutual funds.

Starting out broadly speaking, there are Domestic and International stock mutual funds. Domestic invests in stocks of companies in the United States. International stock mutual funds invest in stocks of companies outside of the US. Sometimes you run across a fund called a Global stock mutual fund which may invest in both domestic and foreign stocks. Another type of international mutual fund is Emerging Markets which basically mean they invest in stocks of smaller counties, counties that are younger in terms of their economic situation. There are no hard and fast rules so don't be surprised to see your domestic stock mutual fund buying foreign stocks once in a while.

I would break down stock mutual funds both domestic and international in this way.

• Growth, invests in stocks that have strong fundamentals in earnings and revenue growth. Generally the stocks will have higher PE ratios (PE means price to earnings ratio, a stock selling for $10 and has earnings for the past year of $1, has a PE of 10, this is a trailing-PE, I will get into this more in the chapters on stocks.). You will also find funds within this type called Aggresive Growth or Maximum Capital Gains. Both of these types simply are suggesting that they invest in the most aggresive or to put it another way, the riskiest of the growth stocks.

• Value, invests in stocks that have strong balance sheets, low debt ratios, and high book values (or low price to book ratios). Generally the stocks will have lower PE ratios.

• Index, invests in stocks that make up a certain index, the goal of the fund is to track or match the investment return of the particular index. An index contains certain stocks. The stocks which make up the index are selected by the company that maintains the index. Examples of indexes are 1) The S&P 500, a large-cap stock index, 2) The NASDAQ 100, the largest cap stocks listed on the NASDAQ stock exchange, 3) The Dow Jones Industrial Average, 30 of the largest industrial companies in the US, 4) The Russell 2000, a small-cap stock index, and 5) The Wilshire 5000, a broad based index, has a lot of stocks in it.

• Equity Income, invests in stocks that pay high dividends. You can get income from both stocks and bonds so as to not confuse you as much I have called this type of stock mutual fund, equity income. Equity when referring to financial planning is sometimes used as a synonym for stocks or for ownership. The reason for this is that basically there are two ways for a company to raise capital to grow its business. One way is through equity financing which is selling stock (equity) in the company. The buyers are giving the company money for part ownership (equity) and for a chance at future profits. The other way is through debt financing which is borrowing money from someone and than paying the money back, with interest. The bondholders, those who loaned the money, have no ownership (equity) in the company, however, when a company files bankruptcy the bondholders are paid before any money or assests are distributed to shareholders and I have never seen any money distributed to shareholders when a company goes under, shareholders, generally, lose their entire investment.

• Balanced, invests in both stocks and bonds. I don't like this type of fund because it screws with the investor's asset allocation percentages. That is, the fund manager decides on what percentage of the funds assets are in stocks and what percentage are in bonds which may not be correct for all the different shareholders who own the fund. However, it's a simple way for the investor to invest in all three categories of the asset allocation model. Virtually, every mutual fund will have some position in cash.

• Market Cap Size, invests in stocks of either large-cap, mid-cap or small-cap stocks. Two popular indexes are the S&P 500 and Russel 2000, the S&P 500 has larger cap stocks in it and the Russell 2000 is a small-cap index. If you thought that the small-cap stocks were going to outperform the larger cap stocks you may want to invest in a small-cap stock mutual fund or a Russell 2000 Index fund.

• Sector, invests in stocks that are in a certain sector or the market, for example, gold, basic materials, insurance, banks, and all the other different sectors of the overall stock market.

The same stock may "fit" in more than one type of stock mutual fund and there may be overlapping from one type of stock fund to another. For example, you may have a large-cap growth stock mutual fund or a small-cap growth stock mutual fund. A sector fund may hold both large and small-cap stocks, a regular growth stock mutual fund may have both large and small-cap stocks. An international fund may invest in small-cap growth stocks.

The last thing I'm going to talk about in "The Basics" is load and no-load mutual funds. One of the first people I came into contact with when I started investing was a Certified Financial Planner (CFP). I was given thirty minutes 'free' when I had my first meeting with a (CFP), however, during that thirty minutes I would found out the minutes were anything, but free.

The way the CFP made their money was by selling load mutual funds. The CFP showed me several mutual funds that I could invest with through them. Each fund carried an eight percent front-end load. What that meant is if I invested $5,000, I would be charged a fee of $400 (8% of $5,000) which would mean I would only have $4,600 working for me instead of $5,000.

I believe that this is one of the best examples to discuss what's in your best interest and who is going to look out for your best interest. Back in the mid-Eighties there were tons of load mutual funds. Even though it had been well demonstrated and continues to be well demonstrated today that sales charges (front-end loads) have nothing to do with management skills and investment performance, that is, the two groups of funds, no-load and load, have, on the average, performed about the same. Shareholders were not getting anything for paying the additional front-end load, but the CFPs were, and therefore a CFP was more likely to recommend a fund with a front-end load than a no-load fund: what was in your best interest was not in the best interest of the CFP.

The customer was getting nothing for the fees they were paying, but no one was doing anything about it. Not the financial news media, not the mutual fund industry, not the SEC, not the NASD, not the politicians, no one. However, as soon as the mutual fund industry had explosive growth and therefore competition within the industry, the number of funds having front-end loads would significantly drop. That is, the cause of the reduction in front-end load funds was not brought about because that's what was best for the small investor, but would come from the industry itself through competition or another way of putting it, the greed of some of the companies in the industry. They wanted more profits for themselves and the way they got more profits was by not charging any front-end loads and getting customers from those fund companies that did charge front-end loads.

There are still some front-end load mutual funds out there. For obvious reasons, they have no purpose in my financial plan. I am proud of the fact that in my fifteen years of investing including when I was a novice investor, not once, did I ever buy a mutual fund that had a front-end load.

You may be asking yourself, if you don't pay a front-end load or some other commission, how does the CFP and the mutual fund company, make money? If the CFP is not charging some kind of fee, load, or commission, than they will charge you an hourly rate. Like I said before, many of us can't afford that, and in my opinion, you don't get very good advice anyway. I personally, avoid CFPs or any other third party, and just buy or invest directly with the mutual fund company. Again, when I buy direct, I still only buy no load. The way the mutual fund company makes money off of its no load funds is by charging a fee called an Expense Ratio. It's a percent of those assets under management, that is, if the mutual fund company's expense ratio for XYZ fund is 1% and you have $10,000 invested in XYZ fund, you will be charged $100 per year. Your $10,000 investment will change during that year period and as they change you will pay more in fees if your assets increase, which you hope they do. The expense ratio does not change, it's still 1%, but now you have more assets under management and therefore the charge to you is more. For example, if this year your investment return is 10% and the assets under management are now $11,000, you will be charged a fee of $110 on a yearly basis. The exact period the mutual fund company uses when it calculates and charges you the fee varies from company to company.

Generally, a expense ratio of less than 1% is okay, it depends on the expenses the fund has to maintain the fund. Index funds usually have the lowest expense ratios becuase the fund manager is buying the stocks of the particular index, there's nothing to it.

Just because a fund has a front-end load or some other kind of load, does not mean is does not also have an expense ratio, it will. And the expense ratio may be higher than the expense ratio of a no-load fund.

Summary of Mutual Funds, The Basics:

• A mutual fund is a fund operated by a company that raises money from shareholders and invests the money in stocks, bonds, cash, and other investment vehicles, and distributes profits and losses of the investments to the shareholders in the form of income and capital gains and losses. For their services they charge the shareholders a management fee.

• Market capitalization of a company is the number of shares outstanding times the current market price of the company's common stock. Market capitalizations range in sizes from large, mid, small, and microcaps.

• A mutual fund company is a manager of assets, not an investor of assets. The most important decisions such as what portion of your portfolio should be in stocks, bonds, and cash, and which specific funds should you invest in, in each category, are made by you. Also, you are the one who is assuming the risk, the mutual fund company assumes no risk and is not required by any rules or laws to produce any given returns.

• There are many different types of stock mutual funds. Domestic and international, global and emerging markets. Domestic and international funds can be either growth, value, index, equity income, balanced, market cap size, or sector fund types.

• Mutual funds sometimes have front-end load or sales charges, avoid these types of funds.

• A mutual fund will have an expense ratio. The expense ratio is a percentage of assets under management that you are charged for the mutual fund company to manage your investment.

May 9, 1999

Why Stocks?:

May 21, 1999

From my point of view, stocks are the only way to go. I fully understand, with today's fast pace life style, very few people have the extra time that is necessary to manage your own stock portfolio. However, it's the only way that you will maximize your investment return.

At work today I recieved a note from human resources. The note was about workshops being offered for employees. One of the workshops was personal financial planning. The workshop will explain to employees, "how you can use a financial plan to manage your investments while controlling risks and maximizing returns." The workshop was hosted by Vanguard. This is total bull. My current 403b retirement plan at work does not offer employees the opportunity to invest in individual stocks. It only allows for the opportunity to invest in stock mutual funds and you can not maximize returns with mutual funds. Mutual funds invest in too many stocks and therefore will only track the overall market or if you invest in sector mutual funds they will at best track the overall sector. To truely maximize returns you must invest in individual stocks which will allow you the opportunity to beat the averages.

You noticed how I said will "allow" you the opportunity. There are no guarantees, but the same is true with mutual funds, that is, you are guaranteed no specific returns from the mutual fund industry over the short or long-term. And more importantly, as far as the risks go, I believe that mutual funds are riskier than an individual stock portfolio because the downside risks for mutual funds is the same for an individual stock portfolio whereas the upside potential for a mutual fund is nothing compared to an individual stock portfolio. For example, last July and August when stock markets all over the world crashed, the vast majority of stocks and mutual funds crashed as well. However, when the market recovered most mutual funds barely kept up with the averages, but many smaller individual stock portfolios went up significantly greater than the averages. (I am not stating that buying one stock is less risky than buying a mutual fund, I am saying that maintaining your own portfolio of stocks where you have at least 15 stocks is less risky than owning a mutual fund that may own over 100 stocks.)

The flexibility just isn't there with mutual funds. This is the main reason why many mutual funds will deliever greater returns when they are in their infancy stages then when they are in their mature stages. There are numerous examples of a mutual fund having great returns when the fund starts out (1 to 2 yrs), and then as the fund gets older, the returns shrink. When the fund was small and producing above average returns new shareholders were attracted to the fund and invested in it. As the fund grew in assets managed, the fund lost the ability to invest in those stocks, usually the smaller caps, that produced the above average returns. You see, as the fund attracted new investors and new money, it had to invest more and more capital. That is, each investment the fund made would be a larger investment and due to Liquidity Issues the fund would have to invest in larger cap stocks (and own a larger number of stocks).

From Barron's Dictionary of Finance and Investment Terms:

"Liquidity, characteristic of a security or commodity with enough units outstanding to allow large transactions without a substantial drop in price. A Stock, bond, or commodity that has a great many shares outstanding therefore has liquidity. Institutional investors are inclined to seek out liquid investments so that their trading activity will not influence the market price."

Why do investors want to be in smaller cap stocks? I will elaborate more on this in the next chapter, but for now I'll just tell you that is where the greatest profit potential lies. The greatest revenue and earnings growth of a company and therefore the company's greatest stock price appreciation, occurs when the company is small.

Just look at Microsoft, no doubt this has been a great company and a great investment. However, Microsoft's market cap when the stock was in the $90s was over $400 billion. For that stock to double just one more time, means that it has to add over $400 billion to its market cap. That's more than enough money to outright buy General Electric Company. As a company grows its revenue, earnings, and stock price (its market cap), it gets harder and harder to increase the same. It's simple mathematics.

Yesterday, a stock I own went up by just over 10% (APEX). The 10% move in stock price equated to a $40 million increase in market cap. I said to myself, "That's a lot of money." However, if you think about it, in today's stock market, $40 million just isn't that much. If Microsoft stock moves by just over 10%, that would equate to a $40 billion increase in market cap. In an average month $10 billion or so comes into all US stock mutual funds. That $40 billion increase in Microsoft's market cap in one day is four times what comes into all US stock mutual funds in a month. Even though Microsoft is still a good company, as the company grows, it gets harder and harder for the company's stock price to move up.

Check out the internet sector. Most of the companies in this sector are less than three years old. They are growing their revenues and stock prices at phenomenal rates. The stocks are young with smaller revenues and market caps and therefore it's easier for them to multiply. Even though the internet sector is a good example of small is beautiful, it's not a good example of fundamental investing which must take into account earnings growth. The vast majority of the internet companies have no earnings and for my purposes this is essential. A company must have earnings and earnings growth to be in my portfolio.

Someone might ask if small companies are where the greatest profit potential lies, why couldn't an investor simply buy a small-cap stock mutual fund? In the prior chapter I talked a little about diversification and how an investor can diversify risk away, but when you diversify away your risk, you also diversify away your chance of large profits. Wall Street and the mutual fund industry loves to imply or suggest to investors that they can get something for nothing, unfortunately, this just isn't true with investing. I am not saying that you shouldn't diversify, what I am saying is, as you own more and more stocks rather it be through stock mutual funds or individual stocks you own, your risk will decrease to a point. However, as you own more and more stocks, your chance of bigger returns also depreciates.

There is a point in a portfolio where adding more stocks will only reduce risk by a small fraction. The point is somewhere between 10-15 stocks.

"Risk associated with investing in individual companies can also be significantly reduced through diversification. However, while experts generally agree that risk is greatly reduced as more stocks are added to a portfolio, the beneficial effect significantly diminishes after 15 stocks. In fact, the most substantial reduction in risk comes at the early stages when the second and third stocks are added. By the time the fifteenth stock is added, there is very little to be obtained in the way of risk reduction." --Investment Vision, February/March, 1991, pgs. 40-41

"In the stock market, two factors will cause a stock's return to vary: changes in the firm or the way in which investors perceive the firm, and movements in the overall stock market. Thus, there are two components to the risk that an investor faces: Market Risk, which is inherent in the stock market itself (also known as systematic risk); and Firm Risk, which is associated with the unique characteristics of any one stock (unsystematic risk)."

"Firm risk accounts for about 70% of the total risk that stock investors face. Yet, this risk can be eliminated by diversifying amony different stocks--investing in, for instance, 10 different stocks rather than just one. Market risk, on the other hand, accounts for about 30% of total risk and cannot be avoided by diversification, since all stocks are affected to some degree by the overall market." --American Association of Individual Investors, "A Lifetime Strategy for Investing in Common Stocks," James B. Cloonan, 1989, pgs. 6-7

If you invested in a small-cap stock mutual fund, the fund would own up to and possibly more than, 100 stocks. The odds of most of those stocks doing well and those that don't do well to at least maintain their current stock prices is slim to none. Yes, if the small-cap sector does well, the mutual fund most likely will have a decent return, but no whereas good as that of a smaller portfolio of good small cap stocks, say a portfolio of 15 maximum.

The exact number of stocks owned is related to how much money is under management, like I said earlier with a mutual fund, as the fund grows in assets under management, the fund manager will add larger cap stocks and more stocks, the same holds true will an individual, that is, if you start out with only a few thousand dollars you may own only 2-3 stocks and than as you grow your assets you will add more and more stocks, I say no more than 15 with at least $100,000 in assets. As an individual investor you will not have to worry about adding larger cap stocks to your portfolio. The reason the mutual fund manager has to add larger cap stocks is due to liquidity issues, they are dealing with transactions that are in the millions of dollars, most likely, an individual will not be making transactions in that amount.

Since mutual funds invest in a lot of stocks and invests in larger cap stocks they are unable to maximize shareholder return. Note too, mutual funds do not own a large number of stocks because it reduces risk, an individual stock portfolio can minimize risk with as little as 10 stocks, mutual funds own a large number of stocks, because of the liquidity issue I talked about before. This is another example of how Wall Street does what's in their best interest first and yours second. It is more profitable for a mutual fund company to operate less individual funds, with each fund having a larger asset base. Moreover, you can see how mutual funds virtually eliminate firm risk simply by owning a large number of companies, not because of the financial acumen of their managers. However, no matter how many companies a mutual fund owns there is still market risk and they have put all that risk on you.

Not only are institutional investors not as likely to produce above average returns, but they are also bad for the country in general. The small company is clearly the backbone of our economy and since institutional investors, those who control more investment capital than any other group, cannot invest in smaller companies because of the liquidity issues, smaller companies do not have the same opportunities as do the larger companies when it comes to investment capital. By establishing your own stock portfolio you not only increase your chances for better returns, but you help the overall economy by directing investment capital to smaller companies. A good example of this is Fidelity, in the late Nineties, Fidelity bought tons of Microsoft, Intel, and Cisco. Microsoft, Intel, and Cisco then turned right around and with their inflated stock bought hundreds of smaller companies with superior technologies to their's.

When I refer to an individual stock portfolio I am not suggesting just any old stock portfolio, but one that has stocks with strong earnings and revenue growth, strong balance sheets, and smaller capitalizations. This initial type of stock portfolio would be first brought to my attention by the American Accociation of Individual Investors back in the late-Eighties. However, due to changes in the overall market and my personal experience I would make changes to the portfolio to better fit my personal investment needs and beliefs.

I talk more about setting up this portfolio and adapting the portfolio in the next chapters.

Summary of Why Stocks:

• You must be willing to put in the time necessary to learn about individual stocks and the overall stock market and to put in the time necessary to manage the portfolio once you set it up.

• Managing your own individual stock portfolio is the only way to maximize your profit potential.

• When it comes to a portfolio of stocks there are two types of risk the investor will face: firm and market risk.

• When I refer to an indvidual stock portfolio I am referring to a stock portfolio that consists of stocks based on strong earnings and revenue growth, strong balance sheets, and smaller capitalizations. Adapting this basic model to one's own experiences and goals.

Key Point Number 4:

Mutual funds are inherently incapable of maximizing profits. Mutual funds own too many stocks and therefore at best will only track a given market or sector over time. Mutual funds because of their large asset bases have liquidity issues which keeps them from owning the stocks that have the highest profit potential which are the smaller cap stocks.

My First Three Stocks:

I purchased my first stock in 1989. At the time, Schwab offered the best broker rates so I went with Schwab. I think it's interesting to point out here that when I became a Schwab customer in 1989 it was due to the cheaper commission rates. As a customer of Schwab between 1989 and 1996 Schwab gave me no investment advice whatsoever and when I asked Schwab about specific questions I had with investing, they generally offered no response. You see during this period, this was not what Schwab was about, that is, advice. Schwab was about cheaper commissions. However, with competition from internet brokers offering even cheaper brokerage rates than Schwab and Schwab's inability to compete with those cheaper rates (still evident today with Schwab's $29 commission over the web), Schwab would, in my opinion, all of a sudden be experts at advice.

What I am trying to point out here is that, as a customer of Schwab in 1996, I wanted cheap commissions, fast executions, the ability to "break the spread" (getting a better price than the quoted market price, if you're selling it would be getting a better [higher] bid price than the quoted market price or if you're buying it would be getting a better [lower] ask price than the quoted market price), and no problems with logging on. What I got was the most expensive web commissions, never broke the spread once, and inexperienced advice. Which brings me to one of my main points with this diary and Inside the Stock Market. Companies do not care about what's in my best interest unless is goes along with what's in their best interest. This is the number one reason I feel that you need to manage your own investments even though it does take time.

One thing that I'm not saying here is that Schwab can't change their focus. I just don't think that Schwab can do it as fast as they claimed. That is, Schwab was not maintaining an employee base of experienced brokers prior to 1996. Why would they? Why pay high salaries to experienced brokers when Schwab wasn't in the investment advice business, but in the discount broker business? And in my opinion, it would take a lot of years to change over from brokers taking orders over the phone, something you can do with a touch tone phone now, to experienced brokers who knew what they were talking about (most of the time anyway).

After establishing my first brokerage account, I purchased my first stock in August, 1989. Not much went into my decision. I got the stock from a recommendation list in Money magazine. The stock was Stanford Telecom (STII).

I sold the stock in March, 1991. During the time I owned it the stock price was mostly under what I paid for it. I sold it for a 26% loss.

The second stock I bought in November, 1989. Again, not much went into my decision. I was reading and checking stock prices in the business sections of newspapers a lot. At the time the only other information you could get on a daily basis for a stock outside of its price was the high and low price for the past 52 weeks. I thought if a stock was at a low it was bound to come back. The second stock I bought was Lee Data simply because it had hit a 52 week low. The stock basically stayed there and in July, 1991 I sold it for the same price I paid for it. The stock would aventually double and change its name, but that was after I sold it.

The third stock I bought in May, 1990 was Cascade International (KOSM). This was the first stock that I put some time in researching, however, I did get the stock from another list. It was listed in the journal of the American Association of Individual Investors (AAII). The journal called the list an illustration and not a recommendation list.

The strategy I learned from AAII was to buy "good" companies that had low institutional investors. The ownership of a company's stock is generally broken up into three categories: 1) Insiders who are directors, officers, and key employees who hold the company stock, these individuals are prohibited from trading on their knowledge, 2) Institutions, which are mutual funds, investment banks, brokerage houses, banks, insurance companies, pensions funds, and unions, and 3) Individuals, such as small investors. The theory was that if you could find good companies and buy them before the institutions got interested and held, adventually the institutions would become interested. Since the institutions had so much purchasing power, if and when the institutions got involved in the stock, the stock price could significantly rise on institutional buying.

This goes back to the liquidity issue I talked about in the prior chapter. That is, if you have a company that has a low number of shares outstanding, most likely, a smaller cap stock, and the demand for the shares increase, in the above example because of institutional interest and therefore buying of the shares, the price of the shares will significantly increase because there is a small supply of shares available (supply and demand theory).

This is a good time to talk about "float". The Float of a stock is the number of shares outstanding minus insider ownership. For example, if you have a company that has 10 million shares outstanding and the insiders own 3 million, the float of the stock is 7 million. When it comes to stock price movement caused by supply and demand, the float is more relevant than simply the shares outstanding because the float is specifically the number of shares that are currently available for trading.

Be advised at any given time the float can be increased by insiders selling or by the company itself issuing more shares (selling equity in the company). The exact opposite happens in these cases, that is, the supply of shares is increased which can cause the stock to fall in price. I am not saying that is what will happen for sure. The company may be growing its business at the rate necessary to attract more investors and even though the float increased, the number of new investors or the demand for the shares floated is greater than the number of shares added to the float, and therefore the price of the stock actually goes up.

To summarize, the third stock I bought was based on the theory that buying stocks that had lower institutional ownership and smaller floats could result in substantial stock price increases if institutions would become interested and therefore buyers of the stock. This was one of the criteria I considered with my first stock, but there were other criteria as well.

Large insider ownership was another criteria. The theory was that if the people who ran the company had a vested interest, that being they owned common stock in the company, those running the company would be more focused on the company's stock price. For me this specific criteria prove to be meaningless. That is, most high level executives are already very wealthy compared to other stockholders and the month to month or even the year to year fluctuations in the company's common stock had very little to do with their personal finances. A great example of this was a few months ago when Larry Ellison the CEO of Oracle was interviewed by Ron Insana of Fox News. Oracle stock had just taken a hit. During the interview Insana remarked to Ellison about Ellison's losses being somewhere around $1 billion. Ellison remarked back that the amount was closer to $3 billion, but not to worry, he wasn't driving a different car or living his life any different because of it. I guess the $8 billion or so Ellison had left was enough to pay his bills.

Another example of this is with Leisure Concepts (LCIC). This stock I bought in February 1993 and was the sixteenth stock I bought. It had very high CEO ownership. I paid $7 1/2 for it and within months it would double. At the time, I was more of a long-term investor so I held. Unfortunately, the stock would turn at around $14 and nose dive to $3, I sold at $2 5/8. Just last year I picked it up again at just under $3, it's in the low $20s now (the name was changed to 4Kids Entertainment, KIDE). My point is that during the whole time from 1993 when I first bought it, to now, it's always had high CEO stock ownership and that ownership did not correlate at all to the stock price. This is one of many examples of this lack of correlation between high insider ownership and stock price appreciation.

The fact is, the number one goal of executives of a company is suppose to be stock price maximization regardless of the executives ownership percent in common stock. But in reality even though the executives may want to increase stock price because that's what the shareholders want or they want to do it because they own a lot of stock themselves (including stock options), the executives are still only a small portion of what makes a company successful. Granted, they get most of the credit and financial rewards, but that doesn't mean they deserve it.

So far the only criteria for a stock in my portfolio is a small float, most likely a smaller cap stock. Back in the late Eighties and early Nineties I would have also included large insider ownership in my criteria. However, from experience I have found that large insider ownership means nothing and therefore, it is no longer part of my criteria. In the next chapter I talk about the specific fundamentals I look for in a stock.

One final thought for this chapter. Remember the third stock I bought, Cascade International. In September, 1991 I sold it for a 200% gain. Two months later, The Overpriced Newsletter (I think that's what it was called) remarked about the stock. The newsletter said they couldn't verify the number of stores the company claimed to have open and operational. The stock started falling. As the stock was falling the company denied the accusations.

I thought about buying it again after the stock lost half its value. The only question was who to believe, the newsletter or the company? I believed the company and bought. Within a couple of weeks the CEO could not be found and the stock price went to zero. The SEC remarked about the incident, saying they couldn't watch every company. Every now and then I still receive information about the class action lawsuit against the company, but I have still not received any money.

It took several more years and disappointments before it would sink into my brain that I couldn't believe anybody on Wall Street. To me it didn't matter if it was an outright lie or an oversight, the end result which was a loss of money, was the same. I was raised in a small town and was brought up believing in high ranking officals and the news media, however, when I got involved in the stock market, this proved to be anything but true.

Summary of My First Three Stocks:

• Before you can buy a stock you need to decide on a broker. Pick a broker that best can meet your needs as a customer. Is it advice you're looking for (good luck if it is)? Or is it cheap commissions? Realize that brokers will change their business plan and their changes might not be good for you. Remain flexible, and if your broker is not meeting your needs, change brokers.

• The first two stocks I bought were shots in the dark (not recommended). The third stock I bought was a small-cap stock with a small float.

• Ownership of a company's stock can be broken down into three categories: 1) Insiders, 2) Institutions, and 3) Individuals.

• The float of a stock is the total shares outstanding minus insider ownership. The float is the number of shares available for trading and if the float is small, the stock price will appreciate faster with buying.

• When I first started, I looked for stocks that had high insider ownership. I thought that if the insiders owned a lot of common stock they would be more focused on the stock price. In time, this proved not to be true.

Key Point Number 5:

Don't believe the company, a newsletter, an analyst, or anybody else in business. Take infomation with a grain of salt. It's not about being cynical or skeptical, it's about being smart and protecting your financial assets.

Fundamental and Technical Analysis:

May 30, 1999

There are many different ways to analyze stocks. For my purposes there are two basic types of analysis when it comes to stocks: fundamental analysis and technical analysis. Technical Analysis is the study of stocks and the overall market based on supply and demand. A technician (as one who employs technical analysis is called) studies price movements, volume, trends, and patterns, from charts and computer programs. Based on these studies, a technician attempts to predict future price movements in individual stocks, the overall market, and other investment vehicles. Fundamental Analysis is the study of stocks based on a company's balance sheet and income statements, and for the study of the overall market, based on data such as gross national product, inflation, interest rates, unemployment, factory manufacturing levels and inventories. Based on these studies, the fundamental analyst attempts to predict future price movements in individual stocks, the overall market, and other investment vehicles.

As with most things in life the key is balance. To buy a stock just because its trend is up (based on technical anaylsis) is crazy. And buying a stock that hasn't moved in price for 5 years just because you think it's worth twice as much (based on fundamental analysis) is just as crazy. I think the best strategy is a combination of the two.

The first criteria I use in selecting a stock is low float (previous chapter). The theory here is a stock that has a small supply of shares available for trading will rise in price faster with buying. This is supply and demand theory and comes from technical analysis. The last and most important part of technical analysis I use is "the trend is your friend" or prices move in trends and trends persist. For my purposes I am going to call this cliche "momentum." Momentum is a "force" behind a stock's price movement. The force can be fundamentals such as a good earnings report or superior new product. The force can be an interest in the stock by institutional investors. The force can be an interest in the stock by day traders, since to have momentum you need stock price movement and movement is volatility which is what day traders like.

If a stock has been idle regarding its price and the fundamentals suggest the stock is undervalued and a buy, I will not buy the stock because the stock has no momentum. Likewise, if I have already bought a stock and the stock price has moved up to a point where fundamental analysis suggest the stock is now overvalued and a sell, I will not sell if the stock still has momentum on the upside.

You may ask how do you quantify momentum, in my experiences you don't. You will get a feel for momentum by watching the stock price, volumes, and fundamentals. Because momentum is not exact you don't try and time it perfectly, that is, buy 1,000 shares at the low and then sell them all at the high (I know that's what you want to hear, but it just doesn't work like that). Since I can't time it perfectly, I will first buy 200-500 shares based on my strategy and then buy more if my analysis is proven correct by an increasing stock price. Likewise, when my strategy suggests I should sell, I will sell only a portion of my holdings initially and then sell more when my analysis is proven correct by a decreasing stock price.

The rest of my criteria for buying a stock is mainly based on fundamental analysis. On the subject of fundamental analysis there are two basic types: growth and value. (When I talked about the types of mutual funds, two of the types were growth and value, these types of mutual funds buy stocks based on these two types of analysis.) Fundamental analysis using the Growth Approach, analyses a company's revenue and earnings growth rates (mainly the company's income statements). The theory is a company that sustains consistently superior revenue and earnings growth will see its stock price appreciate in a superior fashion as well. Fundamental analysis using the Value Approach, analyses a company's valuation and financial strength (mainly the company's balance sheets) and from the analysis determines if the company is over or undervalued as compared to the company's stock price. The theory is a company that has financial strength and tangible value more than its current stock price will, at some point, do so. Some may say that fundamental analysis in general determines the valuation of a company's stock, however, for my purposes, determining valuation is more specifically a part of fundamental analysis using the value approach. (I discuss the income statement and balance sheet in the next chapter.)

Again, as with most things in life a balance is the best approach. There are companies that have both good earnings and revenue growth, and financial strength and tangible value. Especially now with mutual funds being forced to buy larger cap stocks because of liquidity issues, leaves the small-cap stocks as a whole undervalued. If you have the richest person not attending your auction, you're not going to get as much for your products.

This fact creates an opportunity, but is also poises a possible problem for the small-cap stock investor. You may have invested in a small-cap stock with great earnings and revenue growth, and good value, but because it is a small-cap stock with a small float, not all mutual funds can be buyers of the stock.

This a big question you have to ask yourself. For the past decade, mutual funds have increased their asset bases by literally trillions of dollars creating liquidity issues for many individual stock mutual funds. The question is will these liquidity problems remain in the future? Hopefully, mutual fund assets are not going to go down in asset size which would mean there was a bear market (Technically a Bear Market is a correction in the stock market of 20% or better, it does not matter how long it takes for the correction to occur.), or investors were simply losing confidence in the market and started withdrawing their money. And if mutual fund assets continue to grow there will still be a liquidity problem suggesting tipid growth in small-cap stocks. However, there is also clear evidence the larger cap stocks are getting severely overvalued, maybe to the point where investors, including the institutional investors, must look to other areas such as the small and mid-cap sectors. Based on the past two months of market activity the latter seems to be occurring, that is, there has been greater interest in the smaller cap sector (the Russell 2000) than the larger cap sector (the S&P 500 stock index).

I would like to point out there is one way that stock mutual fund assets could go down and be good for the market. That way is if individuals would become their own managers. Individuals would withdraw assets from their mutual funds, but turn right around and invest the money back into the market through individual brokerage accounts. Personally, I think this would be great for the economy as well as the stock market, but it most likely will not happen. The mutual fund business is using your money to sell itself to America though a powerful marketing machine, also most Americans are already too busy keeping up with everything and have no time left to devote to managing their own investments.

One way I try and draw attention to the stocks in my small-cap portfolio is to buy stocks in a certain sector. Last fall I was heavily invested in semiconductor capital equipment, the stocks had lost over half their values after the correction in the overall market last summer. Within six months my porfolio would be up over 150%.

Summary of Fundamental and Technical Analysis:

• There are two basic types of stock analysis: technical and fundamental.

• Momemtum is a "force" behind a stock's price movement and is based on technical analysis. I try to judge a stock's momentum when I buy and sell a security.

• Fundamental analysis can be either based on the growth or value approach. I use both for my analysis of a stock.

• To draw attention to the stocks I own I will focus on certain sectors of the overall stock market that I feel will perform better than the overall market. So far, the number one sector for me has been technology.

Key Point Number 6:

Small-cap stocks have historically produced the best investment returns. However, because of liquidity issues, small-cap stock investors must ask themselves one question. Will the liquidity issues continue to be a problem for the small-cap sector or will the overvaluation of the larger cap stocks force institutional investors to look for better values in the small and mid-cap sectors?

Analysing a Company Based on Fundamentals:

March 23, 2000

In this chapter I am going to discuss some specifics of fundamental analysis, both growth and value. I am not going to get "deep" into this and I'm not suggesting I could if I wanted to. One thing you have to realize about stock investing is that if it was about "crunching numbers", large brokerage houses with their huge staffs and computers would have figured out how to do it a long time ago. Based on their performance, not their advertised performance, but their true performance, brokerage houses including the mutual fund companies have not come close to figuring it all out.

What I mean by "crunching numbers" is like with technical analysis where you study charts and volumes to determine buys and sells. And as far as crunching numbers with fundamental analysis, I'm referring to sophisticated ratio analysis including indepth financial statement analysis. My strategy for buying and selling individual stocks does not include any of this type of number crunching. I only use some basic ratio and financial statement analysis in regards to fundamental analysis and as far as technical analysis, I only look at momentum which I have already discussed.

One part of fundamental analysis using the value approach tries to estimate a price a company is worth, not what investors are willing to pay for the stock which is the market price, but what the company is worth based on the balance sheet and income statement. The Balance Sheet shows assets, liabilities, and shareholder equity (assets minus liabilities equals shareholder equity). The Income Statement shows revenues, expenses, and net income (revenues minus expenses equals net income). To determine the valuation or an estimated worth of a company I use three ratios: 1) Price to Book, 2) Price to Sales, and 3) Price to Earnings.

To determine the Price to Book Ratio we must first determine the per-share book value. The per-share book value is equal to the difference between the balance sheet assets and the balance sheet liabilities called shareholder's equity, divided by the number of shares of common stock outstanding. For example, a company's assets equal $100 million and their liabilities equal $40 million, $100 million minus $40 million equals $60 million (shareholder's equity). If I take this amount of shareholder's equity and divide it by the number of shares of common stock outstanding, let's say, 30 million, I have a per-share book value of $2. Now take the current price (market price) for one share of common stock and divide it by the per-share book value of $2. If the current price of one share of common stock is $10 the price to book ratio is 5, $10 divided by $2.

So now you have a stock that has a price to book ratio of 5, what does that mean? It means investors are willing to pay 5 times what the company's estimated value is based on the balance sheet's liabilities and assets (its book value). Understand, the company's balance sheet liabilities and assets are made up of several items. For example, liabilities include short-term and long-term liabilities. There's not much estimation needed here, that is, if the company is being honest, the balance sheet should show exact short-term and long-term obligations of the company. However, with the asset side of the balance sheet there is much more room for stretching the truth so to speak. Depending on the accounting policies of the company, assets can be valued at different amounts. For example, inventories can have a higher valued placed on them depending on what inventory accounting policy the company uses. It's not important to understand the different accounting policies, but it is important to understand the balance sheet does not necessarily have amounts that are exact. Also note the book value is not the liquidation value, that is, the book value is simply the value of the company based on the balance sheet which is only an estimate.

The balance sheet is usually only done once a year, that is, at the time the balance sheet was done, e.g., December 31, the per-share book value was $2, however, six months after the balance sheet was done nobody really knows what the current per-share book value is. Obviously, you should not put a lot of weight on just one ratio.

Generally speaking, I start to say a stock is overvalued based on its price to book ratio when the price to book ratio gets over 10. Does that mean the stock is to be called overvalued? No. It means the stock looks overvalued based on its price to book ratio.

Some tid bits of history on price to book ratios. When I started investing in the mid-Eighties a price to book ratio of greater than 5 was considered overvalued and the stock market as a whole would start to be considered overvalued when its overall price to book ratio started to get over 3. This was pretty consistent throughout the Twentieth Century until the Nineties. In the Nineties several factors would cause people to invest in stocks at high levels: a fear of Social Security failing, since people didn't think Social Security would be there for them they started to invest, they didn't have a lot to invest so they went where they could get the best return, the stock market; a powerful marketing campaign from Wall Street and the mutual fund industry; a generation (the baby boomers) who had only known good times; and an outstanding economy and thoughts of a bright future for the economy (in spite of Mr. Greenspan). This demand for stocks would cause stock prices to go up and inturn drive the overall stock market to a higher valuation. Investors are willing to pay more for stocks in general, hence, now to be called overvalued based on price to book ratio, a company's price to book ratio needs to be at least 10.

A wise investor is one who realizes this: just as easily as investors are willing to pay 10 times price to book values, investors can decide to pay only 2 times price to book value.

Back to fundamental analysis based on the value approach. The next ratio I look at is the Price to Revenue Ratio. To find the price to revenue ratio we first must determine the revenue per-share amount. The revenue per-share amount is equal to the total revenue of the company (income statement) divided by the number of outstanding shares of common stock. For example, if the total revenue is $90 million and the number of outstanding shares of common stock is 30 million, I have a revenue per-share value of $3, $90 million divided by 30 million. Now take the current price (market price) for one share of common stock and divide it by the per-share revenue amount of $3. If the current price of one share of common stock is $10 the price to revenue ratio is 3.3, $10 divided by $3.

So now you have a stock that has a price to revenue ratio of 3.3, what does that mean? It means investors are willing to pay $3.30 for every $1 in revenue. Generally speaking, I start to say a stock is overvalued based on its price to revenue ratio when the price to revenue ratio gets over 10. Does that mean the stock is to be called overvalued? No. It means the stock looks overvalued based on its price to revenue ratio.

The last ratio regarding valuation is the Price to Earnings Ratio. To find the price to earnings ratio divide the current stock price (market price) by the amount of earnings for the last four quarters in dollars. For example, if the current price of one share of common stock is $10 and the earnings for the last four quarters in dollars is 0.25 (25 cents) the price to earnings ratio is 40, $10 divided by $0.25.

Generally speaking a price to earnings ratio of 40 suggests the stock is overvalued based on its price to earnings ratio. Does that mean the stock is to be called overvalued? No. It means the stock looks overvalued based on its price to earnings ratio.

Historically speaking anytime the overall market had a price to earnings ratio of greater than 25, the overall stock market would be considered overvalued. For example, in the 1920s the price to earnings ratio of the overall market was around 20. In the 1987 crash it was in the low 20s. There was (I say was because you rarely hear about it any more) a rule of 17.5:

"Simply put, the rule of 17.5 states that over the long run the sum of a given year's inflation rate (as measured by the consumer price index) and the same year's average market P/E multiple (as measured by the S&P Industrials' P/E) tends to equal 17.5." A.G. Edwards & Sons Inc., Securites Research, Special Report, The Growth Stock Approach To Investing, Donald T. Spindel, CFA, 1990.

Summary of My Stock Portfolio Strategy:

In this chapter I'm going to summarize my stock portfolio strategy. I am not going to talk about asset allocation (I discussed this in previous chapters). Just to refresh your memory though. Asset allocation is where you make a decision on how you will divide up your investment capital among the three major asset classes: cash, bonds, and stocks. You may decide to not allocate any of your investment capital to stocks (you don't want the risk) or if you do decide to invest in stocks, you may decide to have a mutual fund manage your stocks vice doing it on your own (you don't have the time and trust the mutual fund company). In both of these cases, this chapter is not applicable to you.

This chapter is for those of you who have decided to invest in stocks and to setup your own stock portfolio.

• Don't listen to any one person, magazine, financial news program, or any other financial news media source. Utilize a diversity of investment opinions and informational news sources. Develop you own strategy. Hopefully, your strategy will include some type of fundamental analysis and not just buying and selling on momentum like the crowd is doing now.

• I believe the best chance for investment profits lies with the smaller cap stocks. Most of the stocks I own have less than $1 billion market caps. I rarely buy a stock that has a market cap greater than $10 billion. small-cap stocks have the best overall stock performance in the 20th century. Most stock price appreciation occurs when the company is young and in its growth stage. The float of small-cap stocks is small compared to the larger cap stocks, a low float means the supply of stocks available to be bought and sold is low and therefore, when demand heats up for the company's stock, the stock price will increase rapidly.

  Note: there is a catch 22 with the small-cap sector: the smaller floats are good for stock price appreciation, but the small floats are bad for liquidity purposes, due to the poor liquidity of the smaller cap stocks, large institutions don't like them. When you have the biggest buyers not coming to your auction, that's not good. However, since the large institutions are busy buying the larger cap stocks which are severely overvalued, the smaller cap stocks are actually undervalued even though they have the best earnings and revenue growth rates. This is a perfect example of how Wall Street does what's in their best interests and not yours.

• I look for earnings and revenue growth (fundamental analysis using the growth approach). I would like to have consistent (3 years) earnings and revenue growth greater than 30%. However, the past couple of quarters of earnings and revenue growth is more important, and the next couple of quarters (which can only be an estimate since they're in the future) are the most important. Most likely, you won't find the perfect stock. I look at operating earnings growth as well as general earnings growth and I look for internal revenue growth.

• I'm going to lump valuation, debt, and performance ratio analysis (fundamental analysis using the value approach) all together. No one ratio stands alone. I look at all three parts and each individual ratio, but my final opinion is based on an overall assessment.

• I now compare the two parts of fundamental analysis: growth and value. Is the growth I'm getting worth the price I'm paying for the stock?

• I find stocks that fit my fundamental analysis guidelines by searching databases using a stock screener, from friends, and by keeping up with the business and market news (For example, I may read a certain magazine and read about a stock, I will check out the stock's fundamentals and see if I'm interested).

• Once I find a few stocks that match my criteria for market cap and fundamental analysis I look for momentum. I don't want to waste my time holding a stock that has great growth and valuation, but no stock price movement. I want some investment interest in the stock.

• After the fundamentals and momentum, I read most of the last year's news stories on the stock. This is not as hard as it may seem, my stocks are mostly small-cap and they generally don't have as much news as the larger caps. I don't read every news story and of the ones I do decide to read, I don't necessarily read the entire article.

• After watching the stock, I make a decision. If I decide to buy, I will start out with a small chunk, about $2,000 to $5,000 worth. If my decision to buy is reinforced by the stock going up I will buy more. As long as the fundamentals are there to support the stock price, I may continue to buy. At some point I will start to take some profits, and if the fundamentals turn negative, I will intensify my selling and may even liquidate my entire position. I can't be more specific because too many things are happening during this period, that is, the period from when I start to buy to the time I'm completely out of the position. Most NASDAQ stocks are now held for only a couple of months. My time horizon is slightly greater than that, say, 1-2 years. However, If I think I have a real winner, I put no time limit on the stock.

• For those of you who are thinking as you're reading, you may be asking what about the company's management and products or services. Why aren't these things mentioned? They're too hard to analyze, most of us don't have the means or knowledge necessary to analyze a company's management or products. I'm not saying that you can't try and in some instances, getting into it, may help you make a better decision. For example, the company's products are ones you, or someone you know, are very familiar with and therefore, you have the experience necessary to do a more indepth analysis of the company's products.

• My analysis so far has been company specific. Stocks are not only affected by company specifics, but by sector and the overall economy. Again, sector analysis and trying to analyze the overall economy is very difficult. This is another reason why I like the small-caps, they are less affected by their sectors and by the overall economy. Even though, it's still a good idea, to evaluate sectors and the overall economy as best you can.

  The last chapter in this Diary I'm going to devote to talking about the overall economy and sector watch.

What Didn't Work for Me:

July 3, 2000

When it comes to investing there are all sorts of gimmicks which are said to improve your investment return if you implement them. For example, gimmick number 1, Insider Ownership. (I have discussed this before, but will reiterate it here.) The claim is: if you own stocks that have a large percentage of insider ownership your stocks will perform better than those stocks that have low insider ownership because the CEOs have more of a vested interest in the company's stock price.

CEOs makes so much money from their salary and bonuses there is really no pressure to make additional money from stock options or from their holdings of common stock. Sure, it's great for them if they do, but if they don't, they still have millions to spend. Short-term swings in stock prices that can be up to 60-80% losses, have very little impact on upper management (I'm not saying they like it, what I am saying is that it doesn't really affect them financially one way or the other... in the short-term, and if the stock does stay down, it's almost guaranteed that the compensation board will lower the strike price for the CEO's stock options at their very next opportunity.). However, small shareholders can be severely impacted. And to make matters worse the small shareholders don't know if what they are being told is true or not, that is, is the 50% loss they have seen in the share price due to one bad quarter or is the problem really worse than what the company is owning up to, meaning, the stock could lose even more?

The reality is CEOs focus on the company internals and when the company's stock price takes a drive, most CEOs will simply play another round of golf. That is, they will take no specific, active, action in addressing the issue of their company's stock dropping. And if they do decide to at least open their mouths about the falling stock price it will be only to let investors know that they don't comment on their company's stock price, they will concentrate their efforts in making their company one of the best darn companies in the world.

I have seen no significant difference in stock performance when it comes to comparing stocks with high verses low insider ownership.

Gimmick number 2 is Insider Trading Activity. Some say when an insider buys that's a good sign for investors. They say the insider is buying because the future looks good and if anybody would know about the future prospects for a company, insiders would. The problem with insider trading activity is with the amounts being bought. Here's a CEO worth $millions and she buys a couple of hundred thousand bucks worth of her company's stock. So what? If CEOs really had faith or assurance that their company's stock was in for a ride up, they wouldn't be buying a few hundred thousand dollars worth, but would be buying millions and the vast majority of insider buys are not in the millions.

I have seen no significant difference in stock performance when it comes to comparing stocks with insider buying verses those with no insider buying.

Note: It means nothing in itself when an insider sells. What executives do most of the time is sell their common stock and continue to add more stock options to their compensation packages. You see, with common stock there is risk, but with stock options there is no risk: if the stock falls in price, compensation boards will just reset the strike price for the executive's stock options. Look at the vast majority of stocks from their IPOs and you will see tons of insider selling and after a few years, most executive will own very little common stock.

Gimmick number 3 is stock buybacks. A Stock Buyback is when a company buys back its own stock. Some say if the company is buying back it's own stock, the stock must be a buy at this price. A stock buyback is kind of like insiders buying, that is, in a stock buyback the executives make the decision to buy back the company's stock, with insider buying, again, the executives are making the decision to buy the company's stock, however, in a buyback the money used to buy the company's stock comes out of the company's till whereas with insider buying, the money used to buy the company's stock comes from the personal till of the executive who is buying. Also, the profits or losses from the buying of the company's stock with insider buying falls on the executive who bought, if the stock goes down the executive will personally lose money, if the stock goes up the executive will personally make money. It's more complicated with a stock buyback when it comes to profits and losses from the buying back of company stock, but the end result is the same, that is, if the company's stock goes up after a buyback, that's good for the company, and if the stock falls that's bad. The reason it's more complicated with a stock buyback is that remember when we talked about earnings per share and how to calculate it. Part of the caluculation is outstanding shares, when a company buys back stock, it reduces the number of outstanding shares which will, at that moment in time, increase earnings per share, which inturn reduces the price to earnings ratio. How investors and the stock market react to these new numbers is nothing more than a guess.

I have seen no significant difference in stock performance when it comes to comparing stocks that have instigated a stock buyback (or stock repurchase plan) verses those with no announced stock buybacks. I say announced because this is when the stock will see action, if any: on the announcement, however, the company, even though they announced a stock buyback, may not actually buy their own stock back in the amount they stated in the stock buyback announcement.

Gimmick number 4 shorting a stock. When you Buy Long you believe the stock price is going to rise. When you Sell Short you believe the stock price is going to go down. To sell short a stock you borrow the shares from your broker and sell them at the current price. Why are you selling them now? It's because you believe the stock price is going to go down, if you're correct, you will be able to buy the shares back at a lower level. When you do buy the shares back you will immediately turn them over to your broker, paying your broker back the shares you borrowed from him before (the key here is to realize that you borrowed X number of shares from your broker and that's what you owe him: X number of shares, not some cash amount like with a regular loan). For example, I borrow 100 shares of a $10 stock from my broker and sell them (proceeds from the sell $1,000 minus commissions), later the stock falls to $5. I buy the 100 shares back for $500 plus commissions and pay back my broker the 100 shares. My profits are $1,000 minus $500, minus commissions and minus the interest expense during the period between selling and buying back the security (my broker charged me interest for borrowing the shares until I paid him back the shares). Profits from the transactions about $450.

The above example is when the investor made a good call: the stock lost half its value. How much could the investor who shorts make at most? Since the investor believes the stock is going to go down, the best thing for a short position holder is for the company's stock to go to zero. In this case, the best the investor can do is to almost double his money. For example, I borrow 100 shares of a $10 stock from my broker and sell them (proceeds from the sell $1,000 minus commissions), later the stock falls to $0. I buy the 100 shares back for 1 dollar plus commissions and pay back my broker the 100 shares. My profits are $1,000 minus 1 dollar, minus commissions and minus the interest expense during the period between selling and buying back the security. Profits from the transactions about $950. Since the stock cannot fall below zero, I limit my profits to about 100%.

What if the investor who shorts makes the wrong call: the stock goes up...and up...and up? The investor who shorts has unlimited risk in this case. For example, I borrow 100 shares of a $10 stock from my broker and sell them (proceeds from the sell $1,000 minus commissions), later the stock rises to $30. I buy the 100 shares back for $3,000 plus commissions and pay back my broker the 100 shares. My loss is $1,000 minus $3,000, minus commissions and minus the interest expense during the period between selling and buying back the security. Loss from the transactions about 2,050. I lost over 200%. And if I had waited longer to close out my short position and the stock continued to rise, I could lose more and more. To make matters worse: remember you borrowed the shares and every time the stock rises, your equity in your margin account gets less and less, and you could get a margin call, that is, you will have to come up with some cash to get your margin account equity up to the requirements of your broker (to short a stock you need a margin account as well as a broker, I talk about margin accounts later).

The odds are completely against you when you short a stock: when it comes to stocks and the stock market the trend is up, not down; most companies are trying to improve their businesses which helps stocks; the profit potential with shorting is limited to l00%; and the risk is unlimited.

Gimmick number 5 is short interest. Some say that when a company's short interest rises, look out, the stock is in for a correction down. A company's Short Interest is the number of shares outstanding that are held is a short position vice long position. For example, if a company has 30 million shares outstanding and 3 million shares are shorted, the short interest is 10%. Short interest above 10% is generally considered bearish. However, even when the short interest is 10%, the long position in the stock is still 90%, for every one investor who thinks the stock is going to fall there are 9 investors who think the stock is going to rise.

It is very difficult to try and estimate at what percentage of short interest the company's stock will correct. Will it be 5%, 10%, 20%, for a particular stock, and when you learn what percentage it was with any given particular stock, will the percentage be close to the same for other stocks?

I have seen no significant difference in stock performance when it comes to comparing stocks with higher levels of short interest verses those with lower levels of short interest.

Gimmick number 6 upgrade/downgrade watching. This is one of my favorites. Upgrade/Downgrade Watching is when you put some faith in the analyst's recommendation for a given stock (analysts rate stocks as buys, hold, and sell, and many brokerage houses have come up with their own phrases such as long-term accumulate, etc.). In the early Nineties I asked my broker at the time, Charles Schwab, how I could get analyst's upgrade and downgrade info. At that time Schwab was not much into providing info like that, and when I asked for the info, I never got a response from Schwab (Schwab was not being challenged by on-line brokers then, that is, Schwab was not in the info business, mostly just cheap commissions was his thing, in my opinion Schwab wouldn't get into the info business until he was force to by cheaper on-line commissions, sometime around 1996). Why I wanted the analyst's upgrade and downgrades was because when they talked some investors would listen and the stock would fall or rise depending on what the analyst's recommendation was. However, as time went on, I noticed the analyst's recommendations were having less and less affect and what affect they did have was becoming more and more unpredictable. In other words, the upgrade and downgrade info was not very useful to me as an investor. Even if you do find an analyst to listen to, it won't be long before they turn sour and you'll need to find another analyst to listen to...and on and on. (Three months ago there were 30 analysts following Amazon according to Yahoo Finance Research: 11 rated Amazon strong buy, 11 rated it moderate buy, and 8 rated it a hold, out of 30 Analysts, not one, rated Amazon a moderate sell or strong sell, today, Amazon has lost 40% of its value in the last three months, you have to admit to yourselves rather you like it or not, to not have one analyst out of 30 rate Amazon a moderate or strong sell and then have the stock fall by 40%, makes the analysts as a group, look pretty stupid.)

Part of the Game:

July 15, 2000

Someone once said, "Don't judge someone on their intensions, judge them on their track record." Don't judge a company, a ceo, the NASD, the SEC, a financial news media source, an analyst, a broker, or anybody else in business on their intensions. For example the SEC wants to believe they do a pretty good job, but in reality they do a pretty piss poor job. Most of the time, when market sensitive information is released, you can look back a few hours, a few days, and sometimes even a few weeks and see the underlying investment vehicle moved before the news was made public, that is, there was a leaking of inside information. This would not be true if the SEC was doing their job. Is there less inside information being leaked out now than in the Twenties, of course, in the Twenties the leaking of inside information wasn't even against the law.

I am the type of person who sees things as they are regardless. Just because I would like to think the SEC is doing its job, I can't tell myself they are when I see so much stock price movement before the news.

If you are going to invest in stocks they are some things you have to accept because it's part of the game. Insider trading is one thing you will have to accept.

I personally believe one reason there is so much leaking of inside information is the simple fact companies do not fully disclose market moving information. I'm not talking about proprietary information that has to do with products or a company's competitive advantage in the market place. I'm talking about information all investors should get at the same time: earnings figures, loss of an important customer, mergers, tender offers, insider trading activity, secondary offerings, and the list goes on and on. If companies would fully disclose market moving information in a more prudent manner vice sitting on it, there would be less insider information leaking out. The longer a company sits on the information, the more likely the information will leak out illegally.

Just yesterday (July 14) a stock I own fell 11 points and the day before it fell 6 points. Bloomberg had put out a story stating the company was going to miss earnings estimates. The company did not inform investors until after the market closed on Friday that they were unaware of any problems with the earnings estimate, they were comfortable with the estimates. The company executives claimed to be in a meeting at the time their stock was falling 20% and were unable to get out the story in a more timely manner. Tens of millions of dollars were lost by shareholders as the company execs sat in the meeting.

To make matters worst, some companies will offer a "no comment" remark to questions involving their company's stock price movement. For example, it's not unusal for an analyst or a financial news media source to make negative comments about a company's stock. When the company is asked directly about the remarks, the company simply says, "No comment, we don't discuss matters involving our company's stock price."

Maximizing Profits:

The vast majority of capital in America is invested to preserve capital. Most of the money in America is in a few hands, and those individuals have so much money that their only concern is to preserve what they have, they don't need to make any more.

However, I still need to make more money with my money. I need to maximize my profits. No, that doesn't mean I'm going to put my money in some get-rich-quick-scheme, but I am going to try and get as much bang for my dollar as I can.

One way to do that is with a margin account. Yes, margin accounts are risky, but they are what I call fair risk, you get what you pay for.

A Margin Account is an account that allows you to borrow money using your stocks as collateral, you use the borrowed money to buy more stock. A margin account increases your investment leverage. Being a responsible investor is mandatory when dealing with margin.

Basically, when it comes to my margin account, I'm mostly concerned with "equity percent." If I open a margin account I can borrow an equal amount to buy more stock (Note: my broker requires that the stocks I buy have a share price of $10 or more or they are not considered fully marginable, brokers vary regarding this issue.). If I initially invest in my margin account $4,000 I am able to buy an addition $4,000 worth of stock.

The broker is now holding $8,000 worth of my stock and I have $4,000 in equity or $4,000/$8,000 which is 50% margin which is what the SEC requires (margin requirement is another thing that is set by the Fed). Another way of looking at it is I'm leveraged at 2 to 1. If my portfolio ($8,000) doubles I make $8,000 and I did that with $4,000 in cash (2:1). I still owe the broker $4,000 plus any margin interest. I don't have to pay the broker back at any specific time, I can just continue on if I choose. Now my equity percent is $12,000/16,000 which is 75% which is great and I can relax a little bit (even though this may be an over statement since the market, even as a whole, is becomming very volatile).

However, always remember that just the opposite could have occurred. That is, I put in the $4,000 and buy $8,000 worth of stock, my equity percent is 50%. Instead of my portfolio doubling it drops by 25%. After dropping 25% my margin equity is $2,000/$6,000 or an equity percent of 33% (My account equity is only $2,000 now not the original $4,000 because my portfolio just lost me $2,000 of my money, $8,000 worth of stock minus 25% or $2,000, then take the $2,000 from my original $4,000 and you get my equity of $2,000.). Brokers vary on when they send out a "maintenance call" which means I have to come up with additional cash or I have to sell stock to bring up my "equity percent" to an acceptable level.

Like I said, brokers vary, mine is 35%, and when my equity percent fell below which it did at 33%, I would get a "maintenance call" and be required to bring my equity percent back up to 35%. If I don't send in cash or sell stock immediately, my broker will sell stock in my account to do it, that is, bring up my equity percent. In this example, my portfolio only had to fall by 25% for me to get a "maintenance call" when I initally margined to the maximum allowed which was an equity percent of 50% (or 2:1 leverage).

Another way to maximize profits is though good tax planning. I'm not giving any advice about taxes, I'm simply going to tell you some things you should be aware of. If you hold an investment for greater than one year the capital gains tax drops from 28% or higher to 20%. If you buy a stock today and six months later you feel the stock is going to tank, don't hold the stock just so you can save a little on capital gains tax. If on the other hand you have owned a stock for two days shy of a year and want to take some profits, and the stock is fairly steady, wait two more days before you sell that way the sell will be recorded as a long-term gain and the tax rate will be 20%.

Utilize tax deferred plans like IRAs and 401Ks. Investigate the possibilities of ROTH IRAs. Unfortunately, when it comes to taxes there are no easy answers. Speaking for myself, I believe taxes are going to go up in the future, I don't want to defer all my taxes with regards to my savings and investment. On top of that, unless you're one of the super rich, when you make money you like to spend and enjoy some of it and to do that you are going to have to realize the gain and therefore are going to pay taxes on the gain.

Deferring taxes is great because you have more investment capital to work with, but at the same time holding a losing investment, that is, losing your capital because of a bad investment is just as bad as having to pay taxes on it.

Summary of Maximizing Profits:

• A margin account allows you to borrow money using your stocks as collateral and is a good way to increase your investment leverage. Being a responsible investor is mandatory when dealing with margin.

• The way an investor deals with taxes through IRAs, ROTH IRAs, 401Ks, and long-term capital gains can make a big difference in your total net return over your investing lifetime.

Key Point Number 8:

Remain flexible. The market and investor sentiment are constantly changing. You need to adapt to the current market conditions to maximize profits. For example, value investors got burned in the Nineties because they did not want to except the fact that investor sentiment was shifting to growth stocks in the early part of the last decade. Being flexible is not to be confused with a buy and hold strategy. That is, if you believe there is no way to exploit stocks or the stock market, then you need to dollar-cost-average into an index mutual fund and hold for the long-term, however, if you believe there is a way to "beat" the market, I feel you will need to remain flexible to "beat" the market consistently.

Market Overview:

July 20, 2000

When someone decides to invest in the stock market through individual stocks you can be a bottom up or a top down type. The bottom up type looks first at the indivdual company, then the sector, then the overall economy. The top down does just the opposite. (An investor who only invests in mutual funds may decide to be neither, that is, they have decided to be long-term investors, using dollar-cost-averaging over a long period of time, and they don't care about individual stocks, sectors, or the overall market.)

I am a bottom up for two reasons: 1) Trying to predict which sectors are going to be hot and for how long is very difficult, and to try and predict where the overall economy is going is even more difficult, 2) The companies I invest in are smaller in size and are less affected by the overall market. Regardless of the individual companies you invest in, that is, even if you only invest in small companies, your stock's prices will still react to changes in the corresponding sector and the overall economic conditions.

The biggest thing the overall economy is affected by is interest rates. Interest rates are affected not only by market conditions, but by the Federal Reserve's fiscal policy. Lately, the key factor in determing bond interest rates has been the Federal Reserve and their attitude regarding inflation. The Federal Reserve headed by Greenspan has increased the Fed funds rate 6 times in the last year. Their reason for the rate increases is to slow the economy down enough where they feel inflation will not be a threat. The Fed's theory is that if they don't slow the economy down, inflation will increase to a point that will cause the economy not only to slow down, but to even turn negative. (to gauge the economy people look at the GDP, the gross domestic product and if the GDP turns negative two quarters in a row that period will be called a recession, since it takes a long time, several months, to get GDP numbers, you may be out of a recession before you even know you're in one).

Today, Greenspan stated that history amply demonstates how inflation, if left unchecked, can severely impact economy growth. The problem I have with Greenspan and his beliefs is that the ecomony is not the same now as it was before. Greenspan himself has made several remarks about the "new economy," and how productivity is much greater now than it was before. Using old fiscal policies, that may be outdated, may not be the way to go. And it seems the Fed and the politicians don't even want to discuss the issue, that is, just maybe, old fiscal policies are no longer the best way to go.

As Greenspan stated today, the Fed is in a complicated situation. But the Fed only offers old fiscal policy. The biggest inflation concern of the Fed is worker's wages, the Fed doesn't want worker's wages going up more than what they feel the economy can handle without igniting inflation. How does the Fed address their concerns for worker's wage rates? Increase the Fed funds rate which will make capital, investment as well as consumer capital, less plentiful. Less investment and consumer capital will slow the overall economy and if the Fed gets what it wants, workers will be laid off, increasing the labor pool and therefore holding worker's wages at a level they feel comfortable with. Of course, the Fed wants to increase the Fed funds rates just enough to slow the economy down a little, they don't want to slow the economy down so much as to cause a recession (the term coined for this is a "soft landing"). Unfortunately, this fiscal policy may have work when the overall economy was mostly acricultural workers, or manufacturing workers, but is it really the answer when the workforce is so complexed: service workers, tech workers, manufacturing workers, acricultural workers, and all these different workforce areas have different unemployment amounts? To me, it looks like the real demand for workers is mostly in the tech area. I think the Fed needs vision and new ideas for fiscal policy. Ideas which are geared to a more complexed "new economy" workforce.

To make matters worse to sustain the stock market at the current valuation levels you have to have outstanding economic growth. I think we can handle the growth necessary, but the Fed doesn't. They want to keep the economy growing at a 3-4% pace, the pace that history says can be sustained without cuasing inflation.

Why do I feel we can handle more economic growth? The US economy is not the same economy it was 20 years ago, or 40 years ago. Capitalism is spreading like fire across the world, competition is increasing with the global economy and that helps control inflation. Also, technology is helping to increase productivity to levels which can handle greater GDP growth.

What you or I think doesn't matter, what matters is what the Fed thinks. And as an investor, you need to keep abreast of what the Fed is up to. As long as you keep up with the Fed, you'll be keeping up with the general economic conditions of the overall economy.