Introduction to Investment

The two most important characteristics of common stock as an investment are its residual claim and limited liability features.

How many times have you flipped to the back of a company’s annual report and found yourselves blankly starting at the pages of numbers and tables? You know that these should be important to your investing decision, but you’re not quite sure what they mean or where to begin.

Smart investors have always known that financial statements are the keys to every company. They can warn of potential problems, and when used correctly, help determine what a business is really “worth”. An investor who understands financial statements will never have to ask “is this company a good investment?”.

For every business, there are three important financial statements you must look at; the Balance Sheet, the Income Statement, and the Cash Flow Statement.

The main theme of Investments is The Risk-Return Trade-off.

Securities = stocks, bonds, options, and futures contracts.

We can usefully divide the process of investing, both in theory and in practice, that is: -

Security Analysis is the attempt to determine whether an individual security is correctly valued in the marketplace; that is, it is the search for mispriced securities.

Portfolio Management is the process of combining securities into a portfolio tailored to the investor’s preferences and needs, monitoring that portfolio, and evaluating its performance.

Common Stocks, also known as equity securities or equities, represent ownership shares in a corporation. Each share of common stock entitles its owner to one vote on any matters of corporate governance that are put to a vote at the corporation’s annual meeting and to a share in the financial benefits of ownership.

The two most important characteristics of common stock as an investment are its residual claim and limited liability features.

Residual Claim means that stockholders are the last in line of all those who have a claim on the assets and income of the corporation.

Limited Liability means that the most shareholders can lose in the event of failure of the corporation is their original investment.

Preferred Stock has features similar to both equity and debt. Like a bond, it promises to pay to its holder fixed dividends each year.