This page:



Key points
in one hundred words


Bull-market characteristics

1. Historically high price level
2. High P/E ratios
3. Low dividend yields compared to bond yields
4. Much speculation on margin
5. Many new, poor quality, common-stock offerings

Call provisions

Means that the company can buy back the bond at a predetermined low price when market value of the bond increases. Undesirable for investors.

Capital expenditures

Expenses made to acquire or upgrade physical assets such as buildings and machinery.

Capitalization rate

Is the ratio between income and estimated value. Estimated value is income divided by capitalization rate. It is also said to represent the expected annual return on an investment

Consumer Price Index
= A measure of inflation

Convertible Bonds

Convertible bonds are bonds that can be converted into a predetermined number of common stocks. You can keep them and get a little bit of interest, or exchange for common stock whenever that seems more profitable. They fluctuate in price, similar to the stocks, but less extreme. On the downside, they pay lower interest rates than other bonds, and when the company goes out of business, you're not first, but second in order of claim. In Graham's time, convertible issues used to decrease more in value than stocks in bear markets, but in recent years, convertibles have outperformed the S&P500 during periods of decline. So you have some protection against bad times, in exchange for less profit when things go well. Convertibles are often issued in mergers. Conversion rights imply that the number of common stock can increase any moment, diluting the earnings per share. So in calculating earnings per share, it is best to assume convertibles will be converted.

Dollar cost averaging

Invest a fixed amount every month or quarter. If you had invested $12000 in the S&P500 in 1929, 10 years later you would have $7000. However, if you simply invested $100 monthly, you would have $15000. (note that 1929-1939 captures an enormous market crash).

Earning power
= earnings yield = roughly the inverse of P/E ratio.

It is a measure of the amount that a firm might be expected to earn if the current conditions remain the same.

Efficient Market Hypothesis

The hypothesis that the price of stocks incorporates all publicly available information about a company. The implication is that severe mispricings do not exist for long.

Interest rates

The interest you pay on your credit card is not the same as the interestrates they talk about on the news. What the media talks about are actions bythe Federal Reserve that influence interest rates on all kinds ofloans, including money you borrow yourself.

Why does the Federal Reserve want to control interest rates? When interestrates are low, it is cheaper to borrow money. When it is easy to borrow money, people are more likely to buy stuff, and that can stimulate the economy. On the other hand, if it is too easy, there will not be enough goodsfor everyone to buy, and prices will increase (inflation). When interestrates are too high, less people can borrow money, less products will be purchased, and the economy can enter a recession.

The federal reserve sets a target that banks are charged for borrowing money overnight from the Federal reserve. When the bank has to pay more to borrow money, it has to charge its customers more to borrow money, so they are less likely to buy things, especially things for which you have to get aloan to buy them.

Intrinsic value

The "true" value (of a company), irrespective of the stock's current market price. You can look at qualitative (business model, governance, target market factors etc.) and quantitative (ratios, financial statement analysis, etc.) aspects of a business to see if the business is currently out of favor with the market and is really worth much more than the market price suggests.


1. Borrowing money with the goal to increase the potential return of an investment.

2. The amount of debt a company has. More debt than equity means that the company is "highly leveraged".


Market cycle

A complete market cycle goes from bear market low to bull market high and back to bear market low. Between 1890 and 1949, 11 full cycles occurred, six took 4 years, four took 6 or 7 years, and one took 11 years.

Net income
= Total earnings

Operating expenses

Expenses made in the normal course of business, such as electricity bill.

Owner earnings (Warren Buffett)

Net income plus amortization and depreciation, minus normal capital expenditures. Adjusts for entries like amortization and depreciation that do not affect cash balances, therefore can be a better measure than reported net income. One could also subtract costs of granting stock options,'nonrecurring' charges, 'income' from the company's pension fund.

Preferred stock

The preferred stockholder lacks the legal claim of the bondholder and the profit-possibilities of the common stockholder because of the fixed dividend rate. The preferred stockholder only gets his dividend paid before the common stockholder, but when the common stockholder can't even be paid, the preferred stockholder is also in danger. whereas the preferred stockholder gets the fixed dividend only, the bondholder gets not just that, but also payment of principle on a fixed date. Graham says preferred stocks are not worth having.

Proxy statement

The proxy statement is sent to all shareholders. It announces the agenda for the annual meeting, discloses what compensation managers receive, including transactions between insiders and the company. It can be an early warning system if something is wrong. If you read the proxy, and are unsatisfied, you can:

- Vote against every director to let them know you're not satisfied.
- Attend the annual meeting and speak up
- Find an online message board devoted to the stock and rally others to join you

= gross income


With "risk", people often mean the chance of the stock price decreasing, but another risk factor is whether the company is losing money or not. You only notice the bad effects of a low stock price when you are forced to sell. If you purchased them cheaply, a temporary decline in stock price is no big deal. The danger of defining risk only in terms of price volatility is that too much emphasis is placed on market fluctuations. If the company keeps making a profit, the stock will pull through as well. (Brealey, "An introduction to risk and return", MIT press 1969).


Net income-dividends, divided by total capital. A measure that helps determine whether a company is using invested capital effectively. An ROIC of 10% is nice. http://www.investopedia.com/terms/r/returnoninvestmentcapital.asp

Safety of principal

Principal is the original amount you put into an investment, so safety of principal is the chance of keeping at least that. Speculative operations havelow safety of principal: you might win big, but you may well lose it all.


A security is a fungible ("fungible" means it is interchangable with other assets, identical in quality), negotiable interest representing financial value. Securities are broadly categorized into debt and equity securities. The company or other entity issuing the security is called the issuer.

Securities may be represented by a certificate or, more typically, by an electronic book entry interest. They include shares of corporate stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or other options, etc.

(net) Tangible assets
= book value = asset backing = net worth

Tangible assets include the company's physical property (real estate, factories, equipment, inventory), as well as financial balances. Not included are brands, patents, copyrights, franchises and goodwill. From total shareholders' equity, subtract all soft assets such as goodwill, trademarks, and other intangibles.

Total return

Total return accounts for two categories of return: income and capital appreciation. Income includes interest paid by fixed-income investments, distributions or dividends. Capital appreciation represents the change in themarket price of an asset.

Trading costs

Trading costs have decreased over the years (Jones, "A century of stock market liquidity and trading costs" at http://papers.ssrn.com). There are now automatic periodic stock purchase plans at low rates: http://www.sharebuilder.com; http://www.foliofn.com;http://www.buyandhold.com. Watch out though: only $4 per transaction is cheap, but if you invest only $50 at atime, $4 is 8%! Also, buying in small increments means a big tax burden. Keep a detailed record. Another cheap way to get stocks is direct purchase from the company (DRIP). More info at http://www-us.computershare.com, http://www.directinvesting.com