How the Stock Market Works: a Beginner's

i ii iii iv If you speculate on the stock market, you do so at your own risk. Publisher’s note Every possible effort has been made to ensure that the information contained in this book is accurate at the time of going to press, and the publishers and authors cannot accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the mate- rial in this publication can be accepted by the editor, the publisher or either of the authors. First published in 2002 Reprinted in 2002, 2003 Second edition, 2004 Reprinted in 2005, 2006, 2007 (twice), 2009 Third edition 2010 Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted under the Copyright, Designs and Patents Act 1988, this publication may only be reproduced, stored or transmitted, in any form or by any means, with the prior permission in writing of the publishers, or in the case of reprographic reproduction in accordance with the terms and licences issued by the CLA. Enquiries concerning reproduction outside these terms should be sent to the publishers at the undermentioned addresses: 120 Pentonville Road 525 South 4th Street, #241 London N1 9JN Philadelphia PA 19147 United Kingdom USA www.koganpage.com © Michael Becket, 2002, 2004 © Michael Becket and Yvette Essen, 2010 The right of Michael Becket and Yvette Essen to be identified as the authors of this work has been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. ISBN 978 0 7494 5689 4 British Library Cataloguing in Publication Data A CIP record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Becket, Michael (Michael Ivan H.) How the stock market works : a beginner's guide to investment / Michael Becket, Yvette Essen. -- 3rd ed. p. cm. Includes index. ISBN 978-0-7494-5689-4 1. Portfolio management. 2. Investment analysis. 3. Stock exchanges. I. Essen, Yvette. II. Title. HG4529.5.B43 2010 332.64'2--dc22 2009030898 Typeset by Saxon Graphics Ltd, Derby Printed and bound in Great Britain by Bell & Bain Ltd, Glasgow v vi vii viii ix Contents How this book can help xiii Acknowledgements xv 1. What and why are shares? 1 Quoted shares 2 Returns 4 Stock markets 4 2. What are bonds and gilts? 6 Bonds 6 Preference shares 10 Convertibles 11 Gilts 11 3. The complicated world of derivatives 15 Pooled investments 15 Other derivatives 21 4. Foreign shares 32 5. How to pick a share 34 Strategy 38 The economy 44 Picking shares 45 6. Tricks of the professionals 57 Fundamental analysis 58 Technical analysis 70 7. Where to find advice and information 72 Advice 72 Information 79 x Contents ___________________________________________________ Indices 87 Online 88 Company accounts 89 Using the accounts 100 Other information from companies 100 Other sources 102 Complaints 105 8. What does it take to deal in shares? 107 Investment clubs 109 Costs 111 9. How to trade in shares 115 How to buy and sell shares 116 Using intermediaries 117 Trading 121 Stock markets 122 Other markets 123 10. When to deal in shares 129 Charts 135 Technical tools 143 Sentiment indicators 144 Other indicators 146 Selling 147 11. Consequences of being a shareholder 150 Information 150 Annual general meeting 151 Extraordinary general meeting 151 Consultation 151 Dividends 152 Scrip issues 152 Rights issues 152 Nominee accounts 154 Regulated markets 154 Codes of conduct 155 Takeovers 156 Insolvency 157 ___________________________________________________ Contents xi 12. Tax 161 Dividends 162 Capital profits 162 Employee share schemes 163 Tax incentives to risk 164 ISAs 164 Tax rates 164 Glossary 167 Useful addresses 175 Further reading 181 Index 185 Index of advertisers 189 xii This page is intentionally left blank xiii How this book can help Making money demands effort, whether working for a salary or investing. You get nothing for nothing. Anyone who tells you the stock market is an absolute doddle, and money for old rope, is either a conman or a fool. And the proof of that became very clear with the stock market depressions starting in 2007. But doing a bit of work does not necessarily mean heavy mathematics and sev- eral hours every day with the financial press, the internet and company reports – though a bit of all those is vital – but it does mean taking the trouble to learn the language, doing a bit of research and thinking through what it is you really want and what price you are prepared to pay for it. At the very least that learning will put the investor on a more even footing with the people trying to sell. It has been hard enough earning the money, so this book helps with the little bit extra to make sure the cash is not wasted. There are few general rules about investment but the most important is very simple: if something or somebody offers a sub- stantially higher profit than you can get elsewhere, there is a risk attached. The world of investment is pretty sophisticated and pretty efficient (in the economists’ sense that participants can be fairly well informed), so everything has a price. And the price for higher returns is higher risk. There is nothing wrong in that – Chapter 5 sets out how to decide what your acceptable level is – but the point is it has to be a conscious decision to accept the dan- gers rather than make a greedy grab for what seems a bargain. Scepticism is vital but it needs to be helped with something to judge information by, and this book provides that. In the end xiv How this book can help _____________________________________ though, there is no better protection than common sense, asking oneself what is likely, plausible or possible. For instance, why should this man be offering me an infallible way of making a for- tune when he could be using it himself without my participation? Why is the share price of this company soaring through the roof when I cannot see any reasonable substance behind it? What does the market know about that company that I do not which makes its shares seem to provide such a high return? What is my feeling about the economy that would justify the way share prices in general are moving? The stock market is of course not the only avenue of investment. People buy their own homes, organize life assurance and pension policies, and have rainy-day money accessible in banks and building societies. And indeed those foundations should probably precede getting into the stock market, which is gener- ally more volatile and risky. Shares have had their low moments, for example at the dotcom crash or more recently during the credit crisis, but over any rea- sonably middle-term view the stock market has provided a better return than most other forms of investment. That, however, is an average and a longish view, so you still have to know what you are doing. That is why this book starts with setting out what the various financial instruments are: shares and other things issued by companies, bonds and gilts, and then derivatives, which are the clever ways of packaging those primary investments. Each has its own character, benefits and drawbacks. That helps with the decision on where to put your money. At least as important is the timing. That applies whether you are an in-and-out energetic trader or a long-term investor, and Chapter 10 will provide help. xv Acknowledgements Michael Becket is grateful to Kay Broadbent for reading through this, to help get it a bit more right and useful, and for her advice, which he occasionally followed. The mistakes of omission and commission are despite her best efforts, and are his alone. Yvette Essen would like to thank her family and fiance, David Bird, for their support in producing this book. We are grateful to Barclays Capital for the charts from the annual publication, Barclays Bank Equity Gilt Study. xvi This page is intentionally left blank 1 What and why 1 are shares? Businesses need money to get started, and even more to expand and grow. When setting up, entrepreneurs raise some of this from savings, friends and families, and the rest from banks and ven- ture capitalists. Backers get a receipt for their money which shows that their investment makes them part-owners of the company and so have a share of the business (hence the name). Unlike banks, which provide short-term finance at specified rates that has to be repaid, these investors are not lenders: they are the owners. If there are 100,000 shares issued by the company, some- one having 10,000 of them owns a tenth of the business. That means the managing director and the rest of the board are the shareholders’ employees just as much as the shop-floor fore- man or the cleaner. Being a shareholder carries all sorts of privi- leges, including the right to appoint the board and the auditors (see Chapter 11). In return for risking their money, shareholders of successful companies receive dividends. The amount varies with what the company can afford to pay out, which in turn depends on profits. At some stage the business may need more than those original sources can provide. In addition, there comes a time when some of the original investors want to withdraw their backing, espe- cially if it can be at a profit. The only way to do that would be by selling the shares, which meant finding an interested buyer, which in itself would be far from easy, and then haggling about the price, which would be awkward.

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