Forex

what to do with your
excess income and wealth. When you invest, you use today’s dollars to
purchase assets that generate future cash flows in the form of annual
income (dividends, interest, rental payments) and price appreciation
over time.
We assume that you have fulfilled your consumption needs, however
extravagant or spartan they may be; have purchased sufficient insurance
to take care of potential catastrophes; have saved enough in
a money market or savings account to take care of financial emergencies;
and now must allocate your wealth among different investments.
We consider only passive financial investments—ones that do not require
you to make operating decisions, such as a personal business in
which you control the hiring and firing of personnel, or the ownership
of a rental property where you may contend with late-night calls regarding
broken water heaters or leaking toilets.
Finance is the study of why, how, and whether to invest in projects,
ventures, or stocks that have uncertain (risky) cash flows to be received
in the future. The decision to buy or sell any investment or stock
should be based upon three cash-flow-related criteria: a conservative
projection of the amount (rate of return) of the cash flows, the probable
timing of the cash flows, and a reasonable assessment of the probability
or risk associated with receiving the cash flows. Once you esti-
4 STREETSMART GUIDE TO VALUING A STOCK
mate the amount, timing, and risk, you use financial techniques to determine
the true value of the investment or stock.
When you consider an investment in real estate, each property’s
location makes it a unique asset. This is not so in the stock market.
Shares of common stock of a company are identical2 and plentiful.
Cisco has over seven billion shares outstanding, and after a stock split
in January of 2003, Microsoft has over ten billion shares. When Sarah
buys 100 shares of Cisco through her online broker, it doesn’t matter
if the seller is Lehman Brothers, the Christian Brothers, or the Blues
Brothers—the shares are identical from an ownership perspective. The
world’s major stock markets are extremely liquid. Shares of thousands
of companies trade on a day-to-day, minute-to-minute basis, with
prices reported for all to see.