In the last part of this series, I discussed Fixed Income Investments. Today I turn the discussion to Stocks. People are generally far more interested in stocks than they are in bonds. While some have made fortunes in the bond world. The more famous names are those who have their fortunes in the world of stocks. There are the investors; Warren Buffet, Peter Lynch, and the now tarnished star of Eddie Lampert. In addition to the investors there are more importantly the entrepreneurs who’s fortunes have been tied to the stock in the companies they founded. Bill Gates, Larry Ellison, Sergey Brin, and Larry Page are the name today. But in the past it was the likes of Ray Kroc and Henry Ford. While the times have changed, the fundamental nature of stocks have not.

Stocks merely represent a ownership shares in a company. However typically when we talk about stocks in the investment sense, we talk about shares of publicly traded companies. Public companies agree to certain account conventions and rules of disclosure for privilege of allowing it’s shares to trade on public exchanges such as the New York Stock Exchange. There are two primary reason for companies go “public.” 1) to raise capital to grow the business 2) to allow the original investors to cash out (at least some portion). More often than a not a company will go public both reasons as is typical with a tech start up. A technology start-up both needs to capital from an Initial Public Offering (IPO) to grow the business, and allow for the initial investors, typically venture capital firms, an easy method to quickly earn a return on a investment.

A share in company represents exactly that a share of the company. Let’s take for example Google which has a share price as of 2/12/08 $518.09. Google has a total of 312.8 Million shares outstanding. One share therefore represents 1/312,800,000 of the company. The total market cap (or total worth) of Google is $518.09 X 312,800,000 or about 160 billion dollars. While one would think that the intrinsic value of a company should not really change very much day to day or minute to minute. However in the case of public companies it does. Everyday shares exchange hands and at any given time those shares are worth only as much as what the next person who wants to buy is willing to pay. For that reason Google has lost about 40 billion in value over the last 2 months despite running the same business it has ever run.

For most people stocks, though not individually but in a vehicles such as Mutual Fund, should make up the bulk of one’s investment portfolio. Historically speaking U.S. equities have returned between 9 and 10% annually, far outpacing fixed income. Of course if you were to look at how those returns were delivered, it’s not smooth ride of 10% year in and year out.

So what do you look for investing in stocks. While I have my own metrics, mostly based my reading of the Intelligent Investor, stock picking is difficult. Few professionals consistently beat the market, and many academics believe it’s outright impossible to do so. I’ll save the arguments on beating the market for another day.