Financial Literacy - Growing your bottom line
Long-term investing strategies

It's a fairly complicated endeavor. Dan Newhall, principal in Vanguard's Portfolio Review Department, cautions that the average individual investor may be better served by choosing an actively managed mutual fund rather than investing directly in stocks themselves.

With a mutual fund, individual investors get professional money management, diversification of investments, potentially lower costs, plus access to information, technology and teams of financial analysts.

That said, if individuals know what they're doing, they can invest in individual stocks and keep a diversified portfolio. One general rule of thumb to ensure that too many eggs don't get stuck in one basket is to devote no more than 3 percent of a portfolio to one individual stock.

Well aware of the risks, the hopeful securities investor bent on traditional fundamental analysis would begin investigating the economy and the various industries within the economy.

"What you want to think about in fundamental analysis basically is the relation of the firm to the macro economy," says Stephen Penman, George O. May professor of accounting at Columbia Business School and author of "Financial Statement Analysis and Security Valuation."

By macro, Penman refers to the big economic picture that takes into account lots of different variables, such as inflation, unemployment and industrial output. With the advent of the Internet, finding data on broad economic developments is much easier than in the pre-wired days of yore.

Well-known indicators are tracked, analyzed, dissected and quickly available for public consumption. For example, The White House regularly releases reports on economic indicators.

A few of the more common gauges of economic activity include the Consumer Price Index, the national Gross Domestic Product, short-term interest rates set by the Federal Reserve and housing starts.

Filtering down to the industry level, one would look at how the economy is affecting businesses -- for good or bad. For instance, at this point in time, "World financials are very doubtful and they're in bankruptcy," says Penman.

"Whereas another company like Procter and Gamble would be more concerned with the effect of the financial situation flowing into the real economy -- the consumer economy -- and what the effect would be there," he says.

Lots of other things affect industries as well: consumer sentiment, technology, the weather, politics, government regulation, competition and labor conditions -- to name a few.

Shifting down yet another level to companies within a sector or industry, investors should "look where the industry is going and note the firm's market share of the industry. Because ultimately among the drivers of fundamental value are future sales and future revenues that come in," Penman says.

To investigate individual companies, investors can turn to the annual or quarterly financial statements, called the 10-K and 10-Q reports, respectively, filed with the Securities Exchange Commission.


The annual 10-K report reveals a company's accounting as reflected in the balance sheet, income statement and cash flow statement.

It also offers the perspective of senior management, who explain events of the past year and also predict what might happen going forward.

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