NBR Complete Transcripts-"How Wall Street Works"
Monday, September 03, 2007Why Companies Issue Securities
SUSIE GHARIB: The securities markets aren't for everyone, since trading carries significant risk and offers no guarantees. But contrary to what many people think, Wall Street is not the world's biggest casino. Unlike a casino, Wall Street serves a vital role in the American free enterprise system because it makes it possible for companies to raise large amounts of money. That's a process known as capital formation.
PAUL KANGAS: And by providing a place where individuals and money managers can cash in their securities on a daily basis, these markets make it possible for you and me to participate in that process. To find out how capital formation works and Wall Street's role in it, let's begin not in Manhattan, but thousands of miles away in the tropics.
JEFF YASTINE, NIGHTLY BUSINESS REPORT CORRESPONDENT: Cruising is a pastime that's gained huge popularity and Carnival is truly the world's largest cruise line, carrying thousands upon thousands of passengers on its ships each week. One of the keys to its popularity is being able to offer newer, bigger ships filled with the latest amenities that people want. And that takes money -- a lot of money -- as Mickey Arison, the chairman and CEO of Carnival, told us.
MICKEY ARISON, CHAIRMAN AND CEO, CARNIVAL CORP.: It's a capital intensive business and building new ships is not cheap. It takes hundreds of millions of dollars.
YASTINE: So where does a cruise line go for financing? In years past, Carnival went to Wall Street. In 1987, the company sold its stock to the public for the first time. It held what's called an initial public offering or IPO, selling 27 million shares of Carnival stock for about $15.50 each. That raised nearly $400 million for Carnival. Members of the public bought these shares and became part owners. As Carnival made money over the years, these stockholders shared in the company's profits through payments, which are called dividends and they also benefited through the appreciation in the company's stock price.
However, the success of the company is not guaranteed. And because it's not a sure thing, some investors prefer an investment that carries a stronger promise of payment. So, in 1990, Carnival chose a different route to raising money. It sold bonds. Much like a loan, a bond permits the company to borrow money from the buyer of the loan for a fixed period of time. In return, the bond owner is paid a fixed rate of interest until the company repays the debt. In Carnival's case, its original bonds were 15- year, 7.5 percent, zero-coupon convertible bonds. Now here's what all that means: 15 years is the term of the bond, the maximum length of time the company can hold that money; 7.5 percent is the yearly interest rate paid on that money; and convertible means the owner of the bond has the option of converting it into a certain amount of Carnival common stock. That could make the bond worth more if the price of Carnival shares goes higher. If you managed to hold all of Carnival's bonds, you'd definitely be rich, but you still wouldn't be able to control the cruise line company. In order to do that, you would have to own a majority of Carnival's nearly 800 million shares of common stock and it would take an awfully large buy order to do that. Jeff Yastine, NIGHTLY BUSINESS REPORT, Miami.
How a Stock is Traded
SUSIE GHARIB: Once a company goes public, it usually doesn't sell its shares to new investors. But you can still buy the firm's stock if you can find a shareholder who's willing to sell it to you. For that, you go to a stock market like this one, the New York Stock Exchange. On any given day, several billion shares of stock change hands here and a similar level of activity occurs at the competing NASDAQ stock market. That's possible because each stock trade is accomplished in no more than a few seconds and often a lot less time. Scott Gurvey looks at the process that makes a stock trade happen.
SCOTT GURVEY, NIGHTLY BUSINESS REPORT CORRESPONDENT: When you think about buying or selling stock, the image that comes to mind is probably this one -- the floor of the New York Stock Exchange or NYSE for short. Here stocks are traded by open outcry, with brokers calling out their offers and specialists acting as auctioneers, bringing buyers and sellers together. When buyers and sellers are far apart on a price, the specialists try to maintain an orderly market, sometimes by buying or selling for their own inventory. It takes an average of nine seconds to execute a trade in this way. But the mechanics of trading have changed dramatically in recent years.
RICHARD HARRIS, SPECIALIST, BEAR WAGNER SPECIALISTS: The reality is that 80, 90 percent of the order flow now is electronic. There's still orders that are sensitive enough that they want a human broker on the floor, or the stock may be illiquid enough that they want somebody personally handing it in front of the specialist. But with the increase in algorithms and program trading, most of the order flow is electronic now.
GURVEY: So even if your stock is listed on the NYSE, the odds are your order will not be executed here on the floor but someplace else, most likely inside the maze of computers connected by networks, which now make up the global trading system. The NASDAQ is a virtual exchange. All the trading is done over a computer network and there is no trading floor. To place an order to buy or sell a stock, you can visit your broker's office or call her on the telephone. But it is increasingly common for individual investors to enter their orders by using their broker's proprietary computer software or on their broker's Internet site, which can provide stock research and analysis as well as trading. For most listed stocks, you can readily see the bid and the asked; that is, the highest price someone is willing to pay and the lowest price someone else is willing to accept for the stock at that moment. If you are willing to buy or sell at or near the current market price, you put in a market order. A limit order means you are only willing to buy or sell a stock at a price that you set. With a market order, you may get confirmation that the trade has taken place almost immediately. That's because the order is electronically matched by the trading system computers in just a fraction of a second without human action. Wherever your trade is executed, you can expect to get confirmation delivered to you electronically and depending on the computer system you use, the computer can even automatically post the transaction to a portfolio of your stock holdings. Scott Gurvey, NIGHTLY BUSINESS REPORT, New York.
Earnings & Stock Prices
SUSIE GHARIB: The idea on Wall Street is to buy low and sell high. But how do you know if a stock is worth $1 or $100? That's a tough question and the answer depends mostly on one thing: the company's earnings. As Suzanne Pratt reports, Wall Street pays a lot of attention to how much money the firm is making and how much it has the potential to make.
SUZANNE PRATT, NIGHTLY BUSINESS REPORT CORRESPONDENT: What happens four times a year in January, April, July and October and involves all US public companies? The answer: the release of earnings for the previous three months, known as quarterly earnings. For corporate America, it's the equivalent of children bringing home report cards and when the numbers come out it's considered earnings season.
CHUCK HILL, CHAIRMAN, VERTIUS ET LUX: During that time, there's a great deal of focus on the earnings releases, not just to see what the results are for the current quarter, but also a lot of the companies will make some comments about what they see for the rest of the year or for the upcoming quarter.
PRATT: Every three months, publicly traded companies are required by law to report their financial results to the Securities and Exchange Commission. Every company also issues its quarterly earnings report to the public and makes it available on the firm's web site. On the day of the earnings release, company management usually hosts a conference call for Wall Street analysts, professionals employed by investment firms to analyze public companies and rate the stocks. This was an earnings call for Schering-Plough, the pharmaceutical company:
ALEX KELLY, VP OF INVESTOR RELATIONS, SCHERING-PLOUGH: We appreciate you joining us at this our and apologize in advance to our investors in other time zones for the early start.
PRATT: During a call like this one, the company's CEO and other company officials field questions from analysts about the earnings news. But management also receives queries regarding other business areas.
FRED HASSAN, CEO, SCHERING-PLOUGH: It's important to get the basics of the message out. But it's also important to answer the concerns that might be out there on people's minds. It's really a dialogue with the investors and a dialogue with the stakeholders.
PRATT: The earnings conference call is usually posted on the company's web site and available to any potential investor. Still, small investors may find the earnings news complicated, particularly the plethora of numbers and financial terms. Net income, diluted earnings and operating income are some of them, all different measures of a company's financial success. The most-watched number is the firm's earnings divided by the number of shares of the company's stock, better known as earnings per share.
EDWARD NUSBAUM, CEO, GRANT THORNTON: For almost every company, the most important number is earnings per share, prepared in accordance with generally accepted accounting principles-- GAAP. And that needs to be disclosed and every investor should look at that number and compare it.
PRATT: Earnings reports also contain other crucial measures of a company's health. The revenue line, sometimes called sales, gauges demand for a company's goods or services. That's often a key to predicting future earnings. Predicting a company's quarterly earnings is an exercise that Wall Street takes very seriously. An unexpected number can lead traders to snap up or sell off the stock and that can have big consequences for the company's share price. Suzanne Pratt, NIGHTLY BUSINESS REPORT, New York.
How News Affects the Markets
PAUL KANGAS: Besides earnings, other factors can also send a stock's price up or down. One of these is something we cover every night on NBR: the state of the overall market. As Erika Miller reports, a bit of news or even a rumor about politics, the economy or interest rates can make the entire market turn hot or cold.
ERIKA MILLER, NIGHTLY BUSINESS REPORT CORRESPONDENT: September 11, 2001- - a date that America will never forget, marking the commission of the worst acts of terrorism in U.S. history. The attacks on the World Trade Center literally hit too close to home for Wall Street and the financial markets, which never opened that day. But when the exchanges reopened six days later, stock prices plunged across the board, with the Dow Jones Industrial Average dropping 684 points, more than 7 percent. It was the biggest one-day point loss ever. By the end of the week, the index had fallen 14 percent. Veteran market watcher Jim Awad says the sell off was due in large part to worries about the economy.
JIM AWAD, CHAIRMAN, W.P. STEWART ASSET MANAGEMENT: They were afraid that the whole U.S. economy would seize up and shut down because of fear of terrorism, that people wouldn't go to malls and that if people weren't going to malls, they wouldn't spend money and if consumers weren't spending money, then businesses wouldn't spend money and they wouldn't hire people.
MILLER: But it doesn't take news as momentous as a terrorist act to move stock prices. These days, almost anything -- including an economic indicator, an earnings report, even a rumor -- can affect the mood of the entire market. But on the other hand, the stock market often discounts important developments. Sometimes, if news has been well circulated, it can have very little impact on stocks. Here's a common example. If the outcome of a presidential election is widely anticipated, there is frequently little reaction in the stock market the day after Election Day. And as trader Tom Thurston points out, stocks typically move more on the rumors of a corporate merger than on the actual announcement.
THOMAS THURSTON, HEAD OF TRADING, SANDLER O'NEILL: By on the rumor, sell on the news. If that rumor has been looked into and people are able to think there's some credibility to it, then when the news hits, they unwind the trade.
MILLER: Investors should also understand that certain companies have influence well beyond their own stocks. For example, as a leading retailer on the Internet, any news from amazon.com is widely regarded as a gauge of what is happening in terms of web sales generally. Similarly, a good sales report from General Motors can reverberate across the entire auto sector and even the entire market. The challenge for investors has always been to separate the noise from the news, but it's even tougher today. There's more information available and less time to analyze it. Erika Miller, NIGHTLY BUSINESS REPORT, New York.
The Dow and Other Indices
PAUL KANGAS: Because stocks often move together, it can be helpful to know the general direction of prices on Wall Street. That's why every few minutes, investors ask: how's the market doing? And the answer boils down to one number: the Dow Jones Industrial Average or the Dow for short. Actually, the Dow is an index of the prices of 30 component stocks. As we can see here, it currently includes some of the biggest names in corporate America and it has a long history. I talked about that with David Leonhardt of the "New York Times." First, just how did the Dow Jones Industrial Average get started and what makes it such a key market barometer?
DAVID LEONHARDT, COLUMNIST, NY TIMES: Well, it started in 1896 when Charles Dow sat down with a piece of paper and a pencil and tried to make sense of the stock market. Until then it was really hard for investors to know what was going on; they would see some stocks up, some down. And what he did was he calculated an average and it was incredibly important and it remains incredibly important. The main reason it remains so important, though, is that it has been followed for so long. If you're looking for an accurate gauge of the stock market, the Dow Jones Industrial Average is not the best place to go today.
KANGAS: Now here is the list of the original 30 components of the Dow way back in 1896. And it's interesting to note that only one of the originals-- General Electric -- is still in the average. Who decides what's stocks get in the Dow and how often are its component stocks changing, David?
LEONHARDT: Well, editors at Dow Jones decide what goes in there and the fact that General Electric is... as you can see from that list, it changes with regularity. And the fact that General Electric is the only company left just tells you about the amount of creative disruption that there is in the American economy. The most important companies today were nothing like the most important companies 30, 50 and certainly 110 years ago and that tells you, in some ways, about the dislocation and also about the dynamism of the economy.
KANGAS: Interesting. Now besides the Dow Jones Industrial Average, there's another broad market index, namely the Standard & Poor's 500. What can you tell us about the S&P 500 and do you think it's a better measure of market activity than the Dow?
LEONHARDT: I do think it's a better measure. I think it's a significantly better measure than the Dow for two reasons. One, as you noted, it's much, much broader. It covers 500 large cap companies rather than just 30, which is what the Dow Jones covers. For a second thing, there is a funny way that the Dow Jones Industrial Average is calculated. And it's calculated that way because, as I said, Charles Dow started this in 1896 with pencil and paper and it's not so easy to create a weighted average with pencil and paper. And so, for technical reasons, in the Dow Jones, a company like Caterpillar is actually more important than General Electric of Citigroup or Microsoft. Obviously in the broader economy, Caterpillar is not more important than General Electric or Microsoft or Citigroup. And the S&P is weighted toward the size of companies. Now, the S&P has some of its own flaws, but as a broad market measure, it really is significantly better than the Dow today. As a historical measure going back to 1896, you can't do better than the Dow Jones Industrial Average.
When is it Time to Sell
SUSIE GHARIB: Buying a stock is one thing, but how do you know when it's time to sell? Karen Blumenthal followed the stock of Starbucks for a year and wrote about it in her book "Grande Expectations: A Year in the Life of Starbucks' Stock." She says some there are signs that may indicate when a stock's price is peaking and when it may be a good time to sell your shares.
KAREN BLUMENTHAL, AUTHOR, "GRANDE EXPECTATIONS: A YEAR IN THE LIFE OF STARBUCKS' STOCK": Growth is what moves Wall Street. They're always looking for who's going to grow faster because then the stock price should grow faster. And that's why Starbucks just keeps opening more and more stores; that's why they've moved into more and more countries; why they're selling new Paul McCartney CDs and new kinds of drinks that they want to build those sales and keep that growth going. When the same store sales get a little sloppy or a little bit sluggish, then there may be problems in the core of the business and that could be a problem.
KANGAS: Right. Now you point out that every stock trade involves one person who buys and another who sells. How is it that two informed investors can reach opposite conclusions about the same stock?
BLUMENTHAL: It's an amazing thing. I interviewed a short seller, somebody who bets that the stock will go down and he was looking at the same numbers as the guy who had a big mutual fund who was sure the stock was going to go up and a lot of it is in how you interpret the numbers. II mean, one saw consumers getting nervous about spending. The other saw consumers are addicted to their coffee. You know, you get those different points of view and that's what makes the stock market move.
Securities Regulation
PAUL KANGAS: Now you may have heard claims that the markets are rigged or crooked. Like any place where a lot of money is at stake, Wall Street has its share of greedy and unscrupulous individuals. But as Stephanie Dhue reports, there are rules that apply to anyone who is involved in securities trading.
STEPHANIE DHUE, NIGHTLY BUSINESS REPORT CORRESPONDENT: The U.S. Securities and Exchange Commission is Wall Street's top watch dog. Established by Congress with the 1934 securities act, the agency sets the rules and is on the lookout for securities fraud -- things like stock price manipulation through false information or trading on information not available to the public, better known as insider trading. SEC Chairman Christopher Cox says the commission has a wide-ranging mandate to protect investors.
CHRISTOPHER COX, CHAIRMAN, SECURITIES AND EXCHANGE COMM.: Congress chartered this agency to make sure that in the more specialized world of investing, there were law enforcement people who would keep track of markets, make sure those markets were orderly, make sure that trading in them was honest and make sure that investors at all times have access to timely information about the terms of their investment.
DHUE: The SEC requires companies file periodic financial reports and notify investors of news events that impact the bottom line. Investors can look up those reports online using the SEC's Edgar system. The SEC also monitors stock market activity. Experts here are looking for unexplained price moves. The SEC has the power to halt trading in a stock if it suspects illegal activity or that investors have been kept in the dark about important corporate developments.
COX: Information -- quality information, including financial disclosure -- is what separates investing from roulette.
DHUE: The SEC has strict rules for stockbrokers, which the agency calls broker-dealers. Brokers are also policed by the industry's own regulatory group, the financial industry regulatory authority, or FINRA. Mary Schapiro heads up this organization. She notes that FINRA maintains a broker-check system, which allows investors to look into the background of any stock broker.
MARY SCHAPIRO, CEO, FINANCIAL INDUSTRY REGULATORY AUTHORITY: We maintain a central repository of information about brokers and investment advisors that includes their qualifications, the places they've worked. For example if somebody has moved brokerage firms once a year for the last several years, that's a red flag. You might want to understand why they've been moving around a lot.
DHUE: The database also includes any disciplinary actions and complaints registered about a particular broker. FINRA urges investors to check out a broker's record before coming his or her client. To use the broker check system, you can go online to the finra.org web site or you can call 800-289-9999. To avoid fraud in securities trading, regulators say it's important to use an established brokerage and deal only in registered stock or bond offerings. Those can be verified with your state security agency before you put any money down. But if you believe you've been misled or taken advantage of, you can file a complaint with Federal, state and industry regulators. Stephanie Dhue, NIGHTLY BUSINESS REPORT, Washington.
