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Finding Your Way on 'the Street'

October 23, 1987|MICHAEL A. HILTZIK | Times Staff Writer

The share's real "value" might be very different from its price, however. Stocks rise and fall on investors' expectations about companies' future profits. Different investors may have different ideas about how fundamental conditions of the company--its prospects for profits, its chances of winning or losing a court case, the likelihood that it will be taken over--should be reflected in that price.

Q: Why does a company issue stock? A: This is one way corporations raise money from the public. A company has two basic choices: It can issue bonds, in which case it is borrowing money from the bond buyers at a fixed or variable interest rate that it must continue to pay regardless of whether its profits cover the cost, or common stocks, for which there is no fixed payment. That is why stock dividends can fluctuate with the rise and fall of profits. There are also preferred stocks, a hybrid of bonds and common stocks.

The company gets money when it first issues its stock, but gains nothing more directly when the shares are subsequently traded among investors. Companies remain intensely interested in their share prices for several reasons, however. For one thing, if the shares become cheap, they can more easily be purchased by someone intent on accumulating enough to own the whole company--a takeover. In addition, a company planning to raise more money by issuing more stock wants its existing shares to trade at a high price so investors will pay more for the newly issued shares. Executives are also keenly interested in the value of shares because, in addition to their salaries, many are compensated with stock options. These options give the executives the right to buy their companies' stock at a discount, under certain conditions. They may also receive stock outright as bonuses.

Q: What does the Dow Jones industrial average have to do with the price of these stocks? A: As its name implies, the Dow is a measure of the prices of 30 leading stocks, recomputed instantaneously as the price of each component stock changes. These stocks include American Express, Eastman Kodak, IBM, McDonald's and Exxon. The average was created at the turn of the century by Charles Dow, whose corporate descendants at Dow Jones & Co. publish the Wall Street Journal. Stocks included in the Dow average have changed many times over the years; the Dow was originally only 12 stocks.

As an indicator of the prices of only 30 of the common 1,500 stocks traded on the New York Stock Exchange, the Dow average does not always reflect the movement of the stock market as a whole. As recently as Tuesday, the Dow moved up sharply while the prices of stocks on the American exchange and the over-the-counter market continued their slide.

But as the most familiar market index, the Dow is widely treated by the public as interchangeable with the stock market. Among other widely followed stock indexes is the Standard & Poor's 500, a measure of the market value of 500 stocks heavily held by professional investors.

Q: How is a trade carried out on the New York Stock Exchange? A: This is where all those people milling around in the chaos of the exchange floor come in.

The people on the floor fall into several distinct groups. The most numerous are floor brokers, who carry the buy and sell orders of brokerage clients. Each broker with a buy order is on the prowl for a broker with a corresponding sell order, and vice versa.

The most important group are the "specialists." These are brokers, often working for family firms passed down from generation to generation, who under exchange rules supervise what amounts to an auction in a number of stocks. A single specialist firm might be responsible for 30 or more stocks. The specialist stands at a permanent post--the large circular counters set about the floor and bedecked with ranks of television screens. His job is to ensure that floor brokers find their match and that every such trade in his assigned stocks is reported to the exchange and its price quoted publicly on the video screens hanging from the post.

Moreover, the specialist is charged with maintaining an orderly market in each of his stocks. In practice, he is supposed to ensure that the price of the stock moves in steps of no more than an eighth or quarter of a dollar at a time, so that sudden, sharp price changes do not create unfair advantages for certain investors. He does this by buying shares when sell orders prevail and selling when most others are buying.

In a normal market, the specialist can make enormous profits on the routine eighth- and quarter-point price moves. In an exceptionally heavy market like Monday's, in which stocks head straight down, the specialists can take a beating. One crippled firm has already been taken over by Merrill Lynch.

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