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Last week the federal government took over Fannie Mae and Freddie Mac, the nation’s largest mortgage institutions, in a move to save the companies from completely going under. By the end of the same week, speculation and rumours started to surface about Lehman Brothers and a financial crisis. Over a hurricane-filled weekend, Lehman Brothers declared bankruptcy and AIG asked the Federal Reserve for liquidity assistance. Meanwhile, Merrill Lynch was taken over by the Bank of America powerhouse (who will soon indeed become the bank of America). On a sunny Monday morning, investors pulled out enough funds from the market to tank the indices over 500 points, or down nearly 5%. The only other thing that could tank the market in this fashion is the day two planes flew into two skyscrapers, permanently affecting the Manhattan skyline (dramatic enough for you?)

On Tuesday the Federal Reserve refused to cut rates and refused to provide support for Lehman brothers, sending the markets down even further, but fortunately enough half-full kind of guys bid it back up. But Wednesday’s trifecta perfected the bloodbath on Wall Street, resulting in further triple digit losses. The government agreed to bail out AIG, and speculation ensued on “who’s next”? Goldman? Morgan? Only time will tell.

So what is happening?? The headlines spell financial crisis.

What we are dealing with here is a major broad-based price correction in the markets. As the Washington Post described earlier this week - we are in the midst of building a new architecture for the financial world. After years of record earnings and creative new methods of financing, the titans and powerhouses of Wall Street have to reckon with the reality that the financial sector they built has grown too large and is unsustainable given the amount of leveraging and debt usage they’ve incorporated. The economy is in danger due to incessant greed.

The regulators and the financial institutions themselves completely miscalculated the risks they were putting the economy and the country into. When wealth grows beyond sustainable levels - it will correct itself. The timeless mantra of Benjamin Graham and his disciples such as Warren Buffett and Phillip Fisher states that the natural law of time will indeed correct overpriced companies and simultaneously reward and correct underpriced valuations. We are well into correction phase. When institutions dream up crafty new ways of building wealth in the markets - they are forgetting the fundamental rule of business - offering a quality product or service for the right price to the markets and monitoring competitive threats every step of the way. Instead of offering quality mortgage loans to the buyers/lenders/borrowers, crummy mortgage loans were offered and then repackaged. No matter how many times crummy mortgage loans are repackaged into clever packages (and then offered as bonds to the public), they are still crummy.

When markets need to correct - you generally see it gradually over several years. The good guys end up watching the bad guys suffer as earnings prove unsustainable, and vultures pick up the pieces left by companies falling part. But when there has been a gross and broad-based miscalculation by just about everyone, what we see is a dramatic series of midnight meetings, last minute bailouts, triple digit losses, and what looks like the entire American financial system crumbling in front of your eyes.

But I suggest to my readers - fear not. Keep the cash on the sidelines ready to pounce when the iron is hot. A correction does not mean meltdown. It simply is the path necessary to return to normalcy and rationalism.

This too, shall pass.

We’ve heard it millions of times before. Isn’t investing in stocks just like gambling?

Oh how I loathe this argument. Personally, I am not a gambler and I further have moral issues with gambling as a general institution. So you can imagine the frustration I feel when people compare the NYSE with the latest Belmont stakes.

Investing involves risks, just like anything else does in life. But comparing investing in solid companies at good prices to a roll-the-dice scenario is unfair and wrong at best. A gamble in the traditional sense is usually set with high stakes, you can win big all at once compared with losing little by little. Although in some traditional types of gambling, you can also lose big in one shot as well, unfortunately. But investing is quite the contrary…

The attraction that people have to the markets is driven on money and riches. It is true that the market has been the primary source for some of the world’s wealthiest people, and media attention to those people simply increases the attraction. Big shot investment bankers, private equity guys, investors, traders, hedge funds, and mutual fund managers - all are some of the world’s richest and they did indeed make their money on investing. But what is the difference between them and casino-rollers? The difference is a methodical and calculated method of finding undervalued companies at good prices and then deciding what to do with those companies after acquiring a part of them. Chance is much less a factor as much as mathematics are.

But traditional gambling throws caution to the skies and there is a chance of winning based on the will of some unknown being. “Winning,” so to speak, in investing is not the result of chance but the result of consistent and ongoing increasing earnings for a company. If a company has been able to demonstrate quarter after quarter and year after year to the Street that they have a stellar product lineup that outperforms their competitors every time - you’re bound to profit from that company’s performance. Is that really a gamble?

Sure if you just place your bets and invest in any company that you just have a “gut feeling” will rise - that can be considered a gamble. But this site and smart investors don’t ever condone that. What do we look for to avoid gambling and decrease risk? Look at the company’s annual report - read and understand what they do. Use your mind and think of what the market forces are and whether the market may be rewarding them in the coming years. Find out what the company’s expected cash flow generation is for the future, and run a discounted cash flow analysis to come to your price target. Find out what the price is today that you’re paying for the company and whether this is at a discount or at a premium - and walk away if it is the latter. What is the competition doing? Read through their reports as well. What about the global trends? Are more people or less people buying into this product/service over time? What about costs which decrease the bottom line? Are material costs rising or falling? Answer a myriad of questions like these and you’ll be sure to invest in solid companies, thereby avoiding any gamble.

Does that mean you’ll always make money? No, of course not. But if and when you do lose money - it means you were simply incorrect in your analysis, as opposed to being exposed on your gamble. The world’s best investors - Warren Buffet, John Bogle, Philip Fisher, Kirk Kerkorian, Peter Lynch - these guys took their time and understand what they were buying. Does gambling and throwing all caution to the wind result in billions of dollars? No. If you’re smart - you’ll understand that investing in the stock market takes time and skill as opposed to mindless gambles. You may be correct, or not in your picks. But you also might be wrong when you try and buy something cheap somewhere in order to sell it higher anywhere else. Sound familiar?

I always like to look at the lessons we can learn from history. Humans don’t change - we’re fickle-minded impatient people and we have been forever. So in this current official bear market, what can history teach us about the future?

First of all - stop panicking. We’re in a bear market, again. This isn’t some life-threatening ordeal. It amazes me how in every bear market, people always put the US up for sale in a heartbeat, but never seem to learn. Sure things are bad. Very bad - a perfect storm is indeed brewing with real estate, oil prices, job losses, etc. But this too, shall pass. The S&P’s peak was October 12 at 14,093 - we’re off over 23% from those highs. That’s a pretty steep drop. It gets me excited to start dumping more money in. Here’s why.

The average decline during the last nine bear markets was 31%. This means that it’s possible, yet unlikely, to fall further down to 9,700. But with that said - most of the drop has already happened, historically speaking. Most, but not all of the bad news is already priced in. Now is the time to start buying up into indexes slowly and methodically. After falling 20% - the last nine bear markets have returned a positive average of 3% within just one month of crossing that negative 20% threshold. And within twelve months, the last nine bear markets have returned an average of 17%.

17% - that is not chump change. This means that if history proves true, and we invest today given that we’ve crossed the 20% threshold, we’ll earn about 17% in the next twelve months. And if we’re no where near the bottom, we still stand to gain perhaps 10% (also not chump change).

History can’t always prove correct, but it’s definitely a good indicator. So far, this bear market has unfolded exactly as the past nine have. On average, the nine crossed the 20% decline point nine months after beginning their decline. We’re right on schedule. The past bear markets lasted, on average, another five months.

Things are pretty bad out there. But let’s get things in perspective. In the 2002 crash, irrational exuberance ruled, which is something we are all protected against today. Contrarily, when we hit 14,000 back in October, industry experts were wondering “how did it get this high?” as opposed to “how much higher?”. The market was selling at a P/E of 35 before the 2002 crash. The P/E was even higher at 40 times earnings in the 1973 crash. Back in October - we were at a mere 19 times earnings. Sure things were overvalued, but not anywhere near historical records. If that’s not enough to convince you: the 1987 crash showed a 23% drop in one single trading day. It took us eight months to do that this time around. The 1970s showed double digit inflation couple with record oil prices. Perhaps today’s 6% inflation is high, but its still manageable.

In 1990, thousands of savings and loans banks failed, and the financial sector went kaput. This caused a 20% drop in about three months. This one resembles 1990 quite closely.

I do think we have quite a bit more to go, but I wouldn’t bet the horse on it. I’d slowly start putting my money back into the market. The lower it goes, the more aggressive I’ll invest. 10,500 will indicate more deposits into my Scottrade account, and at 10,000 (if we ever get there), I’ll probably dump a ton of cash into the markets. It’s easier to hold long-term than to try and time the market.

So everyone relax and let this bear market unravel itself. It’s happened nine times before since 1956. Turn off the TV Chicken Little - we’re not done investing quite yet.

Much of this article is derived from a great piece written by Kiplinger’s.

Firstly - it’s a scary market out there. Don’t get into new picks and dumping more money unless you’re comfortable tying your money up for at least a year, perhaps several years.Secondly, I’ve been doing some research on “the next big growth area” or whatever you want to call it, and I’m finding that developing nations are now slowly mandating the installation of airbags in all vehicles. This means that key niche companies which focus on airbags and safety equipment and have heavy international exposure may benefit immensely. I found one such company - ALV.

Autoliv is a Swedish based American company with employees in 30 different countries. This pick is a growth play with a one to two year horizon. I took a look at their annual report (which is the first place you should look when analyzing stocks) - and their revenue is in solid shape, increasing 9% in the last year to $6.8 billion after modestly dropping the year prior. Their net income is flat after adjusting for one-time issues (but who doesn’t have one time issues nowadays?). They’re focusing on lowering costs and increasing profitability by switching over to low cost countries - here we go India.

The company generates over half of its revenue from Western Europe, but only a quarter from North America. So 22% is from the rest of the world, which doesn’t bode greatly for our developing nations theory. However the growth and revenue boost they saw in 2007 is directly from emerging markets. They’ve doubled their China based plants to nine in the last year and opened up plants in India and Korea as well.

The competitive arena is limited to three major players besides Autoliv - TRW and Takata. TRW is a major player, but Autoliv seems to have been stealing market share from them. Takata enjoys a smaller share but is growing fast. The remainder of the market is extremely fragmented.

I’d like to look into the risks in more detail - but the prominent risk that stands out is if they can grow profitability in the near and long term. It’s a capital intensive business - and you’ll need thousands of full time resources focusing on this constantly.

Autoliv has been increasing forecasts and guidance lately (one of the few in 2008). The price point of $45 is down 20% for the last twelve months and off 30% since 52-week high of $65. they also raised their dividend to a 3.6% yield, and they’re 87% owned by institutions. They’ve been steadily buying back shares and regularly increasing dividends (dividends increasing at 25% CAGR for the last five years).

I’m going to continue digging before I add it to my portfolio - particularly I’ll have to try and find some sell side reports and find out what the experts think (”expert” is a relative term). But for now - it looks quite intriguing. If you find a stock you may be interested in - you should do a similar type of analysis. What do they do, how do they make money, where does it come from, how has their revenue and profit grown, what is the long term outlook on industry and company, who are key competitors, what are key threats, how expensive is the stock, etc.

The best part is - opening the 10K and writing this article took me about 35 minutes of research. That’s all. Don’t try and time the market - do your research and buy good companies at good prices for a long term horizon - and you’ll be rolling in your investment playground.

With the advent of technology, sometimes it might feel better to avoid purchasing individual stocks and instead just “buy the entire market”. Is this possible? With index investing, it is. Index investing is one method to avoid the madness of Mr. Market, and slowly watch companies’ earnings grow over time. Indexes such as the S&P 500 are the benchmarks which mutual funds compare themselves against. If a mutual fund manager earns 10% in any given year - but the overall indexes have earned 20% - this guy might be on his way out the door (with a grossly large and undeserved bonus). After all - he underperformed the market by 10%.

Outperforming the market or picking phenomenal stocks every time is not easy. Very few people have succeeded. This is precisely why a staple in every investors’ portfolio should be an index fund. The easy way of understanding indexes - basically they are the entire market.

All the stocks in the entire market trade in what is called an index. An index is not an individual stock, but a basket of many different stocks. The weighting of each stock depends on their market capitalization - a complicated term describing “size”. The Dow Jones - the thing everyone talks about - is itself an index. You can not buy the Dow Jones - it is simply an indicator of how 30 carefully selected companies are all together performing. The S&P 500 is a summary of the top 500 companies trading in the markets (those 500 companies are decided by a board of really smart and overpaid people). NASDAQ is a listing of tech-related companies. The Russell 2000 is similar the S&P 500 - except for it includes 2000 of the top companies (rocket science, I know).

How do I invest in an index?

The short answer is that you can’t invest directly in an index, per se. But what you can do is invest in an index FUND - a fund developed which mirrors the index. These are not actively managed funds - they are simply computer programs that create a vehicle for you to dump your cash in. If the target index tanks - your index fund will sink as well. These are passively managed funds which have drastically lower expense ratios.

Can I make more money by having a computer do it for me instead of someone really smart?

Firstly, “smart” is relative. Making money doesn’t make you smart, it makes you rich. And being smart doesn’t always make you money. Most geniuses die before they’re 40, or end up on the streets because following the corporate game is “below them”. But I digress.

Here are the simple stats: since the 1929 crash, the market has returned an average of 11% per year. Some years its gone down 10%, others its gone up 20%. But if you stayed firm and held course, you always gained 10% annualized over eight decades. A mere $1000 investment into an index fund in 1930 would be worth $3.4 million today. There are some “smart” people who have done better, but generally not over several decades. Humans are emotional, and emotions drag down your returns. Investing in an index fund over a long period of time generally will make you enough money to be free.

How much do index funds cost me?

Because index funds are passively managed, they are signficantly cheaper than managed funds. An average managed fund’s expense ratio might be 1.5% (or others can go up to 4%). In addition, some funds carry a one-time “load” fee of 4.5% or so. Contrarily, index funds never carry higher than 0.5% expense ratios. Obviously, running a managed fund carries additional expenses. But you’ve got to achieve some pretty high returns in order to justify a couple percentage points of costs. Only the best managers return that much higher than the market every year (and that list keeps changing).

So how do I invest in an index?

Now the meat of the post. Check out this link at Vanguard’s website. Scroll down to the bottom for the stock index fund listing. You’ve got your S&P index fund, Total Stock Market Fund, High Dividend Yield Fund, International Stock Index, etc. With the repressed levels of today’s market, I recommend you buy into one or perhaps a few of these funds. Further I recommend you enroll in an automatic investing plan to keep on investing additional funds. History shows that over time, you’ll earn an average 10-11% annually.

Another option is what’s called SPDR ETFs. These essentially are index funds that you buy and sell just like stock. There are no minimums, but you do pay standard commission charges. I strongly suggest you put down larger amounts of money into a proper fund such as Vanguard. If you’re investing with $500 or so, maybe you shouldn’t be in the market quite yet. With that said - I did decide to purchase shares in the SPY, just to take advantage of the Dow at 11,300. Check out www.spdrs.com for more info on SPDR investing.

A buddy of mine, we’ll call him Joe G., emailed me this morning:

“Hey. I want to buy stock in a company. Do you think you can advise me on the best way to do this? Through a broker? The Internet? How do I research?”

As great investment ideas this website - I’ve failed to address that fundamental question. How do I get started? We’ll do this in three parts. The first will be the basics of how to get started. The second will be how to research stocks, and the third will be how to research funds.

The first thing I advise you to consider is how much money can I make? This is a fundamental question - set your expectations realistically and you’ll never be disappointed. Before diving in, most people think you can deposit a few hundred dollars, and double it in a couple hot companies. Investing is HARD WORK. Don’t expect to make tons and tons of money. The general rule is to expect 10% returns annually for most, 20% if you’re good. That means - $2000 in investments may earn you roughly $300 in twelve months. Sure there are many exceptions because many companies rocket through the roof (and others sink like a boulder in a fresh water lake). But the general rule and how to guide your expectation is 10%-20% (between 1930 and 2008, the market has returned an average annual return of 11%).

WIth that out of the way, how much money do I need to get started? The answer to this question depends on your costs and fees, such as commissions. A company such as Scottrade charges $7 per trade (one buy or one sell is considered a trade). If you’re spending $14 and investing $500, that means you’ve already lost 2.8% in commissions. This may not seem like a lot, but when you return back to your expectations and realize that 10% is what you can expect - 2.8% is a lot worse than you realize. Your goal is to minimize the percentage lost to fees and commissions. Good mutual funds have expense ratios less than 2%, you should maintain that as well.

So what does that mean? My personal rule is I never invest less than $1000 when I’m paying $14 in commissions. I prefer to invest moreso - but I’m not as rich as all you faithful readers. So $1000 per trade, i.e. per company. That’s the bare minimum - a grand. However, I strongly suggest you start with several holdings, so you should technically have at least $2000 to $3000 to get started. But if you’re antsy, $1000 will get you by for now, until you beef up your cash holdings. See diversification below.

I’ve got my $3000. What do I do now? Next step is to find a brokerage house. I use Scottrade. They’re cheap and provide all the necessary tools that a part-time/small-time investor needs. Graphing options, research options, online deposit and withdrawals using MoneyDirect, live streaming quotes, etc. Contact me to sign up for a new account and receive three free trades. Seriously - Scottrade is offering this new feature where you and I will both get three free trades after referral. A value of $21. Seriously - I don’t care who emails me - all I need is your name and email address. I give it to Scottrade, within minutes you have an invite in your inbox. Sign up and you’re already up $21. It’s really easy to sign up. The typical application form items including your social security number and banking info. The first deposit may have to be by check for security purposes, but after that it’s really convenient. I’ve never seen anyone cheaper than Scottrade - and I haven’t ever had a need for some extensive expensive tool.

I’ve got my money deposited into my Scottrade account. What do I buy? Stay tuned for part II, where we dive into how to properly and efficiently research a company.

Contact me for questions - or for your referral bonus of three free trades at Scottrade.

I’ll be nice and short and try not repeating some of my other posts.

1. $44.27 price from a 52-week high of $53.48 (off 21%) and a low of $40.
2. The stock price has return 130% since Mark Hurd’s entry as CEO in 2005
3. Proven record of integrating companies successfully with the exception of COMPAQ - the result of COMPAQ was poor for the company but did not deter any long term success
4. Proven ability for the company to harness a fundamental trait in an ultracompetitive industry: speed
5. P/E multiple of 15 compared to the industry’s 20.
6. Forward P/E of 11 versus industry’s 15.

Must I continue? I think this is a great long term holding for your portfolio. Now don’t go and buy 5 shares and expect the stock to hit $50 this week. But do your research, buy a large amount dependent on your portfolio size, and then walk away with full confidence that you don’t need to check this stock for weeks. That’s what I’ve done.

This just came across the wires folks - so news is limited as you can understand. But here are my preliminary thoughts.

Firstly - HP has been a solid company that has been able to grow extremely fast (from the tech drop in 2002 of $11.45 to a recent $55 per share). They’re pulling together over $100 billion in annual revenue from a number of offerings - Enterprise Storage and Servers for businesses, IT Services, Software Solutions, Personal System Computers, Imaging and Printing, and financial services. The company’s profit margins are increasing to over 9% (not bad for a production and capital heavy company). The P/E ratio of about 16.5 is under the industry’s 18.5. We’ve seen the stock take a beating from $51 down to $40 and back up to $49.97 this morning. Now with the acquisition news - we’re down to $46. Preliminary reports say the acquisition sticker price is at $12 billion.

Acquisitions are HARD WORK. The reason why the Street will instantly sell a stock once they talk about an acquisition is because many times their acquisition just won’t work out, and a company could lose billions in trying to make it so. Look what happened to Sprint after they bought Nextel. But HP has proven themselves time and time again that they know how to acquire good companies and translate them into top line revenue growth for the company.

EDS - one of the top global providers of IT support - will only strengthen HP’s already strong hold of the IT market. If you’re willing to buy long term (which you should be) - take the weakness in HP today as a buy signal. And any other budding global IT providers better roll up their sleeves, because the battleground just got tougher.

Disclosure: I own stock in HPQ