Assisting Clients Understand the Stock Market Reviewed by Momizat on . Part II of II This is the second of a two-part article. In this second part, Edward Mendlowitz illustrates how stocks can be acquired and what factors to consid Part II of II This is the second of a two-part article. In this second part, Edward Mendlowitz illustrates how stocks can be acquired and what factors to consid Rating: 0
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Assisting Clients Understand the Stock Market

Part II of II

This is the second of a two-part article. In this second part, Edward Mendlowitz illustrates how stocks can be acquired and what factors to consider when developing or modifying a stock portfolio.

Read Part I here.

This is a continuation of last week’s article and illustrates how stocks can be acquired and information obtained.

Ways to Acquire Stock

When someone considers investing in the stock market, they have to decide on what stocks or mutual funds they should buy.  Following are some methods of acquiring stock.

Buy them individually: This method involves the choice of stocks that is believed will outperform all the others, or the market.  In other words, the investor thinks they will outsmart everyone else investing in the market.  They also need to decide on the number of stock issues and dollar amount of each company’s stock they will acquire.  Do they invest in one stock (giving the ability to make a killing) or a basket of stocks (thereby diversifying and reducing the risk of large or significant portfolio losses)?

Question: how many stocks should be in the basket?  The author believes that as little as five stocks will provide the market return similar to that of the group the shares are chosen from; give or take about seven percent.  For example, if the proverbial five darts are thrown at a newspaper’s stock listing page, then those five stocks should basically perform the same as all the stocks on that page within a seven percent range.  Ditto if the choice is five stocks from a single sector—they will get that sector’s averages.  Choosing more than five stocks will reduce the seven percent variance somewhat, but should not produce significantly different gains, or losses.  The average performance should show itself over a reasonable period of time such as a couple of years.

Proof of this can be seen by similarity of performance over a couple of years’ period of the Dow Jones Industrial Average, which is comprised of thirty stocks and the S&P 500 Index.

Buying stocks involves trading costs, management and advisory fees, taxes, and investment services and books, periodicals and online articles, and time spent in all of these activities.

Buy mutual funds: Mutual funds are ways of acquiring stocks and professional management at the same time.  A mutual fund is a pass through entity that sells ownership shares and that owns stocks in many companies.  An actively managed mutual fund is where the managers’ objective is to beat the market indexes.  Passively managed funds are where the objective is to match market indexes by investing in index funds.  Performance measurement is done by comparing the fund’s performance against the appropriate market index.

Actively managed funds usually consist of considerable trading with some with portfolio turnovers of greater than 100 percent in a year.  The reality of turnover is that the choices made are continually changed with portfolio stock being sold and new stock being purchased.

Mutual funds clients buy: Should a client buy a fund that did great last year, or during the last three to five years; or the ones they think will do great during the next year, or years?  Even though past performance is no guarantee of how a fund will do in the future, it is a guide to the success of the fund’s style and choices, turnover and reactions to changing market, and economic conditions.  Or should they buy index funds contenting with the market averages.  When you read about market averages, there are just as many stocks, and funds, that are below the average as above it.  That is what average means.  Does the client want to risk being below the average, or are they content with the average amounts?  An effective financial advisor needs to explain these distinctions to their client.

Getting stock from an employer: This usually happens when the client works for a public company or an emerging one backed by substantial private equity investors.  The employee can receive stock, restricted stock, various types of stock options, or be a participant in an employee stock ownership plan (ESOP), or employee stock purchase plan.  In such situations, they will have concentrated positions and will lack proper portfolio diversification increasing their risk.  Some of these acquisition methods can also apply for a client that is an independent contractor rather than an employee.

DRIPs: This is an easy way to acquire stocks, but not every company has dividend reinvestment plans (DRIPS).  A DRIP allows stock to be acquired at low cost, subject to annual limitations, and to have the dividends reinvested.  The quarterly dividend reinvestment and periodic cash payments create an easy way to increase shares at a dollar cost averaging manner.  Further, after time with compounding, the client can end up with meaningful positions in the chosen companies.  A DRIP alternative is to own the stocks in a brokerage account and have the broker arrange for the dividend reinvestment.

Inherit stocks: This works well when a distant relative you never heard of leaves you stock in their will or IRA.

Choosing What Stocks to Buy

Choosing what stocks to buy is difficult at best and almost impossible at worst.  Many people simply do not do the work necessary to choose the best investments.  Rather, they buy stocks in companies whose products and services they use, are familiar with, or who are located near where they live.  Analyzing individual companies is simply too hard, too difficult, and time consuming, assuming the investor had the proper information, which most people, including members of company’s boards of directors, do not have access to.  A way to put this in perspective is to look at the performance of the actively managed mutual funds and compare how they do against the corresponding indexes for those funds.  Many do not outperform their indexes.  Also, many that do, do not do better on a consistent or long-term basis or in a substantial way.  The managers of those funds are professionals with access to much more data than individual investors and have superior training and experience.  Yet, most do not do better than the indexes.  So, how can our clients expect to?  Editor’s note: Many funds do outperform the market.  This article makes no recommendation as to the type of funds to advise a client to invest in.


Risk is the element that makes achieving gains easier or harder.  The lower the risk the lower the potential returns; the higher the risk the greater the returns.  The level of risk should match the probability of attaining stated goals.  Further, clients should take on the lowest level of risk to attain their goals.  Taking on a greater risk than necessary can jeopardize the investment goals and plan.  Our role is to assist clients in determining their appropriate risk level.

Obtaining Public Information

Before investing, the client should read and analyze, at a minimum, the public filings of the companies they are considering buying stocks in.  Following is a summary of the major corporate filings made with the Securities and Exchange Commission (SEC).

Form 10-K: All public companies must report detailed annual financial results using Form 10-K.  This report must contain an audit report by an independent registered certified public accountant (CPA), details of the company’s liquidity position and capital expenditures, and is due 90 days after the close of the fiscal year.

Annual report: Publicly held companies generally report their financial results to their shareholders once a year in an annual report.  This report, a condensed version of Form 10-K, contains the basic financial statements, the accompanying notes, a report by the independent CPA, and a letter and analysis from the company president.

Proxy statement: This is provided to stockholders in connection with the annual stockholders’ meeting.  The proxy statement explains proposals to be voted on at the meeting including the reappointment of the company’s accounting firm and election of directors.  More importantly, it contains information about management compensation and stock options, special deals for management and directors, and related party transactions.

Form 10-Q: Most (certainly all of the listed and major NASDAQ companies) publicly held companies must file quarterly reports within 45 days after the close of each quarter using Form 10-Q.  This report, which is far less detailed than Form 10-K, contains unaudited financial statements, management’s discussion and analysis of the company, and selected other information.

Form 8-K: This form is used to inform the SEC of special events, including changes in control of the company, acquisitions, dispositions, auditor changes, resignation of directors, and bankruptcy proceedings.  These reports are due within 15 days after the occurrence of the event, except in the case of auditor changes, which must be reported within five days.

Form 144: Insiders must register whenever they buy or sell stock.

Registration statement: Whenever a company plans to issue securities, it must first file a registration statement, including a prospectus and exhibits, with the SEC (using Form S-1 or Form S-18 for initial public offerings).  The prospectus describes the company’s background, financial performance, and future plans.  It is a detailed analytical plan providing many valuable clues that can be used for predicting a company’s future performance.


As financial advisors, our role is to assist clients in developing an investment plan and a method of executing that plan.  The ultimate purpose is to use the stock market as part of the plan that will help the client achieve their goals or secure their financial security.  The main purpose in stock market investing is for our clients to share in the growth of the market as reflected in stock market values over a long period of time as well as to receive regular dividends.  To help the client accomplish this, we should try to help them understand how the market works and what information is available to help them make their decisions.

Edward Mendlowitz, CPA, ABV, PFS is Partner with WithumSmith+Brown, PC’s New Brunswick, NJ, office. He is an accomplished professional and is one of Accounting Today’s 100 Most Influential People. Mr. Mendlowitz is also author of 25 professional books including The Adviser’s Guide to Family Business Succession Planning (AICPA 2006), over 1000 articles and blogs and developer and presenter of more than 250 continuing education courses, speeches and webinars. He has testified twice before House Ways and Means Committee on tax reduction, equity and reform; admitted to practice and argued cases before U.S. Tax Court; and was an adjunct MBA instructor for 11 years.
Mr. Mendlowitz can be reached at (732) 964-9329 or by e-mail to

The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.

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