Volume, Volatility and Another Trip Back to the Glossary

First up this week is Ann Forst, who writes: "Can you help me grasp a couple of things? First, is it better to have more or fewer shares outstanding? Why? Second, when looking at a stock's average daily volume, what kind of number should you look for? Is it better to have a higher or lower number? And why?"

To put a well-worn cliche through the grammatical wringer, fewer is more. If a company's shares outstanding were to increase, each investor's stake in that company would decrease accordingly, ceteris paribus. It's called dilution, and it's why a stock's price drops by 50% when the stock splits. Of course, it would be great news for a company, particularly an acquisitive company using its stock as M&A currency, if this dilution wasn't fully realized in the market place -- that is, if the stock didn't actually drop by 50%. But that's not how things generally work.

Volume is a bit trickier. If you don't like volatility, then volume's your best friend. Stocks with low trading volume lack liquidity, and are often subject to wild price swings when too much buying or selling pressure builds up and there aren't enough investors to take the other side of trades. From a technical perspective, look for volume as a way to confirm the importance of trends. A 10% drop on light volume shouldn't be taken as seriously as the same decline on heavy volume. The more trading in a stock (or a stock market), the better read you can get on investor sentiment. It's just a better data sample.

Try watching the interaction of a single stock's price and volume over a couple weeks. You'll get a sense of the ordinary and the extraordinary, and where the stock is trending.

Next up is Bruce Koopmans, who writes: "What's the difference between core earnings and cash earnings? And what's the difference between book value and tangible book value? Both questions come from my reading of the Bay View Capital (BVC) annual report."

Cash earnings is just another term for cash flow, which represents earnings before depreciation, amortization and any non-cash charges. This figure matters most for corporations that need a lot of ready cash to pay out dividends to shareholders. Core earnings, on the other hand, are a bit more subjective. Companies come up with this figure by ignoring the income they've received from operations they don't consider ordinary. For example, the interest that an auto parts maker might have earned on a portfolio of mortgage-backed securities probably wouldn't go into that company's core earnings. Core earnings figures are useful insofar as they give you a better picture of whether a company's earnings are sustainable. Sometimes, though, talking about core earnings is just a way to avoid talking about money-losing units.

The difference between book value and tangible book value basically can be summed up in a single word: goodwill. A firm's tangible book value is simply an expression of how much all its (surprise) tangible assets are worth. We're talking assets like cash in the bank or machines on the factory floor. Tangible book value doesn't include goodwill, that is, things like brand names or stellar employee relations. The value of such intangibles isn't set by comparing it to similar items; rather, they're worth only what the market will pay for them.

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Memo to Bill Rogers, who wonders what's the point of convertible preferred stock, and what's the advantage of owning it: Issuing preferred stock gives a company a load of capital while improving its debt-equity ratio -- because it's classified as stock, not debt -- and avoiding common stock dilution. Issuing convertible preferred stock, on the other hand, ensures that someone will actually buy the securities in an equity-driven market like this one.

Convertible preferred stock does have a dilutive effect. But that's also its strength. Investors get a steady stream of dividend income, but have the option to convert their shares to common stock (according to a conversion ratio assigned at issuance) if that looks attractive down the road.

Another thing about preferred stock: although it functions like a bond, it's legally considered equity. That means that companies don't have a legal obligation to honor preferred shareholders' claims, although those claims take precedence over common shareholders if the business goes under.

Memo to Nancy Hutchison, who wonders how she can get a quote on a stock listed on the Australian Stock Exchange: Easy. Go to Yahoo! Finance and click "Yahoo! Australia and New Zealand" from the list of countries at the bottom of the page. Bingo. Type in the ticker and you'll get the ASX quote. Caveat: ASX quotes on Yahoo! are based on the previous day's close.

Memo: Have a dumb question relating to finance? Have a problem with something I've written? Send it to [e-mail], and I'll do my best to answer. Include your full name, and please, no questions seeking personal financial advice or regarding personal brokerage disputes. And this reminder: Because of the volume of mail, personal replies can't be guaranteed.

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