Investopedia

How does the Tax Cuts and Jobs Act’s impact home equity loans?

Reviewed by Lea D. Uradu

Deducting home equity loan interest can save you money on your tax bill, but you have to understand the rules under the Tax Cuts and Jobs Act (TCJA) of 2017. A loophole allows homeowners to deduct interest for qualified home improvements.

Key Takeaways

• The TCJA of 2017 significantly altered the rules for deducting home equity loan interest.
• Homeowners can still deduct interest if the loan is used for qualifying home improvements.
• Proper documentation and adherence to IRS guidelines are crucial for claiming deductions.
• There are limitations on deductible interest, including caps on mortgage debt.
• Loans taken before December 15, 2017, may have different deduction rules.

Overview of the Tax Cuts and Jobs Act (TCJA) of 2017

The TCJA was an overhaul of federal tax rules that impacted individuals and businesses. The law lowered income tax rates from many individuals. It increased the standard deduction, but it also introduced limitations on several itemized deductions.

Prior to the introduction of the TCJA, homeowners could deduct the interest they paid on home equity loans. Now, there are limitations on deducting that interest based on how the home equity loan is used. For example, you cannot deduct interest paid on a home equity loan if that loan is used for personal living expenses.

Understanding the Loophole

While the TCJA does limit homeowners’ ability to deduct interest on a home equity loans or a home equity line of credit (HELOC), a loophole allows you to claim a deduction in certain cases.

You can claim the interest paid on a home equity loan as a deduction if that debt is used to build, purchase or improve your home.

Eligible Home Improvement Expenses

You can deduct the interest on a home equity loan secured by your primary home or second home when you use the loan to buy a property or build a home.

You can also claim the deduction when you use a home equity loan to improve your home. Eligible improvement expenses include:

• Remodeling: Remodels are often big projects. You may decide to finance your kitchen remodel, for example, with a home equity loan. The interest you pay on that loan would be deductible.
• Home addition or conversion: Building an addition to your home or converting your basement into a livable space adds value to your home, which means these projects would be eligible expenses.
• New roof: Replacing your home’s roof is a big improvement project. You can likely deduct the interest you pay on a home equity loan that finances the new roof.
• Solar panel installation. Solar panels could boost the value of your home and potentially result in tax deductible interest.

If a project adds to the value of your home, it is typically considered an eligible expense that will allow you to deduct the interest you pay on a home equity loan or HELOC.

Best Practices for Claiming the Deduction

If you plan to claim this type of deduction, it is important that you follow the IRS requirements.

• Check the IRS requirements: Before you move forward with the deduction, make sure that the loan in question is secured by your primary residence or a second home, like a vacation home. Confirm that the proceeds of the loan were used to improve your home or to buy or build a home.
• Gather your documentation: You will need Form 1098, which is your mortgage interest form. It will include the interest you paid on your home equity loan. You may not receive this form if you paid less than $600 in interest.

You will also need receipts to show that you used the funds for eligible home improvement.

• Consider all of your deductions. Interest paid on a home equity loan is one possible deduction. Consider all of your itemized deductions. For example, you may have mortgage points, which you can pay to your lender to lower your interest rate.

Adding up all of your itemized deductions can help you decide between taking those or a the standard deduction. The standard deduction is $14,600 if you file for tax year 2024 as an individual or married filing separately. Married couples who file jointly have a standard deduction of $29,200. If you file as head of household, your standard deduction is $21,900.

Note

If the standard deduction is higher than your total of itemized deductions, the former will save you more on your taxes.

Limitations and Considerations

While can you claim interest paid on a home equity loan or HELOC as a deduction when you use the debt for eligible projects, there are still some other limitations to consider.

The TCJA changed the total mortgage loan amount from which taxpayers can deduct interest. Previously, the total amount was $1 million. Under the TCJA, it is $750,000 for individuals filing as single and married couples filing jointly. If you are married filing separately, the cap is $375,000.

The year you took out the home equity loan can impact your deduction. For loans taken out before Dec. 15, 2017, the maximum remains $1 million.

Keep in mind that you can still qualify for the deduction with loans greater than the cap, but the maximum amount set by the IRS will be used to calculate the interest you pay and can deduct.

The Bottom Line

You have the option to deduct interest that you have paid on a home equity loan, even under the TCJA. But it is important to understand the limitations on taking that deduction, including the way the loan is used and the loan amount.

If this deduction and your other itemized deductions add up to more than the standard deduction, you will save more on your taxes by claiming the itemized deductions.

Fact checked by Vikki Velasquez
Reviewed by Katie Miller

Navigating the complex world of investing has become more accessible and less intimidating thanks to the rise of online brokers and robo-advisors. Both offer unique benefits, providing streamlined, efficient platforms for investing in the stock market by leveraging technology. Online brokers are ideal for those who prefer a hands-on approach, making their own decisions and doing their own research. Robo-advisors are best suited for those who value simplicity and hands-off automation.

It’s essential to understand what they offer and how they align with your financial goals so you can make an informed decision between these two options.

Key Takeaways

• Online brokers are platforms that offer direct access to a broad range of investment opportunities and allow you to make your own trading decisions.
• Robo-advisors are automated investment platforms that use algorithms to create and manage your investment portfolio for you based on your risk tolerance and financial objectives.
• Online brokers offer more control and flexibility and this can appeal to experienced investors.
• Robo-advisors provide simplicity and low-cost investment management, making them ideal for novice investors or those with a hands-off approach.
• Your choice between an online broker and a robo-advisor will depend largely on your investment knowledge, time commitment, and financial goals.

What Is an Online Broker?

The concept of online brokers emerged along with the internet in the late 20th century and it revolutionized the way people trade. An investor had to go through a traditional broker to buy or sell securities before this and it could be a cumbersome and costly process. The barrier was lifted with the advent of these digital platforms. They serve as intermediaries for buying and selling financial instruments that can range from stocks to bonds, mutual funds, ETFs, and even cryptocurrencies.

What differentiates online brokers from traditional brokers is the level of autonomy they provide to investors. Individuals can use these platforms to place trades themselves, using the various tools and resources provided to make informed decisions, instead of relying on a human broker to recommend and execute trades.

Note

Online brokers function as gateways into the financial markets. They enable you to buy and sell a variety of assets like stocks, bonds, exchange-traded funds (ETFs), and mutual funds.

The principle here is self-direction. You have the autonomy to conduct research, analyze market trends, and make individual trading decisions. This gives you full control over your portfolio but it demands time, financial literacy, and a certain comfort level with managing risk. Most online brokers offer their customers a suite of tools, however, to help them conduct research, grab headlines, simulate trading, and access a range of asset classes.

These resources often provide comprehensive research, real-time market data, charting tools, and even educational resources to equip investors with the knowledge to navigate the financial markets. Some brokers go further, offering advanced features like simulated trading, expert market commentary, and customizable alerts for specific market conditions.

What Is a Robo-Advisor?

Robo-advisors are automated platforms that are designed to shoulder the burden of portfolio management. They leverage their algorithms to construct and manage your portfolio when you input your risk tolerance, time horizon, and investment goals.

A robo-advisor uses software to manage your investments. It creates and automatically adjusts your portfolio, offering a more hands-off investment experience. These platforms drastically simplify the investment process and make it more accessible to a wider audience. This allows robo-advisors to offer their services for a fraction of the cost of a traditional human advisor and with far lower opening balances.

The strength of robo-advisors lies in their hands-off approach. This is especially beneficial for beginners or those who prefer not to sift through the intricacies of the financial markets themselves. You can’t choose what goes into your portfolio, however, and you can’t make changes to it.

One of the notable features of robo-advisors is their automated portfolio rebalancing. Market fluctuations can cause your portfolio to drift from its original asset allocation over time. Robo-advisors automatically correct this by buying or selling assets to maintain your chosen level of risk and return.

They can also engage in tax-loss harvesting, a strategy that offsets capital gains with tax losses from similar securities. This automated maintenance and optimization can be a major advantage for those who lack the time or expertise to monitor their portfolio consistently.

Important

Many online brokers incorporate robo-advisory elements into their platforms, providing pre-built portfolios and automating certain investing features. Some robo-advisors allow for a degree of customization, letting users tweak their portfolios based on personal preferences.

How to Choose an Online Broker

Choosing an online broker is about finding the platform that aligns with your trading style, investment goals, and preferred level of autonomy. Don’t neglect to compare commissions and fees.

The landscape of online brokers is diverse and competitive. It ranges from brokers that cater to experienced traders with sophisticated platforms and a vast range of assets to those designed for beginners with easy-to-navigate interfaces and educational resources. These platforms have democratized investing, making it accessible to anyone with an internet connection. They continue to evolve, shaped by technological advancements and changing investor needs.

How to Begin Working With a Robo-Advisor

The process starts with providing essential information about your financial situation and goals. You’ll typically answer a series of questions designed to determine your risk tolerance, your investment time frame, and your financial objectives. These parameters will guide the robo-advisor as it crafts an investment strategy tailored to your needs.

It’s a quick, straightforward process that allows even those who are new to investing to establish a well-diversified portfolio. Those that are created typically utilize low-cost index ETFs and follow the diversification principles underlying Modern Portfolio Theory (MPT).

Wealthfront and Betterment are two early robo-advisors known to have pioneered many standard features.

Online Broker: Advantages and Disadvantages

Online brokers offer a wide array of investment possibilities, serving as a portal to global financial markets. They grant investors the freedom to shape their portfolios according to their own insights, strategies, and risk appetites. This is particularly appealing to seasoned investors who possess the knowledge and confidence to navigate the financial markets independently.

The variety of tools and research resources available on these platforms can significantly enhance the investing experience, providing valuable market insights and aiding in informed decision-making. Many online brokers offer zero-commission trading in many stocks and ETFs.

The autonomy and freedom offered by online brokers come with their own challenges, however. The responsibility of monitoring the markets, staying informed about global economic trends, and adjusting the portfolio as necessary falls squarely on the shoulders of the investor. The wealth of information available can be advantageous but it can also feel overwhelming to novice investors or those who lack the time to engage deeply with these resources.

Pros

• Lots of autonomy and flexibility

• A wide range of securities and asset classes to choose from

• Low-cost or commission-free trading

• Research, screeners, and other tools available to users

Cons

• Requires self-discipline and self-management of the portfolio

• May not be appropriate for novices

• Can encourage overtrading or trades based on emotion

Robo-Advisor: Advantages and Disadvantages

Robo-advisors offer many advantages, particularly for beginners. Their automation of portfolio management makes investing accessible for those who lack extensive knowledge or time for portfolio management. This hands-off approach eliminates the need for constant portfolio monitoring and adjustment, freeing up time for investors.

Robo-advisors are often praised for their cost-effectiveness. Traditional human advisors typically charge a percentage or more of assets managed and this can become quite expensive. The best robo-advisors leverage algorithms to deliver similar services at a fraction of the cost, allowing for much smaller account minimums. This makes them a more affordable choice for those with smaller budgets.

The greatest limitation is the lack of personalized service. Robo-advisors can’t provide the depth of personal interaction that some investors seek. Complex financial planning needs or significant life events often require a human touch for effective management. The customization options provided by robo-advisors are often limited compared to what a human advisor or online broker could offer.

Pros

• Automation of well-diversified portfolios

• Much lower cost than traditional advisors

• Low account minimums

• Continuous monitoring and rebalancing

Cons

• Less flexibility and customization

• Limited investment options and strategies

• Lack of a human touch

What Investor Is an Online Broker Best Suited For?

Online brokers tend to be most beneficial for investors who have a reasonable understanding of the financial markets and prefer a hands-on approach to investing. They appreciate the control and flexibility that online brokers provide such as the ability to actively trade and respond to market changes. They typically don’t mind investing the time necessary for research and are comfortable making investment decisions independently.

Who Is a Robo-Advisor Best Suited For?

Robo-advisors are a good fit for those who prefer a more hands-off approach to investing or who may be new to the world of finance. Robo-advisors are also a great choice for those who seek a low-cost investing option because they typically charge lower fees than traditional advisors.

How Risky Are Robo-Advisors?

The level of risk associated with robo-advisors is primarily linked to the type of investments they make on your behalf and the market conditions at large. Robo-advisors typically invest in a diversified mix of exchange-traded funds (ETFs) that are designed to spread risk across a wide range of assets. This diversification generally leads to a lower risk profile compared to investing in individual stocks.

These platforms are registered with regulators and approved to handle investor money. They often have the backing of larger financial institutions and they’re covered by Securities Investor Protection Corp. (SIPC) insurance just like any other brokerage account.

The Bottom Line

Both online brokers and robo-advisors use technology to make accessing financial markets easier and low-cost. Choosing between an online broker and a robo-advisor hinges on your investment knowledge, time commitment, and the level of control you want over your portfolio. Both options have their merits and can successfully guide you toward your financial goals.

Disclosure: Investopedia does not provide investment advice. Investors should consider their risk tolerance and investment objectives before making investment decisions.

Reviewed by Charlene Rhinehart

The price-to-earnings (P/E) ratio is arguably the most effective and often used valuation metric in equity analysis. Here, you’ll learn how to calculate the trailing twelve-month (TTM) P/E, the forward P/E, and examine how P/E analysis can be applied to the entertainment content behemoth, Netflix, Inc. (NFLX).

Key Takeaways

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Trailing Twelve-Month (TTM) P/E

To determine this calculation, one must first understand the underlying components, which are as follows:

• The numerator of the P/E ratio is the current price of the stock, symbolized by the letter “P.”
• The denominator of the P/E ratio is the earnings-per-share (EPS), symbolized by the letter “E.”

The EPS is itself a ratio that breaks earnings down by the company’s shares outstanding, which can be calculated as follows:

(Net Income – Preferred (Net Income – Pre Dividends) / Weighted Average Number of Diluted Outstanding Shares = EPS

Together, the price divided by the EPS results in the P/E, which reflects how much investors are willing to pay per $1 of a company’s earnings. The price portion is straightforward. One must simply pull up Netflix’s share price (the numerator) on any given day. Determining the denominator is also easy for investors, because the Securities and Exchange Commission requires all public companies to report this ratio in their quarterly Form 10-Qs and annual 10-Ks.

Remember that EPS reflects the company’s earnings to outstanding shares, which demonstrates how much money the company makes per share. This is a fluid and ever-fluctuating value, due to changes in earnings and outstanding shares. For instance, if shares outstanding increase without a corresponding increase in earnings, EPS will decrease.

Furthermore, EPS is typically calculated using diluted shares, which accounts for any convertible shares that may be issued through bonds, warrants, employee benefits, or other sources.

For a TTM P/E example, consider Netflix’s reported EPS for the four quarters ended Dec. 31, 2024:

• Q1/2024: $5.28
• Q2/2024: $4.88
• Q3/2024: $5.40
• Q4/2024: $4.27

Adding these figures up yields a TTM EPS of $19.83. And by dividing Netflix’s Dec. 31, 2024 closing price of $891.39 by that number, we arrive at $44.95 ($891.39 ÷ $19.83), which is NFLX’s TTM P/E ratio on that day. This tells us that at that time, investors were willing to pay $44.95 per $1 of NFLX’s earnings.

Forward P/E

While TTM P/E calculations are objectively measured by historical data, forward P/Es are subjective calculations that consider a company’s projected earnings-per-share growth. The growth rate can be inferred through management guidance, industry prospects, and growth models based on fundamentals, such as return on invested capital.

For 2024, analysts projected an average EPS of $4.21 for Netflix. But keep in mind that the forward P/E also uses the current price of the stock in the numerator. Consequently, determining the forward P/E required the following calculation: $305/$4.21 = 72.50. As was typically the case, the forward P/E was lower due to a higher EPS projection at that time.

Analysis

P/E values can be considered in the context of a company’s competitors. Consider the following TTM and forward P/E ratios for several of Netflix’s rivals: (Note: this analysis also considers price-to-sales (P/S) ratio.)

Name	Ticker	$ Price	TTM P/E	Forward P/E	P/S
Alphabet Inc. A	GOOGL	1,057.05	44.73	22.78	5.88
Amazon.com	AMZN	1,661.25	130.63	63.69	3.86
Apple Inc.	AAPL	215.30	18.91	16.0	4.13
Comcast Corp A	CMCSA	34.12	6.50	12.12	1.74
Meta Platforms Inc.	META	146.11	22.17	18.38	8.83
Netflix Inc	NFLX	301.62	109.30	72.50	9.42
Verizon Comm	VZ	57.42	7.23	11.36	1.70
Average		496.12	48.50	30.98	5.08

This data shows that Netflix had the second-highest TTM P/E and the highest forward P/E. Growth data for the first three quarters of 2018 tells us that revenue had been growing at a 25% rate, and earnings were expected to grow at a rate ranging from 50% to 100%. Netflix also boasts one of the highest P/S ratios. 

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The Bottom Line

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Fact checked by Vikki Velasquez

Semiconductors are materials that conduct electricity but only under certain conditions. They’re an essential component in modern electronics found in products from smartphones and laptops to cars and medical devices. Semiconductors include microprocessors, memory modules, and integrated circuits.

The semiconductor industry is notoriously cyclical and faces vast shifts in demand but it’s expected to grow significantly into the early 2030s.

Key Takeaways

• The semiconductor industry is critical to modern electronics and is a major global industry.
• The industry has occasionally faced chip shortages due to disruptions in the supply chain caused by the pandemic, trade tensions, and shipping delays.
• The semiconductor industry is driven by increasing demand for technologies such as AI and major investments from the U.S. and governments worldwide.
• The largest semiconductor makers in the world are U.S.-based Intel (INTC) and Taiwan’s TSM.
• China, Japan, Taiwan, South Korea, and the United States were the top five countries producing semiconductors as of 2024.

The Semiconductor Industry: An Overview

The importance of semiconductors in the global economy lies in their ability to process and transmit information. Semiconductor companies are among the largest in the global stock markets and include NVIDIA Corporation (NVDA), Taiwan Semiconductor Manufacturing Company (TSM), and Broadcom Inc. (AVGO). Semiconductors are essential to technologies such as artificial intelligence (AI) and the Internet of Things.

The U.S., EU, and other areas have committed billions to expand regional semiconductor manufacturing due to worries about the effects on national security and competitiveness of shortages.

The U.S. CHIPS and Science Act of 2022 provided $39 billion in grants and a 25% investment tax credit plus $13.2 billion in research and development. The Semiconductor Industry Association predicted in a 2024 report that these and similar incentive programs in Taiwan, South Korea, Japan, and India should help propel about $2.3 trillion in private-sector investment in wafer fabrication from 2024 through 2032. The U.S. would see the largest increase in capacity at about 203%.

Semiconductor Shortages

The semiconductor industry faced a prolonged chip shortage after the pandemic that disrupted supply chains and delayed manufacturing in autos and other sectors. PC sales slumped but overall demand for semiconductors from basic microcontrollers and memory chips to the most sophisticated high-performance processors outgrew producer capacity. Production and supply chain slowdowns were largely mitigated by mid-2024, however.

Demand was already outstripping supply before the pandemic because of the increasing demand from companies involved in AI, the Internet of Things (IoT), and advanced cellular networks that require more powerful and efficient semiconductors. The pandemic also reshaped global demand as people shifted to remote work and online learning, exacerbating trends that were already underway. International trade in semiconductors increased 43% between 2017 and 2022.

The semiconductor industry has also been an issue in geopolitical strife and trade tensions. The U.S. government placed export restrictions on Chinese semiconductor companies, citing concerns about intellectual property theft and national security.

Record Profits

The semiconductor industry enjoyed record profits and record stock prices from 2020 through 2024 despite a brief dip in 2022.

Chip stocks slumped in 2022 due to fears of a global recession. Weaker consumer spending meant that companies cut back on semiconductor products even as chipmakers invested billions in new fabrication plants to increase supply. Then the U.S. Department of Commerce announced strict export restrictions on selling semiconductors and equipment to China in 2022 which cost billions of dollars in revenue for several struggling semiconductor firms.

This chart shows the VanEck Semiconductor Index ETF (SMH) prices from 2020 to the second quarter of 2024.

The semiconductor sector began recovering by mid-2023 and reached record highs in early 2024 due in no small part to the rise of NVIDIA, a leader in the growing GPU market for crypto mining and AI applications. NVIDIA is the largest holding for SMH at about 20% with TSM at about 13% and Broadcom at 8%.

Technological Advances in Semiconductors

The semiconductor industry’s future is closely intertwined with the development of several key technologies including AI, IoT, green energy, autonomous vehicles, and 5G+ networks. The increasing demand for faster, more efficient, and more powerful computing devices is driving the need for semiconductor materials, manufacturing processes, and chip architectures.

The Return of Germanium

The return of germanium as a semiconductor material has been a notable development. Germanium was used in the first transistors but it was largely replaced by silicon because silicon is abundant, costs less, and tests better for certain aspects of conductivity. Germanium’s higher electron and hole mobility makes it more efficient for high-performance transistors, however.

Researchers are exploring ways to integrate germanium channels into circuits. This could lead to faster and more energy-efficient devices. Advances in germanium-based transistors such as FinFETs and nanowire designs could help overcome some of the limitations of silicon as the industry approaches the physical limits of its materials.

Highly Purified Silicon

Researchers have also made a breakthrough in manufacturing highly purified silicon and this could be a boon for quantum computing. They’ve created a material that can sustain the delicate quantum coherence necessary for reliable quantum calculations by using a focused beam of pure silicon-28 to replace the undesirable silicon-29 atoms in a chip. This brings the realization of robust, scalable quantum computers one step closer.

Scaling up Capacity

Scaling up production while maintaining quality and reliability is critical for the semiconductor industry. It could involve investing in manufacturing technologies such as extreme ultraviolet lithography which enables the creation of smaller and more precise chip features. The development of sophisticated packaging techniques such as 3D chip stacking and wafer-level packaging can also help improve chip density and performance.

The funding from the CHIPS Act should vastly increase the size of the U.S. semiconductor industry, tripling domestic semiconductor manufacturing capacity by 2032. The EU will also see the fruits of its European Chips Act and China has initiated the third phase of its semiconductor funding. Incentive programs emerged or expanded in the first half of the 2020s in Taiwan, South Korea, Japan, and India.

Companies have made significant investments in both established and new semiconductor manufacturing regions. These will also increase production across the world.

Wafer Fabrication

Wafer fabrication is projected to become more durable by geographically diversifying with leading-edge capacity expanding beyond Taiwan and South Korea to include the U.S., Europe, and Japan. China and Taiwan should continue to hold the largest share in global capacity in assembly, testing and packaging (ATP). Countries in Southeast Asia, Latin America, and Eastern Europe are expected to expand ATP activity, however, helped along by government and investor support.

The development of sophisticated packaging and chiplet designs is also driving some ATP production growth in the U.S. and Europe near their wafer fabs.

Industry Challenges

The semiconductor industry also faces some challenges, however. A major concern is the increasing cost and complexity of chip manufacturing as sizes continue to shrink. Developing manufacturing processes and materials such as germanium requires billions in research and development. Geopolitical tensions and trade disputes such as those between the U.S. and China, can cause bottlenecks in trading.

U.S.-China Semiconductor Tensions

Lingering tensions between the U.S. and China in the semiconductor space stem from U.S. efforts to curb China’s technological advances while also aspiring to rejuvenate domestic chip manufacturing.

Top Semiconductor Stocks and ETFs

The largest semiconductor stocks by trailing 12 months revenue in 2024 were:

1. Samsung (005930.KS): $197 billion
2. TSM: $74 billion
3. NVIDIA: $61 billion
4. Intel: $54 billion
5. Broadcom: $39 billion
6. Qualcomm Inc. (QCOM): $36 billion
7. ASML Holding N.V. (ASML): $30 billion
8. Applied Materials (AMAT): $26 billion
9. Advanced Micro Devices Inc. (AMD): $23 billion
10. SK Hynix (000660.KS): $22 billion

Samsung is based in South Korea and has semiconductor revenues but it’s a diversified business. The others have a very high percentage of their companies involved in semiconductors.

These exchange-traded funds (ETFs) track the semiconductor sector:

• VanEck Semiconductor ETF (SMH)
• iShares Semiconductor ETF (SOXX)
• SPDR S&P Semiconductor ETF (XSD)
• Invesco Semiconductors ETF (PSI)
• First Trust Nasdaq Semiconductor ETF (FTXL)

Who Leads the Semiconductor Industry?

The largest semiconductor makers in the world are South Korea’s Samsung, U.S.-based NVIDIA and Intel, and Taiwan’s TSMC. The top five countries producing semiconductors were China, Japan, Taiwan, South Korea, and the U.S. in 2021.

Why Invest in Semiconductors?

Investors often consider adding semiconductor stocks or ETFs to a diversified portfolio. The semiconductor industry is a crucial component of the technology sector and plays a significant role in powering many devices including computers, smartphones, and other electronic devices.

Demand for semiconductors is likely to grow as technology continues to advance, driving revenue and profits for semiconductor companies. A focus on innovation can lead to significant long-term growth potential for companies that are successful in developing new products.

What Is the Future of Semiconductors?

The semiconductor industry is expected to grow over the long term, driven by continued demand for electronics and technological advances. The industry itself is highly innovative and chips have become exponentially more efficient and powerful.

Semiconductors won’t be replaced anytime soon although they’ll continue to improve. The discovery and application of materials like graphene, a novel form of carbon, the advent of quantum computing, and the use of photonic circuits may also be used alongside traditional semiconductors.

The Bottom Line

The semiconductor sector is a major part of the stock market. It’s not just a major player by market capitalization but is critical to many industries such as automotive, healthcare, and telecommunications. Disruptions in the industry such as after the pandemic showed its importance across the economy.

The performance of semiconductor stocks can impact the broader market, as seen in 2024 when the sector hit record highs. This followed a sluggish 2022 and 2023 when the sector experienced losses, contributing to a measurable drag on the overall market. Investors should closely monitor the performance of the companies that make them because the chip market is expected to continue growing.

Fact checked by Vikki Velasquez

The severity of risk in trading depends on the preferences and objectives of the trader. Buying options tends to be less risky than selling options from the perspective of a trader who’s making a single trade. Your risk is limited to the premium you paid for the option contract because the most you can lose is 100% of your investment if the option expires worthless. The dynamic is reversed when you’re selling options.

Option sellers tend to win more trades than they lose but the losses are larger. An option seller might feel that they’re taking on greater risk because the losses could be larger. The trade even has unlimited risk in some cases.

Key Takeaways

• Options are contracts that grant the right but not the obligation to buy or sell an asset at a predetermined price.
• Buying options involves the risk of losing the initial premium but it offers the potential for unlimited gains.
• Selling options can generate immediate income but it exposes the seller to potentially unlimited losses.
• It will limit both their upside and their downside if sellers also buy other options to make spreads.
• Both buying and selling options have their advantages and pitfalls.

What Are Options?

Options are financial derivative contracts that give buyers the right but not the obligation to buy or sell an underlying asset at a predetermined price known as the “strike price.” They must do so on or before a specified date. The underlying asset could be a stock, bond, commodity, currency pair, or index. There are two main types of options: calls and puts.

Call options provide the holder the right to buy the underlying asset. Purchasing a call option on a stock gives the owner the right to buy that stock at the strike price before the expiration date.

Put options give the holder the right to sell the underlying asset. The seller of a call or put option is obligated to sell or buy the underlying asset if the holder chooses to exercise the option.

The buyer of an option pays a premium for the right to choose the price of the option. The seller receives this premium in exchange for the obligation to fulfill the contract if it’s exercised. This dynamic sets the stage for the varying risk profiles of buying and selling options and shapes the strategies traders employ to capitalize on market movements or to generate income.

Options can be used to speculate on the direction of markets or to hedge an existing position in the underlying asset.

A trader might buy a call option if they expect the stock price to rise. An investor might buy put options to protect against a potential downside in a stock they own.

Understanding Options Risks

An option seller receives the premium upfront but they’re obligated to buy or sell the underlying asset at the strike price if it’s assigned. This exposes you to unlimited risk if the market moves against your position. Selling options can generate income from collected premiums but it requires more experience and risk management to limit losses from adverse price moves.

Option buyers take on defined, limited risk. You pay a premium upfront and your maximum loss is limited to 100% of that premium if the option expires worthless.

Option sellers take on an undefined, potentially uncapped risk if the market moves against their position. Selling options can generate income from the premiums received but it exposes the seller to large losses if they’re assigned on the contracts.

Risk/Return Profile of Options Contracts
	Maximum Potential Gain	Maximum Potential Loss
Long Call	Unlimited if the stock goes up	The amount paid for the option
Long Put	The difference between the strike price and zero if the stock goes down	The amount paid for the option
Short Call	The amount received for the option	Unlimited if the stock goes up
Short Put	The amount received for the option	The difference between the strike price and zero if the stock goes down

Risks When Buying Options

Buying options isn’t without risk. You could lose the entire premium you paid if the option expires worthless which happens if the underlying asset doesn’t move in the direction you were hoping for. This is particularly true for out-of-the-money options where the chances of making a profit are statistically slimmer.

The phenomenon known as “time decay” works against option buyers as well. The value of an option naturally deteriorates as its expiration date nears so you not only have to be right about the direction in which the stock will move but also about the timing of that move. Every day that passes without significant movement in the underlying asset chips away at the option’s value.

Options are highly sensitive to volatility. Increased volatility can boost the value of an option you’ve bought but decreased volatility can do the opposite even if the underlying asset moves in the direction you anticipated. This is known as “volatility risk” and it can be a double-edged sword. Trading options also often involves additional costs such as commissions and fees which can eat into any profits you might make or exacerbate your losses.

Risks When Selling Options

Selling options comes with the possibility of unlimited losses but the risk profile is often more nuanced than this suggests. Many sellers employ strategies that can mitigate some of these losses such as using stop-loss orders or selling options as part of more complex strategies. These might include spreads or covered calls that can limit the downside.

The term “unlimited losses” might imply that these losses can skyrocket to staggering sums in a very short period but this usually isn’t the case.

Important

It’s crucial to remember that the premium received is generally much smaller than the potential loss. It serves more as a buffer than a safeguard against significant losses.

The market in the underlying asset will often have its own set of checks and balances. Extreme moves in underlying assets often trigger trading halts or other mechanisms that are designed to cool down overly volatile trading. Many options contracts are never exercised. They expire worthless or are closed out before expiration.

The theoretical risk is unlimited but the practical risk is often less dire than it might appear. Selling options can provide a cushion against losses due to the upfront premium received. This premium offsets some of the risk and can turn what would have been a losing position into a break-even or slightly profitable one.

Pros

• Unlimited upside potential

• Limited downside risk

Cons

• Can lose the entire premium if the option expires worthless

• Option premium can be expensive

• Options prices decay over time

Pros

• Can collect the entire premium as income earned

• Benefit from time decay

Cons

• Unlimited potential losses

• Gains limited to the premium amount

• Requires margin and may entail margin calls

Is Buying or Selling Options Right for You?

The decision to buy or sell options isn’t one-size-fits-all. It varies based on your investment goals, risk tolerance, market outlook, and even your level of trading experience.

Buying options is often the best way to go for novices and holders of small accounts. Beginners might find that buying options is more straightforward because the concept of paying a premium for the potential of larger gains is easier to grasp. Selling options often involves more complex strategies and requires a deeper understanding of market mechanics. It’s generally more suitable for experienced traders.

Selling options and especially “naked” unhedged options often requires a margin account and a significant amount of capital that you can set aside as margin. This capital requirement could be a limiting factor if your trading account is relatively small. Buying options doesn’t have this requirement, making it more accessible for traders with smaller accounts.

Selling options might be more appealing, however, if you’re looking to generate immediate income. You receive the premium upfront. This could be an option if you’re a more sophisticated trader with the resources and understanding to manage your risk.

One balanced approach to consider is writing covered calls on stocks you already own. This lets you pocket the premium upfront while mitigating some risks because you’re not required to purchase the stock at market price if the option is exercised. This strategy does cap your upside potential, however, because you’ll be obligated to sell your stock at the strike price if the option is exercised. You could potentially miss out on larger gains.

Selling an Option or Shorting a Stock

Selling a call option and shorting a stock both involve betting on a decline in asset value. Selling a put would be a bullish position. They’re fundamentally different strategies with distinct risk profiles, however.

You’re borrowing shares to sell with the hope of buying them back at a lower price later when you short a stock, pocketing the difference. The risk is potentially unlimited because stock prices can rise indefinitely.

You’re selling someone the right to buy or sell a stock at a certain price when you sell an option. You receive a premium upfront and you must buy or sell the stock at the strike price if the option is exercised. Selling a call option also exposes you to potentially significant losses if the stock price rises sharply. Selling a put option exposes you to significant but not unlimited losses because the stock price can only go down to zero.

Option contracts have expiration dates but short positions in stocks can be held indefinitely. Both strategies aim to profit from asset depreciation but they operate under different mechanics and come with unique risks and obligations.

Can You Combine Buying and Selling Options?

Yes, there are more complex strategies that involve both buying and selling options. They include spreads, butterflies, and iron condors. They can be used to hedge against risk, capitalize on volatility, or generate income. They often require a deeper understanding of options, however, and they may involve multiple transactions, increasing your exposure to fees and complexity.

Buying often offsets some of the risks of the short option and selling offsets some of the costs of buying the long option.

What Happens If My Options Expire Worthless?

You lose the premium you paid for it if you’re the buyer and your option expires “out of the money” or worthless. You get to keep the premium received if you’re the seller and your option expires worthless. Your obligation to buy or sell the underlying asset is nullified.

Can I Exit an Options Trade Before Expiration?

Yes, you generally can exit an options trade at any time before the contract expires for American-style options. This can mean selling the option back to the market if you’re the buyer and it’s gained value or you could simply let it expire if it hasn’t. Sellers can buy the same option contract to offset their original position, effectively closing it out.

Exiting early can be a way to secure gains or minimize losses but it’s important to consider the costs that might be involved such as additional commissions or fees.

The Bottom Line

Options trading is a double-edged sword, offering both opportunities and pitfalls, but buying options is generally less risky than selling them. Buying options limits your downside but selling them can lead to potentially unlimited losses. You can navigate the risky but rewarding world of options trading more confidently when you understand these aspects.

Disclosure: Investopedia does not provide investment advice. Investors should consider their risk tolerance and investment objectives before making investment decisions.

Reviewed by Somer Anderson

There are two main markets where stock transactions are conducted. One is the primary market and the other is the secondary market. Each has different functions.

Primary market shares can be difficult to obtain. Decisions about the allocation of new shares are made by a company’s founders and owners and the investment banking firm underwriting the offering.

Any investor can buy shares of stock in the secondary market (as long as they’re available for sale) because at that point, shares trade openly in the public domain.

Key Takeaways

• When companies offer their first shares of stock to the public, the offering takes place in what’s called the primary market.
• These initial public offerings of stock are usually handled by underwriters on behalf of companies.
• The secondary market, or stock market, is where shares trade back and forth after an IPO.
• Secondary market investors have one business day to pay for their purchases.
• To allow a stock price to stabilize, company insiders who receive shares in the primary market usually can’t sell them in the secondary market for up to 180 days.

The Primary Market

Private companies become public companies when they issue new shares of stock to investors by way of an initial public offering, or IPO. This initial, or primary, offering is conducted in the primary market. It is the first sale of new shares of stock.

Usually, one or more investment banks/broker-dealers underwrite the issue. That means the bank or syndicate takes on the financial risk of buying the initial shares from the company and selling them to various investors (at a higher price).

The terms of the IPO indicate how many new shares will be sold to institutions and how many will be sold to individual (often wealthy) investors. Usually, these parties are clients of the underwriting firms.

Prices on the primary market are set prior to the IPO, so investors know how much they will pay for shares of a company’s stock.

This market is usually dominated by sophisticated and experienced investors, such as banks, pension funds, institutional investors, or hedge funds.

Note

Effectively, investors participating in the primary market buy stock directly from the issuing company. Investors within the public-at-large can then buy and sell the company’s stock when it starts trading in the secondary market.

The Secondary Market

The secondary market, commonly known as the stock market, is where investors buy and sell existing shares of stock from other investors. When you give your broker a stock order or enter it yourself online, its execution occurs in the secondary market.

Secondary market trading of IPO shares usually begins hours after the IPO is complete.

The proceeds of secondary market sales go to the selling investor, not to the company that issued the stock or to the underwriting bank. 

Stock prices in the secondary market fluctuate according to supply and demand.

The Shareholder

A shareholder is any individual or entity that has legal ownership of a company’s shares. For example, if you are a shareholder in Microsoft, your name is recorded as such on the books of Microsoft.

When you buy stock from another investor in the secondary market, the next business day, funds to pay for your purchase are moved from your account to the seller’s account. And securities are moved from the seller’s account to yours.

At that time, as noted above, your name will appear in the company’s record books, and you will be deemed the holder of record.

The investor from whom you purchased the shares will, at the same time, be removed from the records. They forfeit all associated rights to the shares, such as voting rights, and any dividends, distributions, or further capital gains (or losses).

How Can I Get Shares in the Primary Market?

Your broker may have access to IPO shares so talk to them if you’re interested in an upcoming offering. Bear in mind though that, frequently, the availability of IPO shares is restricted to institutional investors and wealthy, high-value individual investors.

Can I Sell Shares I Got in an IPO Immediately in the Secondary Market?

Not if you’re a major shareholder. Usually, company employees, founders, and owners, and shareholders with majority stakes, are required to hold IPO shares for a specific period of time (e.g., 90 to 180 days) before selling them. This is intended to keep immediate selling pressure from depressing the share price when shares first start trading in the secondary market. This lock-up rule is self imposed by companies that go public and is part of the terms of the IPO.

Do Shares Always Close Higher in the Secondary Market After an IPO?

No, they don’t. Investors often see excited trading of hot stocks immediately after an IPO. And prices can jump higher. However, where they trade and close depends on things like demand, market conditions, and investor outlook.

The Bottom Line

Investors buy shares of stock in the primary market and the secondary market. The primary market handles the initial offering of newly issued shares of stock from a company that is going public. The company sells these shares to specific investors.

The secondary market, or the stock market, is where shares are bought and sold after an IPO. These existing (no longer new) shares are bought and sold by any investor who wishes to own or dispose of them.

They can be a secure way to avoid outliving assets—but watch out for fees

Fact checked by Vikki Velasquez

What Is a Retirement Annuity?

A retirement annuity is a financial product that provides an income in retirement. It is similar to insurance (some annuities are regulated as insurance products) in that you make regular payments to the annuity company. In return, the annuity company will pay you a set amount of money periodically, with the timeline specified in your annuity contract.

In some cases, an annuity payment can continue after a retiree’s death and be paid to a spouse.

These products are designed to provide a reliable income during retirement that will last as long as you live. While this is appealing to many workers who are concerned about their ability to save enough for retirement, annuities often have drawbacks, particularly their costs and fees, compared with other retirement investment accounts.

Before purchasing a retirement annuity, it is important to understand the advantages and disadvantages.

Key Takeaways

• A retirement annuity provides a guaranteed, regular income for a retiree until their death and sometimes after as a benefit to a spouse.
• Retirement annuities are often funded in advance, either through a lump-sum payment or through regular premiums over several years.
• Annuities may provide fixed, indexed, or variable payments depending on the terms of the contract.

Advantages of Retirement Annuities

Retirement annuities have several benefits, such as…

• Lifelong income
• Deferred taxes
• Guaranteed rates of return
• The possibility of growth

Lifelong Income

The main appeal of a retirement annuity is the guaranteed income that can last for the remainder of your life. “For people who are more cautious and want less risk, annuities can offer some peace of mind with a predictable stream of income,” says Melissa Joy, CFP, CDFA, founder of Pearl Planning. With an annuity, you don’t have to worry about outliving your retirement savings, no matter how old you live.

Deferred Taxes

With some investments, such as certificates of deposit (CDs), you may owe taxes when they reach maturity. However, you won’t owe taxes on an annuity until you withdraw funds. This can help you manage your tax burden strategically throughout retirement.

Guaranteed Rate of Return

Fixed annuities have guaranteed rates of return. You know exactly how much you’ll receive monthly once you start claiming your annuity payments. This guaranteed income can provide peace of mind, in addition to making retirement planning easier by allowing you to plan which sources of income you will tap into at different stages of retirement.

Possible Market Growth

Variable or indexed annuities trade predictability for the possibility of growth. These annuities allow you to benefit from a strong market and receive a higher income than you might otherwise expect.

Disadvantages of Retirement Annuities

While retirement annuities have many advantages, they must also be carefully considered for their disadvantages, which include…

• Complex contracts
• High fees
• How they are taxed
• Illiquidity
• Inflation risks

Complex Contracts

Annuity contracts can contain many riders and extra provisions, which can quickly become complicated. “Each product has its own set of rules and features, and that leads to a lot of confusion,” says Joy. “If you’re going to pay for those fancy features, make sure you have a plan to actually use them.”

High Fees

Annuities often have many fees and penalties baked into them. “The costs can be steep,” Joy warns. “There are fees and penalties. There might be surrender charges or ongoing expenses. A lot of times annuities get sold with riders which enhance the guarantees you get but come with more costs.”

Even without additional penalties or riders, the basic costs of annuities can be up to 3% per year. “If there’s not a clear conversation on costs with the person selling you the annuity, that’s a red flag,” says Joy.

Taxed As Ordinary Income

Taxes on annuities can be complex. While taxes on the interest and investment gains are deferred, once you take withdrawals, the net returns are taxed as ordinary income. In most tax brackets, this is much higher than the rate you would pay on investments that qualify for the capital gains tax rate.

Lack of Liquidity

Many annuities have a surrender fee, meaning you’ll pay a substantial penalty if you try to take an early withdrawal. The surrender period will depend on the type of contract you sign, but six to eight years is typical.

“Annuities are not a good fit for people who want a lower-cost portfolio or people who want more control over when they can access their funds,” Joy advises. “You need to know what you’re getting into.”

No Inflation Adjustment

The guaranteed income of an annuity can be comforting if you’re worried about running out of money in retirement. But unlike the Social Security system, annuities don’t have a cost of living adjustment built in.

“They aren’t necessarily structured to take inflation into account,” explains Joy. “So what you’re agreeing to today might not be worth as much in future dollars.”

Types of Annuities

It’s important to understand the different types of retirement annuities available to fully understand their benefits and drawbacks. While the specific structure of an annuity will depend on the company offering it and the terms of its contract, most consumers will be able to choose between a few common options.

Fixed vs. Indexed vs. Variable Annuities

A retirement annuity is typically funded with either a lump-sum payment or a regular series of payments, similar to an insurance premium. However, the income you receive from it once annuitization begins will depend on whether you select a fixed, indexed, or variable annuity.

A fixed product provides a set payment that remains consistent over the life of the annuity. With a fixed annuity, you know exactly how large your payments will be and for how long you will receive them.

An indexed annuity is an insurance contract with a rate of return pegged to a stock market index such as the S&P 500. This allows you to receive higher payments when the stock market is doing well but, because it follows a broad index, has less risk associated with it than a variable annuity.

A variable annuity is the riskiest type of annuity, though it also has the greatest possibility for growth. The rate of return for these annuities is based on the performance of investment options that you choose when you purchase your annuity.

Note

A variable annuity contract may offer a guaranteed minimum withdrawal for an additional fee. This would provide a baseline income even during market downturns.

For all these types of annuities, you also select the length of the annuity, which can be:

• A set number of years
• Your lifetime
• Your lifetime plus your spouse’s lifetime

Immediate vs. Deferred Retirement Annuities

An immediate annuity is funded by a lump sum payment and begins paying you an income right away. This type of product is also known as an immediate payment annuity or an income annuity. It’s usually appropriate for those who are already retired or just entering retirement and choose to put their retirement nest egg into an annuity to create an immediate and dependable income stream.

A deferred annuity, or deferred payment annuity, is generally part of a long-term retirement plan. It can be funded by either a lump sum or regular payments, but it doesn’t begin paying you an income until the date specified in your contract. If it is a fixed annuity, your money will accrue interest during that time. If it is an indexed or variable annuity, your money will grow if market conditions allow. However, there is the risk of loss if the market declines and doesn’t recover by the time you need to begin making withdrawals.

The Bottom Line

Annuities can be a helpful part of retirement planning for many people, but they aren’t a one-size-fits-all solution. Though they provide a reliable and predictable income that can last the rest of your lifetime, they also come with substantial costs. They can make it difficult to access more money in an emergency.

“Just like you should have a well-balanced portfolio, having well-balanced sources of income in retirement is so important,” says Joy. If you are trying to decide whether annuities should be part of your retirement income, a financial planner can help you create a retirement portfolio that fits your needs and lifestyle.

Fact checked by Vikki Velasquez

These three renowned traders are known for their financial acumen, but as these biographical sketches of each reveal, there is more to each of them than their financial successes. Here is a look into the stories behind George Soros, Michael Burry, and David Tepper.

Key Takeaways

• Born in Budapest, Hungary, George Soros is a Holocaust survivor who came to the United States in 1956 and launched a hedge fund in 1970.
• Michael Burry, the man who would be the subject of the film “The Big Short,” has a medical degree and did a residency at Stanford.
• David Tepper has been investing since his college days at the University of Pittsburgh and owns a professional football team.

George Soros

George Soros was born in Budapest, Hungary, in 1930. He is a Holocaust survivor, and he and his family survived the Nazi occupation by falsifying documents and hiding their backgrounds.

In 1947, he left Budapest for London, where he worked as a railway porter before emigrating to the United States in 1956. It was in the U.S. that Soros launched his hedge fund, Soros Fund Management, in 1970.

His investment style starts with being well-informed about economic trends on a local and global scale and using that knowledge to exploit market inefficiencies with large, highly leveraged bets. In 1992, Soros earned the nickname “the man who broke the Bank of England” for a particularly successful bet against the British pound.

Today, Soros Fund Management is a global investment firm with about $28 billion in net assets. It also manages the assets of the Open Society Foundations, one of the world’s biggest charitable foundations. George Soros’s advocacy of progressive ideals often makes him the object of conspiracy theories.

According to the company’s LinkedIn page, “SFM leverages its permanent capital base, unconstrained mandate, and 50-plus years of experience to invest nimbly across diverse strategies and asset classes, including public and private equities and credit and macro assets. SFM’s approach is unique in the investment industry.”

Michael Burry

Michael Burry was born in San Jose, California. He attended UCLA, where he earned a bachelor’s degree in economics. He earned a medical degree from Vanderbilt University and did a residency at Stanford Hospital and Clinics.

Begun as a hobby, Burry wrote a blog about investing and was active in online forums. In 2000, he launched Scion Capital, an investment fund. Joel Greenblatt of Gotham Capital was an early investor in Scion Capital. A reader of Burry’s blog, he made a $1 million investment in the investment fund.

After successfully predicting the subprime mortgage market collapse in 2008 by closely analyzing the housing market asset bubble, he created a new sort of financial instrument called a credit default swap. That allowed him to short the housing market, thus making a large profit for his investors and himself. Shortly after Burry decided to close the doors on Scion Capital.

He is the topic of the film “The Big Short,” which chronicles how Burry made a fortune predicting the collapse of the subprime mortgage market. Christian Bale portrays Burry in the film.

Burry began Scion Asset Management in 2013. He lives in Saratoga, California.

David Tepper

David Tepper was born on Sept. 11, 1957, in Pittsburgh, Pennsylvania. He was fascinated with football and baseball and attended the University of Pittsburgh, where he earned a bachelor of arts degree in economics in 1978.

Tepper started investing small amounts of money in college and received a master of science in industrial administration from Carnegie Mellon University in 1982.

Tepper worked as a credit analyst on the high-yield debt team for Goldman Sachs and, within six months, became a head trader. He worked at Goldman Sachs for seven years. He specialized in distressed debt, particularly bankruptcies and special debt situations. Then in 1993, Tepper founded the Appaloosa Management hedge fund with his former colleague, Jack Walton.

Appaloosa is a limited partnership hedge fund that uses high-risk methods such as investing with borrowed money to realize large capital gains. It bet and succeeded on bond purchases of troubled companies such as Enron and Worldcom. During the subprime mortgage crash, when sellers were driving down the value of financial institutions, Tepper was actively investing in them. Appaloosa profited in the billions when the U.S. government stepped in.

Tepper has owned the Carolina Panthers professional football team in Charlotte, North Carolina, since 2018, but he continues to act as a regular market commentator. He also owns the Charlotte FC professional soccer team.

The Bottom Line

These three renowned traders came from various backgrounds before making the leap and starting their investment funds, where they had so much success. Soros is a Holocaust survivor and immigrant from Hungary. Burry has a medical degree. And maybe the most relatable is Tepper, who began investing small amounts of money in the stock market as he studied for an economics degree. Each unique story provides a blueprint for success and sheds light on traders you may only know by reputation alone.

Reviewed by JeFreda R. Brown

Form 10-K is the most comprehensive compilation of information on a company. The Securities and Exchange Commission (SEC) requires it for all public companies.

It is the best source of information on a company, providing—among other information—a description of the business and industry, risks, a summary of legal proceedings, and financial statements. It is both a quantitative and qualitative review.

However, this document has its downsides, the most obvious of which is that it is backward-looking. Also, the 10-K can be overwhelming as the document often exceeds 100 pages in length. That said, in addition to other data investors gather on a company, the 10-K provides critical information, as it assembles an investment puzzle.

Key Takeaways

• The Form 10-K is the most detailed report on a public company, covering its complete financial information, business, risks, legal issues, and other relevant matters.
• The main sections in a 10-K include financial performance and management analysis, corporate governance, and financial statements.
• While the 10-K provides a tremendous amount of information, it is extremely long, detailed, and backward-looking.
• Form 10-Ks can be accessed on company websites and the SEC’s EDGAR site.

Breaking Down Form 10-K

A 10-K has many different sections, called items, which are broken up into parts.

Part I

Part I focuses on a description of the company and business. This section provides typically static information that is useful for any investor who requires a general understanding of the industry and company.

It has various sections including business, risk factors, and legal proceedings. Investors should review this section, even if they are familiar with the company or business, paying special attention to any changes in the language, particularly those related to risk factors and legal proceedings.

The company also will typically provide an update on the competitiveness of the industry, including business trends and any other pertinent information that may affect market share and the company’s ability to reach its goals. For example, new laws or regulations passed by the federal government that may impact the company’s ability to operate the business would be included.

Part II

Part II focuses on the company’s financial results of the operations. This includes the very important management discussion and analysis (MD&A). The MD&A informs the investor of management’s explanation of financial results and the factors that impacted the past year.

A summary of financial performance, a discussion of acquisitions or divestitures, and a comparative analysis of the current reporting year to the previous year and the previous year to two years earlier are listed here.

Part III

Part III focuses on corporate governance issues like executive compensation. It also requires information about the company’s code of ethics and certain qualifications for directors and committees of the board of directors.

Part IV

Part IV contains exhibits, including the actual financial statements. It requires items such as the company’s bylaws, information about material contracts, and a list of the company’s subsidiaries.

Getting Started

Form 10-K can be found along with other SEC-required forms and investor information on company websites, generally within an “investors” or “investor relations” section. In addition, the SEC publishes these documents on the EDGAR website.

The best place for investors who are unfamiliar with a company or industry is at the beginning of the document, Part I, Item 1: Business. An industry overview is provided to give the investor a picture of the competitive landscape, the opportunities, and the threats from a risk standpoint.

Company-specific qualitative information is also discussed, including legal proceedings specific to the company as well as to the industry. Generally, a competitive analysis is also provided; typically the names of all competitors are discussed. Investors can compare the wording of the current 10-K to the wording of the previous 10-K, zeroing in on any variations in tone to see if slight changes have occurred that may affect the future operating environment.

Important

Companies also release quarterly reports known as 10-Qs, which provide the financial performance and status of a company for each quarter.

Once general knowledge of the industry and company is obtained, more company-specific information can be ascertained in Part II, the MD&A section.

Company fundamentals, prospects for new businesses or products, and risks as well as a comparison to the previous two years’ financial outcomes are provided. In addition, business segment information is disclosed and discussed in this section.

Often companies with either multinational operations or multi-segment businesses separate the operational results from the consolidated results so investors can analyze the growth drivers for the company.

Reviewing results on a consolidated basis is useful, but understanding what drives the performance of the company via segment analysis augments an investor’s ability to determine whether the investment could be profitable in the future.

What’s in the Numbers?

Form 10-K includes the annual financial statements—the balance sheet, income statement (statement of earnings), statement of retained earnings, and statement of cash flows—for the current reporting year and up to the previous five years.

This is a good opportunity to compare annual financial performance on a year-over-year basis. Often investors use a percent of revenue method to analyze the numbers.

In addition, investors like to look at certain financial ratios to determine whether financial performance is improving or declining. The comparison across multiple years makes this information very helpful.

More 10-K Components

Form 10-K also includes the requirements of the Securities Exchange Act of 1934 and Sarbanes-Oxley regulations—the acknowledgment by management that they certify the results contained in the report. The auditors also provide an opinion based on their audit.

Many investors pass over these exhibits, but they are an important outcome of legislation after several instances of fraud resulted in shareholder loss.

On the first page, the number of shares outstanding is listed as of the published date of the report. Investors will notice that this share count differs from the numbers used to calculate the earnings per share on the statement of earnings. The number of shares outstanding used in the statement of earnings is the average number of shares outstanding during the period, not the ending value.

Filing Amendments

Form 10-K/A is compiled and filed when the company amends Form 10-K after it has been published. It is not an uncommon occurrence to file a 10-K/A. Investors should review these amendments to ensure that they do not materially change the investment thesis.

What Is Form 10-K Used For?

Form 10-K is the annual report required to be filed with the Securities and Exchange Commission by all public companies. It is a comprehensive report on the state of a company, covering everything from financials to legal troubles to governance to management and more. It is used by investors and analysts to fully understand a company. This helps with making investment decisions and recommendations. Investors can use it to determine whether they should buy, hold, or sell stock. Analysts use it for financial modeling and making investment recommendations. Journalists and researchers also use it for reporting purposes.

When Must a 10-K Be Filed?

Companies must file their 10-Ks as determined by their classification.

• Non-accelerated filer (public float of less than $75 million): 90 days after fiscal year-end
• Accelerated filer (public float of $75 million to less than $700 million): 75 days after fiscal year-end
• Large accelerated filer (public float of $700 million or more): 60 days after fiscal year-end

Why Must Companies File Form 10-K?

Companies must file Form 10-K as it is required by law. The primary reason, however, is to protect investors. As investors purchase shares in a company, they need to be fully informed of the risks they’re taking. Form 10-Ks provide investors with comprehensive financial data on a company, its business, its legal troubles, its strategy, and more.

The requirement of publicly sharing this information goes back to the 1929 stock market crash and the Great Depression when there was little regulation around financial reporting. A lot of the information provided was misleading and inaccurate. Reforms after the crash led to the creation of the Securities and Exchange Commission along with standardized financial reporting, all to protect investors from making financial decisions on bad information that could lead to financial loss.

The Bottom Line

Form 10-K provides a comprehensive review of the industry and company, which should help investors form an investment thesis. Although it is an extremely lengthy document, investors will gain a valuable perspective by reviewing the information contained therein.

Not only should new investors who are trying to understand a business examine the document, but current investors already familiar with the business should also review it to analyze any changes to the information reflecting changes in the business and operating environment as these may affect a company’s ability to operate and grow.

Reviewed by JeFreda R. Brown

Southwest Airlines Co. (LUV) has become a staple of travel for consumers within the United States. While many other airlines boast more accommodating features and more lavish upgrades, Southwest Airlines has stuck to a business model of shorter, cheaper flights that cater to consumers looking for quick and painless flight plans.

While Southwest Airlines has become synonymous with airline travel, there are quite a few things that most consumers don’t know about the company. Find out about four things that every consumer should know about Southwest Airlines.

Key Takeaways

• In 1972, Southwest Airlines found itself with only three airplanes and a schedule that required four airplanes, a situation that meant the company needed to implement a quick turnaround in order to make its schedules work.
• Southwest Airlines focuses on operational efficiency and logistics as one of its core differentiators, catering to U.S. consumers who want quick, low-cost flights.
• For the first nine years of its operations, the airline operated as a commuter airline with only three destinations in Texas: Dallas, Houston, and San Antonio.
• Southwest was one of the first airlines to offer consumers a website, an online booking tool, and access to coupons and discounts directly from the airline.
• When Southwest Airlines first launched, it had implemented a love-themed marketing campaign, which then became the origin of its LUV ticker symbol.

1. Southwest’s Efficient Operations Stem From Failure

One of the amazing things about Southwest Airlines is the efficiency of its operations. Known to have a great gate-to-gate turnaround time and consistent on-time logistics, it’s interesting to note that its quick turnaround time was born out of failure.

Back in 1972, when the airline was getting off the ground, it had to sell one of its four Boeing 737s to make payroll and remain in business. In spite of selling a quarter of its aircraft, Southwest remained focused on maintaining its four-aircraft schedule. To handle the demand of a four-aircraft schedule with only three planes, Southwest Airlines implemented a 10-minute turnaround to make the schedule work.

Southwest Airlines keeps that operational efficiency as one of its core differentiators to this day, continuing to implement a quick turnaround so consumers can get from point A to point B as quickly as possible.

2. Southwest Only Had Three Destinations for Its First Nine Years of Operations

While Southwest Airlines can take a consumer all over the U.S. today, this wasn’t always the case. Back in 1966, a group of Texas investors decided to buck the traditional airline industry and provide consumers with a commuter airline option.

The company was started with $500,000 in venture capital. Its founders envisioned it as an airline for Texas commuters between Dallas, Houston, and San Antonio.

Due to the nature of the business model, Southwest Airlines instituted a no-frills approach to flying. Instead of trying to be everywhere at the expense of efficiency, Southwest Airlines instead focused on becoming excellent in the cities it serviced.

As competition and profits grew, Southwest finally made the decision to expand in 1975, growing into the dominant airline consumers know today.

3. Southwest Airlines Has Been a Pioneer of Technology That Helps Consumers

Southwest Airlines is more than a pioneer in commuter-focused airline travel. Southwest was also one of the first airlines to introduce a website as well as an online booking tool.

In 1995, Southwest Airlines launched its first display website, called “Southwest Airlines Home Gate.” While consumers could not yet book flights online through Home Gate, they were able to receive up-to-date information and flight routes. In addition, online users of the Home Gate could receive coupons and discounts for air travel.

In 2000, Southwest Airlines launched a booking tool geared toward corporate travel. This was a great addition to its online functionality and serviced the type of consumer that used Southwest Airlines the most: the corporate commuter. This allowed corporate commuters to receive discounts directly through Southwest Airlines rather than needing to go through corporate discounts.

4. The Background of Southwest’s Ticker Symbol, “LUV”

When Southwest Airlines first launched, it implemented a love potion theme. All flight attendants dressed in love-associated costumes and passed out “love potions” and “love bites,” which later became known as drinks and peanuts.

When Southwest Airlines was listed on the New York Stock Exchange (NYSE), it chose the ticker symbol LUV because of the company’s love potion beginnings.

What Is Southwest Airlines?

Southwest Airlines is a major American airline known for its low-cost fares, free checked bags, and no-frills service. Founded in 1967, it has grown to become the largest domestic airline in the United States

How Did Southwest Airlines Get Its Name?

Southwest Airlines got its name because it initially operated routes within the southwestern United States. The airline’s first flights were between Dallas, Houston, and San Antonio, which fit the “Southwest” theme.

What Makes Southwest Airlines Different From Other Airlines?

Southwest Airlines stands out for its business model focused on low-cost fares, free checked bags, and no change fees. It also operates on a point-to-point route system rather than a hub-and-spoke model, which reduces delays and simplifies operations. Southwest acts more as a low-cost airline provider as opposed to a “higher end service” business model.

The Bottom Line

There’s a lot of things you may not know about Southwest. Southwest owes part of its mission for operational efficiency to its history, and it revolutionized air travel with a fast turnaround time to meet its schedules. Additionally, the airline initially operated as a commuter service in Texas for nine years before expanding.