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12 Investing in Stocks Stocks – shares of ownership in the assets and earnings of a business corporation. Common Stock – the most basic form of ownership.

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Presentation on theme: "12 Investing in Stocks Stocks – shares of ownership in the assets and earnings of a business corporation. Common Stock – the most basic form of ownership."— Presentation transcript:

1 12 Investing in Stocks Stocks – shares of ownership in the assets and earnings of a business corporation. Common Stock – the most basic form of ownership of a corporation. Shareholder – the owner of a stock. Voting Rights – proportionate authority to express a choice in matters affecting the company. Proxy – written authorization given by shareholder to someone else to represent him or her and vote his or her shares at a stockholder’s meeting. 12-1

2 Objective 1 Identify the Most Important Features of Common and Preferred Stocks Two types of stock –Common Stock- provides investors with an ownership interest in a corporation or (growth oriented) –Preferred Stock- a cross between a stock and a bond (income oriented) On average, common stocks have outperformed all other assets over time Need to be patient and do research 12-2

3 Common Stock = most basic form of corporate ownership Stock = equity financing Reasons why corporations issue stock –Raise money to start or expand business –Pay ongoing business expenses –Need not repay the money (like bonds) –Dividends (distributions to shareholders) not mandatory Board of Directors votes each dividend payment But: –Shareholders have voting rights; control of company –Management must often make concessions Why Corporations Issue Common Stock 12-3

4 Investors can make money in three ways –Income from dividends –Dollar appreciation of stock value Price appreciation = capital gain –Possible increased value from stock splits No guarantee price will go up after a split Stock Split – when the shares of stock owned by existing shareholders are divided into a larger number of shares; done to change (lower) price –Example: 2:1- twice as many shares worth half as much A reverse stock split results in smaller number of shares. –Example: 1:2- half as many shares worth twice as much Why Investors Purchase Common Stock 12-4

5 Dividend Dates Declaration Date = Board of Directors votes to pay a dividend (usually quarterly) Record Date = A stockholder must be registered on the firm’s books to receive the dividend Ex-Dividend Date = 2 nd day before the record date; stock begins to trade without the dividend –Investors buying after the ex-dividend date do not receive a dividend for that quarter Payment Date = Dividend is paid to investors 12-5

6 Preferred Stock Hybrid Security –Known cash dividend is about equal to bond interest –Equity position is about equal to common stock but usually non-voting; low % of all stock issued Dividends paid before common stock –Dividend may be omitted Cumulative Preferred Stock –Unpaid cash dividends accumulate –Must be paid before any cash dividends are paid to common stockholders (versus noncumulative preferred stock) Convertible Preferred Stock –Can be traded for shares of common stock –Provides investor with added safety of preferred stock and greater speculative gain through conversion to common stock 12-6

7 Classifications of Stocks Income Stock – may not grow too quickly, but pays a cash dividend higher than that offered by most companies year after year. –Example: utility companies Growth Stock – a company that offers the promise of much higher profits tomorrow and has a consistent record of relatively rapid growth in earnings in all economic conditions. –Example: technology companies

8 More Classifications of Stocks Speculative Stock – a company that has a potential for substantial earnings in the future. Blue-Chip Stocks – a company that has been around for a long time, has a well-regarded reputation, dominates its industry, and is known for being a solid, relatively safe investment. Value Stock – a company with stock that is selling for less than the true worth of its assets.

9 Other Characterizations for Common Stocks (continued) Cyclical Stocks – stock from a company whose profits are greatly influenced by changes in the economic business cycle. –Examples? Countercyclical (or Defensive) Stocks – stock from a company that performs well even in an environment characterized by weak economic activity. –Examples?

10 Objective 2 Explain How You Can Evaluate Stock Investments The Internet –Firm’s home page more current than printed materials – Stock Advisory Services –Most charge a fee –Three most popular: Standard and Poor’s reports, Value Line and Mergent’s Handbook of Common Stock Prospectus- Lists all necessary information as dictated by the Federal government Annual Report- All publicly traded corporations send to their stockholders Securities and Exchange Commission Web site ( Business Periodicals: –Business Week, Fortune, Forbes, Money, Smart Money, Kiplinger’s Personal Finance Magazine 12-10

11 Objective 3 Analyze the Numerical Measures that Cause a Stock to Increase or Decrease in Value Corporate Earnings –One of the most significant factors in changes in the value of a stock Earnings per share (EPS) –Formula: Corporation’s after-tax income divided by number of outstanding shares of common stock –Example: $5,000,000/10, = $0.50 –EPS Increase = generally a healthy sign 12-11

12 Numeric Measures That Influence Investment Price-Earnings Ratio (PE) –Price per share of stock divided by the firm’s earnings per share –Example: $10 price/0.50 EPS = a PE ratio of 20 –Tells how much an investor is paying for a company’s earning power –P/E > 20  investor optimism –P/E < 20  lower earnings expectations –Compare to firms in same industry Projected Earnings –EPS and PE based on historical data –Future expectations more relevant 12-12

13 Common Stock Price Quotes Last trade price = $44.37 Annual dividend = $1.68 P/E =  Earnings per share = 44.37/15.41 = $

14 Other Factors than Influence the Price of a Stock Dividend Yield –Annual dollar dividend divided by current price per share –Dividend yield increase = healthy sign Total Return –Dividends plus capital gains –Cash income + Price appreciation Book Value per Share –(Assets – Liabilities)/ # shares (net worth of company) –Market price per share should be > book value 12-14

15 Objective 4 Describe How Stocks are Bought and Sold Primary Market Investor buys securities from issuer of those securities via an investment bank –Investment bank = financial firm that assists corporations in raising funds, usually by helping sell new security issues (underwriting) IPO = when a corporation sells stock to general public for first time –Cash from security sales goes to issuing company –Generally considered a high-risk investment Secondary Market Market for existing financial securities Traded among investors via brokers and dealers Markets –Stock exchanges (NYSE, foreign securities exchanges) –Over-the-counter markets 12-15

16 Secondary Markets for Stocks Securities Exchanges (NYSE) Marketplace where members, representing investors, meet to buy and sell securities (almost 4,000 companies) Securities sold on an exchange must be listed, or accepted for trading, on that exchange “The Listed Market” = NYSE “Specialist” buys or sells a particular stock The Over-the-Counter (OTC) Market (NASDAQ) Network of dealers who buy and sell the stocks of companies from inventory (several thousand companies) –Dealer = “Market Maker” NASDAQ = electronic marketplace for over 3,200 companies 12-16

17 Brokerage Firms and Account Executives Account Executive (Stockbroker) –Licensed individual who buys and sells securities for his or her clients Churning –Excessive buying and selling of securities to generate commissions –Illegal under SEC regulations –Can be difficult to prove; clients subject to arbitration 12-17

18 Discount vs. Full Service Brokers Service vs. Cost How much advice do you want? Can you buy and sell stocks over the phone? Can you trade stocks online? Where is the nearest office located? Toll-free number for customer use? How often are statements issued? Is there a charge for statements, research reports, and other financial reports? Are there any fees in addition to commissions to buy and sell? 12-18

19 Computerized Transactions Reasons that justify trading online: 1.Size of investment portfolio 2.Ability and desire to manage own portfolio 3.Ability to monitor investments closely 4.Capability of computer and software 12-19

20 Stock Transaction Orders Market Order –Request to buy or sell stock at the current market value Limit Order –Request to buy or sell a stock at a specified price Stop Order (Stop-loss order) –Request to sell a stock at the next available opportunity after its market price reaches a specified amount –Can lose a lot of money in a “flash crash” Brokerage minimum commissions –Range = $7 to $35 –Depends on the number of shares traded and stock value Full service vs. discount brokers –Full service fees > 1% to 2% of transaction amount –Online broker  little advice or service 12-20

21 Objective 5 Explain the Trading Techniques Used by Long-term Investors and Short-term Speculators Long-Term Investment Strategies Buy and hold Dollar cost averaging Direct investment and dividend reinvestment plans (DRIPS) –http://www.directinvesting.com –http://www.dripcentral.com 12-21

22 Dollar Cost Averaging Long-term technique Invest equal dollar amount in the same stock at equal intervals Goals: –Minimize average cost per share –Avoid “Buy High – Sell Low” 12-22

23 Short-Term Investment Strategies Buying Stock on Margin –Borrowing money from broker –Margin requirement set by the Fed –“Bullish” (expect stock price increase) Selling short –Borrowing stock to sell –“Sell high, buy low” –“Bearish” (expect stock market decrease) 12-23

24 Wrap Up Chapter Quiz Concept Check Common Stock and Preferred Stock Concept Check 12-2-Prospectus and Annual Report Figure It Out- Earnings per Share, PE Ratio, Dividend Yield Concept Check How Would You Buy Stock?

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